forex cap- ib
TRANSCRIPT
-
7/31/2019 Forex Cap- Ib
1/56
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
2/56
Foreign Exchange Market
A market for the purchase and sales of foreign currencies is
called foreign exchange market.
-
7/31/2019 Forex Cap- Ib
3/56
Need of foreign
exchange market
Need for foreign exchange marketarises because of the multifarious internationalcurrencies and need for trading in suchcurrencies
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
4/56
Foreign Exchange MarketCharacteristics
Electronic market
Geographical dispersal
Transfer of purchasing power
Intermediary
Volume
Provision of creditMinimizing risks
-
7/31/2019 Forex Cap- Ib
5/56
ConstituentsInter bank market
Its a wholesale market through which
most currency transactions arechanneled.It is used for trading among bankersIts a market through which around
95% of the foreign exchange
transactions are carried out
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
6/56
Three constituentsof inter bank market
Spot marketForward marketSwap market
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
7/56
The SWIFTIt is an international bank communications
network that links electronically all brokers andtraders in foreign exchange.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
8/56
Participants(1)Foreign exchange dealers Bank and non-bank agencies take part in
activities of these dealers. Their role comprises inactual market making. They actively deal in foreigncurrency for their own account. They help inmaintaining the foreign currency within the trading limit.
Their profit comes from buying exchange at bid priceand selling it at a higher offer/ask price.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
9/56
(2)Individuals and firms
Exporters, importers, internationalportfolio investors, MNCs, tourists andothers who use foreign exchangemarket to facilitate the execution of
commercial or investment transaction.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
10/56
(3) Speculators and Arbitragers
Speculators buy and sell currencies solely to profit
from anticipated changes in exchange rates, withoutengaging in the other sorts of business dealing forwhich foreign exchange is essential. Biggest speculator
includes leading bank and investment bank.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
11/56
(4) Central Bank and Treasuries
They use FEM for the purpose buying and selling
countrys foreign exchange reserves.Government make deliberate attempt for altering theexchange rate between two countries by buying oneand selling another is called interventions.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
12/56
(5) Foreign exchange brokers
These are commission agents who bring togethersuppliers and buyers of foreign currency
Some of the service give by them are:-Provision of information on prevailing and future rates ofexchangeMaintaining confidentiality of participants in foreign
exchange marketHelping banks to keep at minimum the contacts withother traders.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
13/56
Transactions
Spottransactions
Foreign exchange transaction where by thepurchase of exchange, delivery and payment forthe same take place between banks usually on the
second following business day.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
14/56
Forward transactions
Foreign exchange transaction where by a specifiedamount of one currency is exchanged for aspecified amount of another currency at a futurevalue date
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
15/56
Swap transactions
Foreign exchange transaction where bysimultaneously and sale of given amount of foreignexchange for different value dates takes place.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
16/56
Rate and QuotationsInter-bank Quotations
Direct QuotationIndirect QuotationBid QuotationAsk (offer) Quotation
Cross rates
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
17/56
Foreign exchange risk
Fluctuation and consequent appreciation or
deprecation in the value of assets, liabilities, income orexpenditures owing to a unanticipated changes inexchange rates are known as foreign exchange risk ispresent in uncovered foreign exchange claim or
liability. Uncovered claim in foreign currency is longand an uncovered liability in foreign currency isshort.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
18/56
Payment methodsPayment in domestic currency
Payment in any currencyTravails of trading currenciesSpot exchange rateForward exchange rate
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
19/56
Foreign exchange risk- illustration
Where some of the assets of an enterprise are notdenominated in the currency of its home country, foreignexchange risk or exposures arises. Owing to the exchangerate fluctuations, loss arises when domestic currency isexchanged for a foreign currency in relation to businessproposed to be under taken. The occurrence of exchange
risk can be explained as follows:
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
20/56
Indian entrepreneur enters into a contract for thepurchase of machinery with the American
supplies, payment to be made after 3 months.
Exchange rate at the time of contract 47.50/$1
Value of machinery $50000
The value of Indian rupee declines to 49.00/$1 after3 months
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
21/56
Results:Amount to be paid to US exporter at the time of
contract (U.S. dollar) = $50000Amount to be paid to US exporter at spot rate (Indian
rupees):$50000*Rs.47.50 = Rs.23,75,000
Amount to be paid to US exporter at future rate(Indian rupees)/amount required for purchasingUS $ 50000 on that date:
$50000*Rs.49.00 = Rs.24,50,000Loss suffered: Rs.75000
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
22/56
Risk management toolsHedging techniquesMechanism through loss on a transaction
can be minimized by a bull operator buyinga put option (right to sell) where he agrees topurchase the security from some body.
