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CH.

INTRODUCTION

1.1 MEANING
The markets, in which participants are able to buy, sell exchange and speculate on currencies. Foreign exchange markets are made up of banks, commercial companies, central banks, investment management firms, hedge funds, and retail forex brokers and investors. The forex market is considered to be the largest financial market in the world. The forex market is the largest, most liquid market in the world with an average traded value that exceeds $1.9 trillion per day and includes all of the currencies in the world. There is no central marketplace for currency exchange; trade is conducted over the counter. The forex market is open 24 hours a day, five days a week and currencies are traded worldwide among the major financial centers of London, NewYork, Tokyo, HongKong, Singapore, Paris and Sydney.

The forex is the largest market in the world in terms of the total cash value traded, and any person, firm or country may participate in this market. The foreign exchange market works through financial institutions, and it operates on several levels. Behind the scenes banks turn to a smaller number of financial firms known as dealers, who are actively involved in large quantities of foreign exchange trading. Most foreign exchange dealers are banks, so this behind-the-scenes market is sometimes called the interbank market,although a few insurance companies and other kinds of financial firms are involved. Trades between foreign exchange dealers can be very large, involving hundreds of millions of dollars. Because of the sovereignty issue when involving two currencies, Forex has little (if any) supervisory entity regulating its actions. The foreign exchange market assists international trade and investment by enabling currency conversion. For example, it permits a business in the United States to import goods from the European Union member states, especially Eurozone members, and pay euros, even though its income is in United States dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation based on the interest rate differential between two currencies.
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In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying some quantity of another currency. The modern foreign exchange market began forming during the 1970s after three decades of government restrictions on foreign exchange transactions (the Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states after World War II), when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system. The foreign exchange market is unique because of the following characteristics:

its huge trading volume representing the largest asset class in the world leading to high liquidity;

its geographical dispersion; its continuous operation: 24 hours a day except weekends, i.e., trading from 20:15GMT on Sunday until 22:00 GMT Friday;

the variety of factors that affect exchange rates; the low margins of relative profit compared with other markets of fixed income; and the use of leverage to enhance profit and loss margins and with respect to account size. 1.2 RECENT TRENDS AND DEVELOPMENT

Federal Reserve Bank of Newyork Dino Kos, Executive Vice President The foreign exchange market is a dynamic environment that is constantly innovating and evolving. Not too long ago, most transactions were executed by one person calling another to negotiate a price. In recent years, technology has enabled an ongoing revolution in how we trade. Some milestones include the introduction of electronic broking systems such as EBS and Reuters for interdealer trading. More recently, single-bank and multi-bank portals are connecting dealers to their customers via electronic media. An increasing number of tickets are now being executed through all forms of e-trading. Given this market's history of embracing technology, I see no reason to doubt that more innovations are on the way. The advent of white labeling and prime

brokerage, while introducing some risks, are also bringing additional participants into the market. Meanwhile, volumes continue to rise. According to the last BIS Triennial Central Bank Survey, daily turnover as of April 2004 rose to $1.9 trillion from $1.2 trillion in April 2001.1 More recent regional turnover surveys conducted by the Foreign Exchange Committee for North America and by the FX Joint Standing Committee for the U.K. confirm that volumes have continued to rise at a double-digit annual pace.2 In short, the business of foreign exchange is very strong. This conference will no doubt explore these topics in greater detail. For my part, I will focus on a subject that traders and policymakers view as very important, though probably for different reasons. That topic is volatility. Viewed from a longer term perspective, the volatility of major foreign exchange rates is historically low. I will explore some potential reasons for that relative stability as well as offer a few possible implications. Given the complexity of the topic and the natural cautiousness of central bankers, it will come as no surprise that I will raise more questions than answers. My goal this morning is to leave you with a few ideas that may prompt further discussion.

The forex market has seen profound changes since the early 1970s, not only in its size but also in the way in which it operates, as a result of structural shifts in the world economy and in the international financial system. Some of the main changes which have occurred in the world's financial environment include:

A fundamental change in the international monetary system from the fixed exchange rates arising out of the Bretton Woods agreement to a much more flexible system in which countries can float their exchange rates or follow other exchange rate practices of their own choosing.

Major financial deregulation across the globe including the elimination of government controls and restrictions in almost every country, which has resulted in far greater freedom
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in national and international financial transactions and hugely increased competition among financial institutions.

A fundamental change in savings and investment, with funds managers and investment institutions around the world diversifying their investments across international borders and into multiple currencies.

Major changes in, and liberalization of, international trade as a result of a series of trade agreements including the Tokyo and the Uruguay Rounds of the General Agreement on Tariffs and Trade, the North American Free Trade Agreement, and US bilateral trade initiatives with the European Union, China and Japan.

Technological advances which have made it possible to achieve the real-time transmission of huge amounts of market information worldwide and to analyze that information rapidly so that market opportunities can be identified and exploited. In addition, financial transactions can now be executed quickly and safely, with a level of efficiency which allows costs to be kept at level well below those which were possible previously.

New thinking in terms of both the theory and practice of finance which have resulted in the development of many new financial instruments and derivative products. Advances in thinking have also served to change our understanding of the international financial system and the techniques we need to use to operate within it.

As markets have grown and developed since the 1970s in a climate of much greater freedom and competition, the role of the markets themselves has changed and we have developed the tools and techniques to allow us to exploit these growing markets to the full. One major beneficiary of these changes has been the forex trader who has an investment vehicle available today which was undreamt of a few years ago and which will continue to provide the small investor with an excellent trading opportunity for many years to come.

1.3 HISTORY OF FOREX MARKETS

The foreign exchange market (fx or forex) as we know it today originated in 1973. However, money has been around in one form or another since the time of Pharaohs. The Babylonians are credited with the first use of paper bills and receipts, but Middle Eastern moneychangers were the first currency traders who exchanged coins from one culture to another. During the middle ages, the need for another form of currency besides coins emerged as the method of choice. These paper bills represented transferable third-party payments of funds, making foreign currency exchange trading much easier for merchants and traders and causing these regional economies to flourish. From the infantile stages of forex during the Middle Ages to WWI, the forex markets were relatively stable and without much speculative activity. After WWI, the forex markets became very volatile and speculative activity increased tenfold. Speculation in the forex market was not looked on as favorable by most institutions and the public in general. The Great Depression and the removal of the gold standard in 1931 created a serious lull in forex market activity. From 1931 until 1973, the forex market went through a series of changes. These changes greatly affected the global economies at the time and speculation in the forex markets during these times was little, if any. The Bretton Woods Accord The first major transformation, the Bretton Woods Accord, occurred toward the end of World War II. The United States,Great Britain and France met at the United Nations Monetary and Financial Conference in Bretton Woods, N.H. to design a new global economic order. The location was chosen because, at the time, the U.S. was the only country unscathed by war. Most of the major European countries were in shambles. Up until WWII, Great Britain's currency, the Great British Pound, was the major currency by which most currencies were compared. This changed when the Nazi campaign against Britain included a major counterfeiting effort against its currency. In fact, WWII vaulted the U.S. dollar from a failed currency after the stock market crash of 1929 to benchmark currency by which most other international currencies were compared. The Bretton Woods Accord was established to create a stable environment by which global economies could restore themselves. The Bretton Woods Accord established the pegging of currencies and the International Monetary Fund (IMF) in hope of stabilizing the global economic situation.
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Now, major currencies were pegged to the U.S. dollar. These currencies were allowed to fluctuate by one percent on either side of the set standard. When a currency's exchange rate would approach the limit on either side of this standard the respective central bank would intervene to bring the exchange rate back into the accepted range. At the same time, the US dollar was pegged to gold at a price of $35 per ounce further bringing stability to other currencies and world forex situation. The Bretton Woods Accord lasted until 1971. Ultimately, it failed, but did accomplish what its charter set out to do, which was to re-establish economic stability in Europe and Japan. The Beginning of the free-floating system After the Bretton Woods Accord came the Smithsonian Agreement in December of 1971. This agreement was similar to the Bretton Woods Accord, but allowed for a greater fluctuation band for the currencies. In 1972, the European community tried to move away from its dependency on the dollar. The European Joint Float was established by West Germany, France, Italy, the Netherlands, Belgium and Luxemburg. The agreement was similar to the Bretton Woods Accord, but allowed a greater range of fluctuation in the currency values. Both agreements made mistakes similar to the Bretton Woods Accord and in 1973 collapsed. The collapse of the Smithsonian agreement and the European Joint Float in 1973 signified the official switch to the free-floating system. This occurred by default as there were no new agreements to take their place. Governments were now free to peg their currencies, semi-peg or allow them to freely float. In 1978, the free-floating system was officially mandated. In a final effort to gain independence from the dollar, Europe created the European Monetary System in July of 1978. Like all of the previous agreements, it failed in 1993. The major currencies today move independently from other currencies. The currencies are traded by anyone who wishes. This has caused a recent influx of speculation by banks, hedge funds, brokerage houses and individuals. Central banks intervene on occasion to move or attempt to move currencies to their desired levels. The underlying factor that drives today's forex markets, however, is supply and demand. The free-floating system is ideal for today's forex markets. It will be interesting to see if in the future our planet endures another war similar to those of the early 20th century. If so, how will the forex markets be affected? Will the dollar be the safe haven it has been for so many years? Only time will to
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TIMELINE OF FOREIGN EXCHANGE 1944 Bretton Woods Accord is established to help stabilize the global economy after World War II. 1971 Smithsonian Agreement established to allow for greater fluctuation band for currencies. 1972 European Joint Float established as the European community tried to move away from its dependency on the U.S. dollar. 1973 Smithsonian Agreement and European Joint Float failed and signified the official switch to a free-floating system. 1978 The European Monetary System was introduced so other countries could try to gain independence from the U.S. dollar. 1978 Free-floating system officially mandated by the IMF. 1993 European Monetary System fails making way for a world-wide free-floating system.

1.4 PROBLEMS OF FOREX MARKET The most profitable market where dealers can make some earnings is the Foreign exchange market. Foreign exchange dealing is the trading of numerous currencies and it edges out the standard stock exchange market as a good place to earn more cash for different reasons. More than $1.8 trillion dollars are exchange everyday on the foreign exchange market compared to the less than one hundred billion dollars that are exchange everyday in the U.S. stock exchange market. This transforms to more important liquidity which means that deals are filled almost instantly utilizing real time information. Aside from that, with more dealers, there is more chance to see important deals that you can participate on. This foreign exchange market also never stops on functioning so you can deal in the foreign exchange market twenty-four hours a day, six days in a week. With the help of existing foreign exchange technology, you can further improve your dealing activity and with a good dealing technique, dealers can earn profits faster than before.
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The foreign exchange market is mainly based on the monetary denomination of numerous countries. While there are a lot of problems that are affecting different countries all over the world, the problem is much smaller is what you can encounter in the equity market. In this market, organizations like Enron and other failed business groups can surprise people and this is usually hard to correctly predict. Profitable dealing in any financial market will depend on how well you manage the problems that you will encounter. With the foreign exchange market, much of dealing techniques are mainly based on the patterns and other vital factors which have been tested through the course of time and with additional testing to be more useful when being utilized for deciding on dealing parameters. This innate stability compared with other dealing markets combine with using online foreign exchange software gives a good opportunity for the dealer to start earning profits in a minimum amount of time. These foreign exchange software dealing tools, the utilization of mathematical formulas and other techniques have proven to be very beneficial in the foreign exchange market. Aside from that, they automate data gathering and technical tasks of dealing. Even the home based dealer can use the power and different features of the foreign exchange market software. You must also take the time to read foreign exchange software reviews so that you can apply in your own dealing what you will learn from them.