Or
In short the method securing oneself againstloss from various risks is called hedging
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
23/56
Types of exchange risks
Transaction exposureTranslation exposureEconomic exposure
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
24/56
Techniques of hedging foreign exchange risk
Forward contract
Contract between banks which calls for delivery, ata future date, of a specified amount of one currencyagainst dollar payments at the rate which isdetermined at the time of contract
Future contractFirm legal commitment to buy or sell a stipulated
quantity of a specified asset at a predetermined priceon a predefined future, which is traded on a well-organized exchange.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
25/56
Currency Arbitrage
Buying currency in one market and selling thesame in another market simultaneously
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
26/56
Interest rate parity theory
According to this theory the currency of the countrywith a lower interest rate should be at a forwardpremium in terms of the currency of the country withthe higher rate
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
27/56
Covered Arbitrage
Movement of short-term funds between two currencies totake advantage of interest differentials with exchange riskeliminated by means of forward contracts.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
28/56
SWAPS
Private arrangements where by cash flows in future areexchange according to prearranged formula are calledswaps.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
29/56
Currency swap
Exchange of principle and fixed rate interest
payments on a loan in one currency for principle andfixed rate interest payments on approx. equivalent loanin another currency.
Types of currency SWAP
Fixed currency SWAPFloating currency SWAP
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
30/56
Benefits of currency SWAPChoiceHedgeBenefit firms
EquilibriumLow costTax savingsRisk-free rate
Subsidized loansOff-balance sheet items
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
31/56
Management of exchange rate
(A) Fixed rate system
Bretton woodsPegged rate
Currency boardGold standard
(B)Semi-fixed rate systemBandsTarget zones
Pegs and baskets
The crawling pegs
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
32/56
(C) Floating rate system
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
33/56
Indian Foreign Exchange Markets
Currency options-was introduced in 1982 inPhiladelphia; since 1982 option market witness atremendous growth this was on the account of desire tomanage foreign currency and interest rate risk more
effectively.
Indian context -until the beginning of 90s the currencyoption is largely unnoticed in India. This concept startedgaining relevance in 1991 when liberalization was initiated
by Govt. the main purpose was to enable cooperatesimporters and exporters with foreign investors.
-
7/31/2019 Forex Cap- Ib
34/56
Incentives and uses
Provision of insurance cover against adverse rate
movement while keeping the chance to gain if the rate
move favorably. Thus to satisfy the cooperate and
financial institutions.
Provision of benefits of favorable movement in
rates.
Indian Foreign Exchange Markets
-
7/31/2019 Forex Cap- Ib
35/56
User of currency options
Financial firms
FirmsBanks
Indian Foreign Exchange Markets
-
7/31/2019 Forex Cap- Ib
36/56
Role of commercial banks
Take active part in financing of foreign trade.
They help in regulating the Foreign ExchangeRegulations Act (FEMA)
They maintain correspondent or agency relationship
with the banks abroad.
Maintain accounts abroad to meet public requirements.
Indian Foreign Exchange Markets
-
7/31/2019 Forex Cap- Ib
37/56
All sales and purchases of foreign currency arerouted through the accounts they maintain with thebanks in important financial centers abroad.
They quote rates at which they buy and sell foreignexchange in accordance with rules and regulations ofRBI and FEDAI (Foreign Exchange Dealer Associationof India)
The rates quoted depends upon the rates prevailingin inter-bank or international market and the banksmargin profit.
Indian Foreign Exchange Markets
-
7/31/2019 Forex Cap- Ib
38/56
Foreign currency accounts
NOSTRO a/c foreign currency a/cmaintained by banks in India with banks in
abroad (our a/c with you).CurrencyPaymentsBorrowings
VOSTRO a/c these constitutes the rupeea/c of foreign banks opened with Indianbanks. (Your a/c with us)
Payments
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
39/56
EXCHANGE RATE MANAGEMENTEvery country that is the member of the agreement
with IMF has an obligation to keep the fund and the
members of the fund informed of the exchangearrangements they wish apply and of any subsequentchanges in them with fund to ensure orderly exchangearrangements
Main purpose is to promote a stable system ofexchange rate.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
40/56
EXCHANGE ARRANGEMENTFluctuating or Fixed exchange rate interm of other currencies or the special
drawing rights or some other basket ofcurrencies.Cooperative arrangements by whichmembers maintain the value of their
currencies in relation to the value of thecurrency or currencies of othermembers.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
41/56
Liberalized Exchange Rate Management System
It came to introduce with effort from March 1, 1992. Astriking feature of the LERMS has been that it followed a dual
exchange rate system. Some of the important features are asfollows.The U.S. dollar replaced pound sterling as the
intervention currency.All Foreign exchange receipts on the current account
transaction (exports and remittance) were required to besurrendered to the Authorized Dealers (Ads) in full as hitherto.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
42/56
Of the total Foreign Exchange receipts, 40percent was to be surrender to the RBI at theofficial rate of exchange announced by the
RBI.
The balance 60 percent of foreign exchangecan be sold in the free market for permissible
transactions at the free market rate quoted bythe ads, taxes to be levied on these exportsproceeds.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
43/56
Unified Market Determined System, 1993The unified Market Determined Exchange Rate System from
March 1993 replaced the dual exchange rate system. Theimportant features of the system are as follows:
All the Foreign exchange transactions, both currentand capital are put through by Authorized Dealers (ads)at market-determine-rates of exchange.