1.5 FOREX MARKETS IN INDIA Foreign Exchange Market in India operates under the Central Government of India and executes wide powers to control transactions in foreign exchange. The Foreign Exchange Management Act, 1999 or FEMA regulates the whole Foreign Exchange Market in India. Before the introduction of this act, the foreign exchange market in India was regulated by the Reserve Bank of India through the Exchange Control Department, by the Foreign Exchange Regulation Act or FERA, 1947. After independence, FERA was introduced as a temporary measure to regulate the inflow of the foreign capital. But with the Economic and Industrial development, the need for conservation of foreign currency was urgently felt and on the recommendation of the Public Accounts Committee, the Indian government passed the Foreign Exchange Regulation Act, 1973 and gradually, this act became famous as FEMA.

Early Years of Foreign Exchange Market Until 1992, all Foreign Investments in India and the repatriation of Foreign Capital required previous approval of the government. The Foreign Exchange Regulation Act rarely allowed foreign majority holdings for Foreign Exchange in India. However, a new Foreign Investment Policy announced in July 1991, declared automatic approval for Foreign Exchange in India for thirty-four industries. These industries were designated with high priority, up to an equivalent limit of 51 percent. The foreign exchange market in India is regulated by the Reserve Bank of India through the Exchange Control Department.

Initially, the Government required that a company`s routine approval must rely on identical exports and dividend repatriation, but in May 1992, this requirement of Foreign Exchange in India was lifted, with an exception to low-priority sectors. In 1994, foreign nationals and nonresident Indian investors were permitted to repatriate not only their profits but also their capital for Foreign Exchange in India. Indian exporters enjoyed the freedom to use their export
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earnings as they found it suitable. However, transfer of capital abroad by Indian nationals is only allowed in particular circumstances, such as emigration. Foreign Exchange in India is automatically made accessible for imports for which import licenses are widely issued.

Foreign Exchange Rate Policy in India Indian authorities are able to manage the Exchange Rate easily, only because Foreign Exchange Transactions in India are so securely controlled. From 1975 to 1992 the Rupee was coupled to a trade-weighted basket of currencies. In February 1992, the Indian Government started to make the Rupee convertible, and in March 1993 a single floating Exchange Rate in the market of Foreign Exchange in India was implemented. In July 1995, Rs 31.81 was worth US$1, as compared to Rs 7.86 in 1980, Rs 12.37 in 1985, Rs 17.50 in 1990, Rs 44.942 in 2000 and Rs 44.195 in the year 2011.

Since the onset of liberalization, Foreign Exchange Markets in India have witnessed explosive growth in trading capacity. The importance of the Exchange Rate of Foreign Exchange in India for the Indian Economy has also been far greater than ever before. While the Indian Government has clearly adopted a flexible exchange rate regime, in practice the Rupee is one of most resourceful trackers of the US dollar.

Predictions of capital flow-driven currency crisis have held India back from Capital Account Convertibility, as stated by experts. The Rupee`s deviations from Covered Interest Parity, as compared to the Dollar, display relatively long-lived swings. An inevitable side effect of the Foreign Exchange Rate Policy in India has been the ballooning of Foreign Exchange Reserves to over a hundred Billion Dollars. In an unparalleled move, the Government is considering to use part of these reserves to sponsor in frastructure investments in the country.

Growth of Foreign Exchange Market in India The Foreign Exchange Market in India is growing very rapidly, since the annual turnover of the market is more than $400 billion. This Foreign Exchange transaction in India does not include the Inter-Bank transactions. According to the record of Foreign Exchange in India, Reserve Bank of India released these transactions. The average monthly turnover in the merchant segment was $40.5 billion in 2003-04 and the Inter-Bank transaction was $134.2 for
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the same period. The average total monthly turnover in the sector of Foreign Exchange in India was about $174.7 billion for the same period. The transactions are made on spot and also on forward basis, which include currency swaps and interest rate swaps.

The Indian Foreign Exchange Market is made up of the buyers, sellers, market mediators and the Monetary Authority of India. The main centre of Foreign Exchange in India is Mumbai, the commercial capital of the country. There are several other centres for Foreign Exchange Transactions in India including the major cities of Kolkata, New Delhi, Chennai, Bengaluru, Pondicherry and Cochin. With the development of technologies, all the Foreign Exchange Markets of India work collectively and in much easier process.

Foreign Exchange Dealers Association is a voluntary association that also provides some help in regulating the market. The Authorised Dealers and the attributed brokers are qualified to participate in the Foreign Exchange Markets of India. When the Foreign Exchange Trade is going on between Authorized Dealers and Reserve Bank of India or between the Authorised Dealers and the Overseas Banks, the brokers usually do not have any role to play. Besides the Authorised Dealers and Brokers, there are some others who are provided with the limited rights to accept the Foreign Currency or Travellers` Cheque; they are the Authorised Moneychangers, Travel Agents, certain Hotels and Government Shops. The IDBI and Exim Bank are also permitted at specific times to hold Foreign Currency.

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1.6 MARKET SIZE AND LIQUIDITY

Main foreign exchange market turnover, 19882007, measured in billions of USD.

The foreign exchange market is the most liquid financial market in the world. Traders include large banks, central banks, institutional investors, currency speculators, corporations, governments, other financial institutions, and retail investors. The average daily turnover in the global foreign exchange and related markets is continuously growing. According to the 2010 Triennial Central Bank Survey, coordinated by the Bank for International Settlements, average daily turnover was US$3.98 trillion in April 2010 (vs $1.7 trillion in 1998).Of this $3.98 trillion, $1.5 trillion was spot transactions and $2.5 trillion was traded in outright forwards, swaps and other derivatives. Trading in the United Kingdom accounted for 36.7% of the total, making it by far the most important centre for foreign exchange trading. Trading in the United States accounted for 17.9%, and Japan accounted for 6.2%. Turnover of exchange-traded foreign exchange futures and options have grown rapidly in recent years, reaching $166 billion in April 2010 (double the turnover recorded in April 2007). Exchange-traded currency derivatives represent 4% of OTC foreign exchange turnover. Foreign exchange futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts.

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Most developed countries permit the trading of derivative products (like futures and options on futures) on their exchanges. All these developed countries already have fully convertible capital accounts. Some governments of emerging economies do not allow foreign exchange derivative products on their exchanges because they have capital controls. The use of derivatives is growing in many emerging economies.Countries such as Korea, South Africa, and India have established currency futures exchanges, despite having some capital controls.

CH.2 RESEARCH AND METHODOLOGY

To define the research methodology, one has to go step by step. Any researchmethodology involves following steps: I. PROBLEM RECOGNITION II. SURVEY OF LITERATURE III. HYPOTHESIS FORMULATION IV. RESEARCH DESIGN V. SAMPLE DESIGN VI. DATA COLLECTION VII. ANALYSIS AND INTERPRETATION. RESEARCH PROBLEM: A problem properly defined is half solved.

It is very necessary for any research that research problem should be recognized.

It is critical to any research.

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Once problem is identified, it is to be formulated properly.

Initially the plan is stated in a broad and general way and then it is p r o p e r l y defined in specific terms.

Problem formulation means defining a problem precisely.

In this study our research problem is: THE STUDY OF FOREX MARKET ANDRISK MANAGEMENT.

LITERATURE SURVEY: To do any research, we have to review/study previousl i t e r a t u r e . F o r t h i s w e s t u d i e d J o u r n a l s , M a g a z i n e s & B o o k s o f F O R E X & R I S K MANAGEMENT and also the search engine www.google.com. To get good results inany research, it is very essential that this review of literature should be carefully done. The review of literature survey for this project includes the following: elliot Wave This is considered by most experienced traders to be the purestform of technical analysis, since Elliott Wave analysis measures investor psychology. The Wave shows how the psychology of traders, en masse, moves f r o m p e s s i m i s m t o o p t i m i s m o n a s t o c k . T h i s s h i f t o c c u r s i n a s p e c i f i c a n d measurable. Detecting where a stock is in the pattern can help a trader estimate the future movements of the market. K.B. Advisory Ltd . This program offers you daily technical analysis and tradingrecommendations that are based on sophisticated trading strategies developed byKeith Black. It boasts a successful three-year track record.

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TRL (Technical Research Limited) T R L i s a S p e c i a l i s t F o r e i g n E x c h a n g e Forecasting Service that can help you with forecasting and trading analysis in theglobal foreign exchange markets. Technical Research Limited is rated the No. 1 FX Advisory Service by customers in 39 different countries around the world. PronetAnalytics - This program is very powerful, and offers real-time analysis for market professionals who are looking for inexpensive real-time data and exchangefeeds with standard and simple graphical trading support. IFR (International Financing Review) IFR Forex Watch has real-time technicalanalysis of the FX spot and options markets. It connects you with analysts in London, New York, Boston, San Francisco, Singapore and Sydney. IFR specializes in sifting through the vast array of information that clutters up currentmarket participants, and boiling it down to its bare essentials. GMR (Global Market Research) G l o b a l M a r k e t R e s e a r c h p r o v i d e s p r i c e forecasting and performancebased Trade Strategies for the FX market. You cancheck out their daily newsletter, their FX Technicals and intraday updates and analysis through the Web. Or you can have them E-mailed to you. ForexTRM F o r e x T R M i s a f o r e x c h a r t i n g s e r v i c e t h a t p a i r s 1 8 w o r l d a n d regional currencies and tracks them every day. This means ForexTRM lets you t

trade any one of the 18 currencies against any of the other 17. It uses trademarkedSigma Bands and Hurst Cycle Analysis to correctly identify overbought/soldF O R E X markets, where trading risk is at its lowest point in time, and w h i c h currency pairs are ready to trade.
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HYPOTHESIS FORMULATION:

Hypothesis is any assumption for the research effectively & efficiently. The hypothesis of my research is that:

Forex market is very volatile in nature. It is changing day by day showing a wide growth in economy. Different factors like speculation, hedging forces different people to enter indifferent market.

Risk is there in Forex market and various risk management strategies are there tomanage it.

RESEARCH DESIGN: Research design is a conceptual structure within which researchis conducted.A Research design is the arrangement of conditions for collection and anal ysis of data in a manner that aims to combine relevance to the research purpose with economyin procedures.Research design can be of various types .- D e s c r i p t i v e .- Exploratory .- Experimental. - Analytical. Research Design of my study is EXPLORATORY & ANALYTICAL.