The exporters instead of surrendering their exportearnings to the RBI shall hereafter do so to the ads.
All payments involving foreign exchange are alsoeffected at market-determined exchange rate through ads
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
44/56
The market rate of exchange is determined by the RBI onthe basis of the prevailing market rates within a 5 percentmargin on either side of the market rate. Accordingly, RBIbuys U.S. dollars from Ads for spot deliveries and sells
the same for purposes approved by the government ofIndia.
Using U.S. dollar as the intervening currency, RBI entersinto swap transactions under which it buys U.S. dollars
spot and sells forward for period ranging for 2 to 6months, instead of buying spot bound sterling, Duetschemark or Japanese yean.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
45/56
Beside the selling and buying rates of Ads RBImakes announcement of its own reference rate
based on the rates quoted by a few selectedbanks in Bombay at noon, the EBI reference ratebeing use for effecting transactions in SDRs andwith countries in Asian clearing union.
Splitting of currency exposure and long-termforward cover is allowed in order to provide depth
to the exchange market and flexibility to marketoperators.
Forward contracts are allowed for remittanceof dividend in respect to FDI.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
46/56
Currency ConvertibilityThe freedom to convert one currency into otherinternationally accepted currencies may be defined ascurrency convertibility.
Convertibility may be oftwo types
Current account convertibility: - Convertibilityfor current international transaction is known as
current account convertibility.Capital account convertibility : - Convertibilitycapital movements are known as capital accountconvertibility.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
47/56
Currency Convertibility has defined as thefreedom to buy or sell foreign exchange forthe following purposes:The international transaction consisting of payment
due in connection with foreign trade, other currentbusiness including services and normal short- termbanking and credit facilities.Payment due as interest on loans and as net incomefrom other investments.Payment of moderate amounts of amortization of loansfor depreciation of direct investments.Moderate remittances for family living expenses.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
48/56
Benefits of Currency Convertibility
Enhanced confidence:Providing a signal to the
international community that the country intends tomanage its affairs without exchange restrictions, whichwould eventually help enhance international confidencein the countrys policies.
Capital flows:Chances of increased capital inflows.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
49/56
BoP management:Freeing exchange restrictions woulduplift the quality management of balance of payments ofthe country. Flexible and realistic approach in exchangerate determination combined with favorable macro
economic policies would help provide
a viable of balanceof payments.
Efficient allocation:elimination of exchangerestrictions would tend to increase capital inflows in theshort run thus and promoting efficiency in the allocation ofthese inflows to the best advantage of the nationseconomy.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
50/56
Consequences of Capital AccountConvertibility Danger of India becoming fully vulnerable to freemovement of foreign capital, which might worsen our
macro economic imbalancesThe high interest rates prevalent in the Indian
economy would serve as an open invitation to theinflow of capital, which will result in an appreciation of
the rupee and consequent fall in exportsBanks and financial institutions with their capitalbase are not financially strong to grapple with theintricacies of full convertibility
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
51/56
Exchange ratesThe different types of exchange rates are used inthe Indian foreign exchange market is explainedbelow briefly:
Merchant rate:The rate at which the foreign exchangedealing takes place between a bank and the merchantbusiness is called the merchant rate. Cash transaction
or ready transaction or spot transaction refers to thecontract for buying or selling foreign, which is agreed andexecuted the same day.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
52/56
Inter-bank rate: The inter-bank rate also known asthe base rate
Refers to exchange rate quoted between banks.Depending upon the time taken for the realization offoreign exchange by the bank, two types of buyingrates namely TT Buying Rate and Bill Buying Rate are
quoted in India.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
53/56
Merchant rate:The rate at which theforeign exchange dealing takes place between abank and the merchant business is called themerchant rate. Cash transaction or ready
transaction or spot transaction refers to thecontract for buying or selling foreign, which isagreed and executed the same day.
Transaction costs are fixed and charged tothe member banks by the FEDAI. In foreigncountries the charges are negotiable with theirclients.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
54/56
Nominal Real & Effective exchange rates
Nominal exchange rate it is the price of onecurrency in terms of others.
Real exchange rate it measures purchasingpower of the currency.
RE = [NE * DP]/ FPEffective exchange rate a measure of
appreciation and depreciation of currencyweighted against the basket of currency withwhom the country trades.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
55/56
RBIs substantial relaxation for ForexMarketsForeign currency-rupeeswaps earlier the banks werepermitted to access the market upto USD 50 million while
offering the product to the customers.Booking of forward contracts based on pastperformanceCancellation and rebooking of forward contracts
Forward cover for foreign direct investments inIndiaInvestments in overseas money/ debts marketsHedging of Tier I capital of foreign banks.
Foreign Exchange Market
-
7/31/2019 Forex Cap- Ib
56/56
(A) Fixedrate system
Gold standard
Bretton woodsPegged rateCurrency board
Foreign Exchange Market