DATA COLLECTION:

The data is of two types: PRIMARY AND SECONDRY. Dataare the facts presented to the researcher from the study environment. The method of datacollection in my study is SECONDRY only. Because I have collected all the data from books and from websites

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CH.3 MARKET PARTICIPANT

Unlike a stock market, the foreign exchange market is divided into levels of access. At the top is the interbank market, which is made up of the largest commercial banks and securities dealers. Within the interbank market, spreads, which are the difference between the bid and ask prices, are razor sharp and not known to players outside the inner circle. The difference between the bid and ask prices widens (for example from 0 to 1 pip to 12 pips for a currencies such as the EUR) as you go down the levels of access. This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the foreign exchange market are determined by the size of the "line" (the amount of money with which they are trading). The top-tier interbank market accounts for 39% of all transactions. From there, smaller banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail market makers. According to Galati and Melvin, Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s. (2004) In addition, he notes, Hedge funds have grown markedly over the 20012004 period in terms of both number and overall size.Central banks also participate in the foreign exchange market to align currencies to their economic needs. Commercial companies An important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational companies can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants.

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Central banks National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading. Foreign exchange fixing Foreign exchange fixing is the daily monetary exchange rate fixed by the national bank of each country. The idea is that central banks use the fixing time and exchange rate to evaluate behavior of their currency. Fixing exchange rates reflects the real value of equilibrium in the market. Banks, dealers and traders use fixing rates as a trend indicator. The mere expectation or rumor of a central bank foreign exchange intervention might be enough to stabilize a currency, but aggressive intervention might be used several times each year in countries with adirty float currency regime. Central banks do not always achieve their objectives. The combined resources of the market can easily overwhelm any central bank.] Several scenarios of this nature were seen in the 199293 European Exchange Rate Mechanism collapse, and in more recent times in Asia. Hedge funds as speculators About 70% to 90% of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency. Hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor.

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Investment management firms Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases. Some investment management firms also have more speculative specialist currency overlay operations, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. While the number of this type of specialist firms is quite small, many have a large value of assets under management and, hence, can generate large trades. Retail foreign exchange traders Individual Retail speculative traders constitute a growing segment of this market with the advent of retail foreign exchange platforms, both in size and importance. Currently, they participate indirectly through brokers or banks. Retail brokers, while largely controlled and regulated in the USA by the Commodity Futures Trading Commission and National Futures Association have in the past been subjected to periodic Foreign exchange fraud. To deal with the issue, in 2010 the NFA required its members that deal in the Forex markets to register as such (I.e., Forex CTA instead of a CTA). Those NFA members that would traditionally be subject to minimum net capital requirements, FCMs and IBs, are subject to greater minimum net capital requirements if they deal in Forex. A number of the foreign exchange brokers operate from the UK under Financial Services Authority regulations where foreign exchange trading using margin is part of the wider over-the-counter derivatives trading industry that includes Contract for differences and financial spread betting. There are two main types of retail FX brokers offering the opportunity for speculative currency trading: brokers and dealers or market makers. Brokers serve as an agent of the customer in the broader FX market, by seeking the best price in the market for a retail order and dealing on behalf of the retail customer. They charge a commission or mark-up in addition to the price obtained in the market.Dealers or market makers, by contrast, typically act as principal in the transaction versus the retail customer, and quote a price they are willing to deal at.

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Non-bank foreign exchange companies Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as foreign exchange brokers but are distinct in that they do not offer speculative trading but rather currency exchange with payments (i.e., there is usually a physical delivery of currency to a bank account). It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign Exchange Companies. These companies' selling point is usually that they will offer better exchange rates or cheaper payments than the customer's bank. These companies differ from Money Transfer/Remittance Companies in that they generally offer higher-value services. Money transfer/remittance companies and bureaux de change Money transfer companies/remittance companies perform high-volume low-value transfers generally by economic migrants back to their home country. In 2007, the Aite Group estimated that there were $369 billion of remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and the Philippines) receive $95 billion. The largest and best known provider is Western Union with 345,000 agents globally followed by UAE Exchange.

3.1 RISK MANAGEMENT


Risk Management is the process of measuring, or assessing risk and then developing strategies to manage the risk. In general, the strategies employed include transferring the risk to another party, avoiding the risk, reducing the negative effect of the risk, and accepting some or all of the consequences of a particular risk. Traditional risk m a n a g e m e n t f o c u s e s o n r i s k s s t e m m i n g f r o m p h ys i c a l o r l e g a l c a u s e s ( e . g . n a t u r a l disasters or fires, accidents, death, and lawsuits).Financial risk management, on the other hand, focuses on risks that can be managed using traded financial instruments. Intangible risk management focuses on the risks associated with human capital, such as knowledger i s k , r e l a t i o n s h i p r i s k , a n d e n g a g e m e n t p r o c e s s r i s k . R e g a r d l e s s o f t h e t yp e o f r i s k management, all large corporations have risk management teams and small groups and corporations practice
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informal, if not formal, risk management .In ideal risk management, a prioritization process is followed whereby the risks with the greatest loss and the greatest probability of occurring are handled first, and risks with lower probability of occurrence and lower loss are handled later. In practice the process an be very difficult, and balancing between risks with a high probability of occurrence but lower loss vs. a risk with high loss but lower probability of occurrence can often Bemis handled. I n t a n g i b l e r i s k management identifies a new type of risk - a risk that has a 1 0 0 % probability of occurring but is ignored by the organization due to a lack of identificationa b i l i t y. F o r e x a m p l e , k n o w l e d g e r i s k o c c u r s w h e n d e f i c i e n t k n o w l e d g e i s a p p l i e d . Relationship risk occurs when collaboration ineffectiveness occurs. Process-engagement risk occurs when operational ineffectiveness occurs. These risks directly reduce the productivity of knowledge workers, decrease cost effectiveness, profitability, service ,quality, reputation, brand value, and earnings quality.Intangible risk management allows risk management to create immediate value from the identification and reduction of risks that reduce productivity.

Risk management also faces a difficulty in allocating resources properly. This is the idea of opportunity cost. Resources spent on risk management could be instead spent on more profitable activities. Again, ideal risk management spends the least amount of resources in the process while reducing the negative effects of risks as much as possible .The Forex Market is the largest and most liquid financial market in the world. Since macroeconomic forces are one of the main drivers of the value of currencies in the global economy, currencies tend to have the most identifiable trend patterns. Therefore, the Forex market is a very attractive market for active traders, and presumably where theys h o u l d b e t h e m o s t s u c c e s s f u l . H o w e v e r , s u c c e s s h a s b e e n l i m i t e d m a i n l y f o r t h e following reasons :Many traders come with false expectations of the profit potential, and lack the discipline required for trading. Short term trading is not an amateur's game and is not the way most people will achieve quick riches. Simply because Forex trading may seem exotic or less familiar then traditional markets (i.e. equities, futures, etc.), it
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does not mean that the rules of finance and simple logic are suspended. One cannot hope to make extraordinary gains without taking extraordinary risks, and that means suffering inconsistent trading performance that often leads to large losses. Trading currencies is not easy, and many traders with years of experience still incur periodic losses. One must realize that trading takes time to master and there are absolutely no short cuts to this process. The most enticing aspect of trading Forex is the high degree of leverage used. Leverage seems very attractive to those who are expecti ng to turn small amounts of money into large amounts in a short period of time .However, leverage is a double-edged sword. Just because one lot ($10,000) of currency only requires $100 as a minimum margin deposit, it does not mean that a trader with $1,000 in his account should be easily able to trade 10 lots. One lot is $10,000 and should be treated as a $100,000 investment and not the $1000 put up as margin. Most trader analyze the charts correctly and place sensible trades, yet they tend to over Leverage themselves (get in with a position that is too big for their p o r t f o l i o ) , a n d a s a consequence, often end up forced to exit a position at the wrong time.

For example, if your account value is $10,000 and you place a trade for 1 lot, you are In effect, leveraging yourself 10 to 1, which is a very significant level of leverage. Most professional money managers will leverage no more then 3 or 4 times. Trading in small increments with protective stops on your positions will allow one the opportunity to be successful in Forex trading

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3.2 RISK WARNING

Trading foreign currencies is a challenging and potentially profitable opportunity for educated and experienced investors. However, before deciding to participate in the Forexmarket, you should carefully consider your investment objectives, level of experience and risk appetite. Most importantly, do not invest money you cannot afford to lose.T h e r e i s c o n s i d e r a b l e e x p o s u r e t o r i s k i n a n y f o r e i g n e x c h a n g e t r a n s a c t i o n . A n y transaction involving currencies involves risks including, but not limited to, the potential for changing political and/or economic conditions that may substantially affect the price or liquidity of a currency. Moreover, the leveraged nature of FX trading means that any market movement will have an effect on your deposited funds proportionally equal to the leverage factor. This may work against you as well as for you. The possibility exists that you could sustain a total loss of initial margin funds and be required to deposit additional f u n d s t o m a i n t a i n yo u r p o s i t i o n . I f yo u f a i l t o m e e t a n y m a r g i n c a l l w i t h i n t h e t i m e prescribed, your position will be liquidated and you will be responsible for any resulting losses. Investors may lower their exposure to risk by employing risk-reducing strategies such as 'stoploss' or 'limit' orders. There are also risks associated with utilizing an internet -based deal execution software a p p l i c a t i o n i n c l u d i n g , b u t n o t l i m i t e d , t o t h e f a i l u r e o f h a r d w a r e a n d s o f t w a r e a n d communications difficulties

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. OBJECTIVES OF RISK MANAGEMENT

Mere survival; Peace of mind; Lower risk management costs and thus higher profits; Fairly stable earnings; Little or no interruption of operations; Continued growth; Satisfaction of the firms sense of social responsibility desire for a good image Satisfaction of externally imposed obligations

3.3 STEPS IN THE RISK MANAGEMENT PROCESS


The core of the process is a series of five steps: Establish the context Identify risks Analyses risks Evaluate risks Treat risks

In parallel with the core process, communication & consultation is required to ensuread equate information is provided and conclusions are disseminated. Monitoring and review is an intrinsic part of the process required to ensure that the process is executed in a timely fashion and the identification, analysis, evaluation and treatment are kept up to date.

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1. Establish the context


Establishing the context includes planning the remainder of the process and mapping out t h e scope of the exercise, the identity and objectives of stakeholders, the b a s i s u p o n which risks will be evaluated and defining a framework for the process, and agenda for identification and analysis.

2.Identification
After establishing the context, the next step in the process of managing risk is to identify potential risks. Risks are about events that, when triggered, will cause problems. Hence ,risk identification can start with the source of problems, or with the problem itself

Source analysis Risk sources may be internal or external to the system that is thet a r g e t o f r i s k m a n a g e m e n t . E x a m p l e s o f r i s k s o u r c e s a r e : s t a k e h o l d e r s o f a project, employees of a company or the weather over an airport.

Problem analysis
Risks are related to identified threats. For example: the threat o f l o s i n g m o n e y, the threat of abuse of privacy information or the threat of accidents and casualties. The threats may exist with various entities, m o s t important with shareholder, customers and legislative bodies such as the government. W h e n either source or problem is known, the events that a source may trigger or thee v e n t s t h a t c a n l e a d t o a p r o b l e m c a n b e i n v e s t i g a t e d . F o r e x a m p l e : s t a k e h o l d e r s withdrawing during a project may endanger funding of the project; privacy information may be stolen by employees even within a closed network; lightning striking a Boeing747 during takeoff may make all people onboard immediate casualties. The chosen method of identifying risks may depe nd on culture, industry practice and compliance. The identification methods are formed by templates or the development of templates for identifying source, problem or event. Common risk identification method sare:

Objectives-based Risk Identification


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Organizations and project teams have objectives. Any e v e n t t h a t m a y e n d a n g e r a c h i e v i n g a n o b j e c t i v e p a r t l y o r completely is identified as risk. Objective-based risk identification is at the basis of COSO's Enterprise Risk Management - Integrated Framework

Scenario-based Risk Identification In scenario analysis different scenarios are created. The scenarios may be the alternative ways to achieve an objective, or an analysis of the interaction of forces in, for example, a market or battle. Any event that triggers an undesired scenario alternative is identified as risk.

Taxonomy-based Risk Identification The taxonomy in taxonomy-based risk identification is a breakdown of possible risk sources. Based on the taxonomy and knowledge of best practices, a questionnaire is compiled. The answers to the questions reveal risks.

Common-risk Checking
In several industries lists with known risks area v a i l a b l e . E a c h r i s k i n t h e l i s t c a n b e c h e c k e d f o r a p p l i c a t i o n t o a p a r t i c u l a r situation.

3.Assessment
Once risks have been identified, they must then be assessed as to their potential severity of loss and to the probability of occurrence. These quantities can be either simple to measure, in the case of the value of a lost building, or impossible to know for sure in the case of the probability of an unlikely event occurring. Therefore, in the as sessmentprocess it is critical to make the best educated guesses possible i n o r d e r t o p r o p e r l y prioritize the implementation of the risk management plan.

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The fundamental difficulty in risk assessment is determining the rate of occurrence sinces t a t i s t i c a l i n f o r m a t i o n i s n o t a v a i l a b l e o n a l l k i n d s o f p a s t i n c i d e n t s . F u r t h e r m o r e , evaluating the severity of the consequences (impact) is often quite difficult for immaterial assets. Asset valuation is another question that needs to be addressed. Thus, best educated opinions and available statistics are the primary sources of information. Nevertheless, risk assessment should produce such information for the management of t h e o r g a n i s a t i o n t h a t t h e p r i m a r y r i s k s a r e e a s y t o u n d e r s t a n d a n d t h a t t h e r i s k management decisions may be prioritized. Thus, there have been several theories and attempts to quantify risks. Numerous different risk formulae exist, but perhaps the most widely accepted formula for risk quantification is:

Rate of occurrence multiplied by the impact of the event equals risk

Later research has shown that the financial benefits of risk management are not so much dependent on the formulae used. The most significant factor in risk management seems to be that

1. risk assessment is performed frequently and 2. it is done using as simple methods as possible.

In business it is imperative to be able to present the findings of risk a s s e s s m e n t s i n financial terms. Robert Courtney Jr. (IBM, 1970) proposed a formulae for presenting risks in financial terms. The Courtney formulae was accepted as the official risk analysis method for the US governmental agencies. The form ulae proposes calculation of ALE ( A n n u a l i s e d L o s s E x p e c t a n c y) a n d c o m p a r e s t h e e x p e c t e d l o s s v a l u e t o t h e s e c u r i t y control implementation costs (cost-benefit analysis).

Potential Risk Treatments


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Once risks have been identified and assessed, all techniques to manage the risk fall in to one or more of these four major categories: Transfer Avoidance Reduction (aka Mitigation) Acceptance (aka Retention)

Ideal use of these strategies may not be possible. Some of them may involve trade offs t h a t a r e n o t a c c e p t a b l e t o t h e o r g a n i z a t i o n o r p e r s o n m a k i n g t h e r i s k m a n a g e m e n t decisions.

Risk avoidance
Includes not performing an activit y that could carry risk. An ex ample w o u l d b e n o t buying a property o r b u s i n e s s i n o r d e r t o n o t t a k e o n t h e liability that comes with it. A n o t h e r w o u l d b e n o t f l yi n g i n o r d e r t o n o t t a k e t h e r i s k t h a t t h e airplane w e r e t o b e hijacked. Avoidance may seem the answer to all risks, but avoiding risks also means losing out on the potential gain that accepting (retaining) the risk may have allowed. Not entering a business to avoid the risk of loss also avoids the possibility of earning the profits

Risk reduction I n v o l v e s m e t h o d s t h a t r e d u c e t h e s e v e r i t y o f t h e l o s s . E x a m p l e s i n c l u d e spr inklers d e s i g n e d t o p u t o u t a fireto reduce the risk of loss by fire. This method may cause a greater loss by water damage and therefore may not be suitable. Hal on fire suppression systems may mitigate that risk, but the cost may be prohibitive as a strategy.

Modern software development methodologies reduce risk by developing and deliverings o f t w a r e i n c r e m e n t a l l y. E a r l y m e t h o d o l o g i e s s u f f e r e d f r o m t h e f a c t t h a t t h e y o n l y delivered software in the final phase of development; any problems encountered in earlier phases meant costly rework and often
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jeopardized the whole project. By developing in increments, software projects can limit effort wasted to a single increment. A current trend in software development, spearheaded by the Extreme Programming community, is to reduce the size of increments to the smallest size possible, sometimes as little as one week is allocated to an increment.

Risk retention
Involves accepting the loss when it occurs. True self insurance falls in this category. Risk retention is a viable strategy for small risks where the cost of insuring against the risk would be greater over time than the total losses sustained. All risks that are not avoided or transferred are retained by default. This includes risks that are so large or catastrophic that they either cannot be insured against or the premiums would be infeasible. War is an example since most property and risks are not insured against war, so the loss attributed b y w a r i s retained by the insured. Also any amounts of potential loss (risk) over the amount insured is retained risk. This may also be acceptable if the chance of a very large loss is small or if the cost to insure for greater coverage amounts is so great it would hinder the goals of the organization too much.

Risk transfer
M e a n s c a u s i n g a n o t h e r p a r t y t o a c c e p t t h e r i s k , t yp i c a l l y b y contracto r b y hedging. Insurance i s o n e t yp e o f r i s k t r a n s f e r t h a t u s e s c o n t r a c t s . O t h e r t i m e s it may involve contract language that transfers a risk to another party without t h e p a ym e n t o f a n insurance premium. L i a b i l i t y a m o n g c o n s t r u c t i o n o r o t h e r c o n t r a c t o r s i s v e r y o f t e n t r a n s f e r r e d t h i s w a y. O n t h e o t h e r h a n d , t a k i n g o f f s e t t i n g p o s i t i o n s i n derivatives is typically how firms use hedging to financially manage
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risk .S o m e w a ys o f m a n a g i n g r i s k f a l l i n t o m u l t i p l e c a t e g o r i e s . R i s k r e t e n t i on pools aretechnically retaining the risk for the group, but spreading it over the whole groupinvolves transfer among i n d i v i d u a l m e m b e r s o f t h e g r o u p . T h i s i s d i f f e r e n t f r o m traditional insurance, in that no premium is exchanged between members of the group upfront, but instead losses are assessed to all members of the group.

Create the plan


Decide on the combination of methods to be used for each risk. Each risk management decision should be recorded and approved by the appropriate level of management. For example, a risk concerning the image of the organization should have top management d e c i s i o n b e h i n d i t w h e r e a s I T m a n a g e m e n t w o u l d h a v e t h e a u t h o r i t y t o d e c i d e o n computer virus risks. The risk management plan should propose applicable and effective security controls for managing the risks. For example, an observed high risk of computer viruses could be mitigated by acquiring and implementing anti virus software. A good risk mana gement plan should contain a schedule for control implementation and responsibile persons for t h o s e a c t i o n s . T h e r i s k m a n a g e m e n t c o n c e p t i s o l d b u t i s s t i l l n o t v e r y e f f e c t i v e l y measured

4.Implementation
Follow all of the planned methods for mitigating the effect of the r i s k s . P u r c h a s e insurance policies for the risks that have been decided to be transferred to an insurer, avoid all risks that can be avoided without sacrificing the entity's goals, reduce others, and retain the rest.

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5.Review and evaluation of the plan


Initial risk management plans will never be perfect. Practice, experience, and actual loss results, will necessitate changes in the plan and contribute information to allow possible different decisions to be made in dealing with the risks being faced .Risk analysis results and management plans should be updated periodically. There are two primary reasons for this:1. to evaluate whether the previously selected security controls are still applicable and effective, and2 . t o e v a l u a t e t h e p o s s i b l e r i s k l e v e l c h a n g e s in the business environment. For example, information risks are a good e x a m p l e o f r a p i d l y c h a n g i n g b u s i n e s s environment

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3.4 FOREX TRADING EXAMPLES


Example 1
An investor has a margin deposit with Saxo Bank of USD100,000

.The investor expects the US dollar to rise against the Swiss franc and therefore decides to buy USD2,000,000 - his maximum possible exposure.

The Saxo Bank dealer quotes him 1.5515-20.

The investor buys USD at 1.5520.

Day 1: Buy USD2,000,000 vs CHF 1.5520 = Sell CHF3,104,000.

Four days later, the dollar has actually risen to CHF1.5745 and the investor decides to take his profit.

Upon his request, the Saxo Bank dealer quotes him 1.5745-50.

The investor sells at1.5745

.Day 5: Sell USD2,000,000 vs CHF 1.5745 = Buy CHF3,149,000. As the dollar side of the transaction involves a credit and a debit of USD2,000,000, the investor's USD account will show no change. The CHF account will show a debit of CHF3,104,000 and a credit of CHF3,149,000. Due to the simplicity of the example and the short time horizon of the trade, we have disregarded the interest rate swap that would marginally alter the profit calculation.

This results in a profit of CHF45,000 = approx. USD28,600 = 28.6% profit on the deposit of USD100,000.
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CH 4 Conclusion
Currency markets present a good investment opportunity. However, investors should participate only after a thorough understanding of how they work. In options, the risk is lower because the loss is limited to the premium paid. But investors need to know how puts and calls work and whether the premium being paid for an option is feasible. It's advisable to take a course on forex derivatives offered by currency exchanges and associations. One has to be clued in to global developments, trends in world trade as well as economic indicators of different countries. These include GDP growth, fiscal and monetary policies, inflows and outflows of the currency, local stock market performance and interest rates. The currency derivatives market is highly leveraged. In the stock futures market, a 20% margin gains a five-fold leverage. In forex futures, the margin payable is just 3%, so the leverage is 33 times. This means that even a 1% change can wipe out a third of the investment. However, the Indian currency markets are well-regulated and there is almost no counter-party risk. Investors should start small and gradually invest more.

Liberalization has transformed Indias external sector and a direct beneficiary of this has been the foreign exchange market in India. From a foreign exchange-starved, control-ridden economy, India has moved on to a position of $150 billion plus in international reserves with a confident rupee and drastically reduced foreign exchange control. As foreign trade and cross-border capital flows continue to grow, and the country moves towards capital account convertibility, the foreign exchange market is poised to play an even greater role in the economy, but is unlikely to be completely free of RBI interventions any time soon.

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CH 5 REFRENCES
http://en.wikipedia.org/wiki/Foreign_exchange_market http://www.investopedia.com/terms/forex/f/forex-market.asp http://economictimes.indiatimes.com/topic/forex-market

Volatility Spillover in the Foreign Exchange Market by saurabh ghosh


http://www.scribd.com/search?query=forex+market+

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