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MEANING OF FOREIGN EXCHANGE

Foreign exchange, also termed as Forex refers to the conversion of one country’s
currency into another country’s currency. A single country’s currency is valued
against another’s currency or against a basket of currencies.

MEANING OF FOREIGN EXCHANGE


Foreign exchange, also termed as Forex refers to the conversion of one country’s
currency into another country’s currency. A single country’s currency is valued
against another’s currency or against a basket of currencies.

The global foreign exchange market involves daily volumes ranging in trillions of
dollars thereby making it the largest financial market in the world. Foreign
exchange transactions are executed over the counter and there is no specific
centralised market for the same.
On knowing the meaning of foreign exchange, let us now know about the foreign
exchange market.

MEANING OF FOREIGN EXCHANGE MARKET


The foreign exchange market is a floor provided for buying, selling, exchanging
and speculation of currencies. Foreign exchange market also undertakes currency
conversion for investments and international trade. The Foreign exchange
markets also termed as, Forex markets, consists of investment management
firms, central banks, commercial companies, retail forex brokers, and investors.
On understanding about the foreign exchange market, we will gain an insight on
the foreign exchange transactions that take place in these markets.
MEANING OF FOREIGN EXCHANGE TRANSACTIONS
Foreign exchange transaction refers to purchase and sale of foreign currencies.
The transactions are done with an exchange of a specific country’s currency for
another at an agreed exchange rate on a specific date.
Let us move on and know about the types of foreign exchange transactions.

TYPES OF FOREIGN EXCHANGE TRANSACTIONS


Foreign exchange transactions include all conversions of currencies which may be
done by a traveler on an airport kiosk or billion-dollar payments made by financial
institutions and governments. The growth in globalisation has led to a massive
increase in a number of foreign exchange transactions in the recent years.
The following are the types of foreign exchange transactions:
SPOT TRANSACTIONS
This method of transaction is the fastest way to exchange currencies. Spot
transaction refers to the exchange or settlement of the currencies by the buyer
and seller within two days of the deal without a signed contract. The Spot
Exchange Rate is the prevailing exchange rate in the market.

FORWARD TRANSACTIONS
Forward transactions are future transactions when the buyer and seller enter into
an agreement of purchase and sale of currency after 90 days. The agreement is
framed on the basis of a fixed exchange rate for a definite date in the future. The
rate at which the deal is fixed is termed as Forward Exchange Rate.

FUTURE TRANSACTION
Future transactions also deals with contracts in the same manner as forward
transactions. However, in case of future transactions, standardized contracts in
terms of features, date, and size should be followed. Whereas, regular forward
transactions have flexibility and can be customized. In future transactions, an
initial margin is fixed and kept as collateral in order to establish a future position.

SWAP TRANSACTIONS
A simultaneous lending and borrowing of two different currencies between two
investors are referred to as swap transaction. One investor borrows a currency
and repays in the form of a second currency to the second investor. Swap
transactions are done to pay off obligations without suffering a foreign exchange
risk.

OPTION TRANSACTIONS
The exchange of currency from one denomination to another at an agreed rate on
a specific date is an option for an investor. Every investor owns the right to
convert the currency but is not obligated to do so.
CONCLUSION
In a nutshell, foreign exchange is the conversion of one currency of a country into
the currency of another country in order to settle payments.1–3
References
Methods of International Payments
The main international payment methods used around the world today include:

 Cash in Advance
 Letters of Credit
 Documentary Collections
 Open Account
 Consignment
 Cash-in-Advance:

 Cash in advance is a payment method in international trade in which an


order is not processed until full payment is received by the supplier in
advance.

 Sometimes cash in advance is called cash with order.

 Please always keep in mind that under the cash in advance payment, the
funds received by the exporters before the ownership of the goods is
transferred to the importers.

 Cash in advance possess highest risk to the importer, lowest risk to the
exporter.

1) Letter of Credit

 A letter of credit is a letter from a bank guaranteeing that a buyer’s


payment to a seller will be received on time and for the correct amount. If
the buyer fails to make the payment on the goods purchased, the bank will
be required to cover the full or remaining amount of the purchase.
 2) Open Account:

 Open account means that buyers pay the cost of the goods after goods
have been shipped by the supplier.
 In an international trade transaction open account defines as a sale where
the goods are shipped and/or delivered before payment is due, which is
usually in 30 or 60 days.

 Open account posses highest risk to the exporter, lowest risk to the
importer.

3)Documentary Collections:

International trade procedure in which a bank in the importer’s country acts on


behalf of an exporter for collecting and remitting payment for a shipment.

The exporter presents the shipping and collection documents to his or her bank
(in own country) which sends them to its correspondent bank in the importer’s
country.

The foreign bank (called the presenting bank) hands over shipping and title
documents (required for taking delivery of the shipment) to the importer in
exchange for

 cash payment (in case of ‘documents against payment‘ instructions) or


 a firm commitment to pay on a fixed date (in case of ‘documents against
acceptance‘ instructions).

A documentary collection (D/C) is a transaction whereby the exporter entrusts


the collection of a payment to the remitting bank (exporter’s bank), which sends
documents to a collecting bank (importer’s bank), along with instructions for
payment.

Funds are received from the importer and remitted to the exporter through the
banks involved in the collection in exchange for those documents.

7 Key Factors That Influence Foreign Exchange Rates


Being one of the most important determinants of a country’s relative economic
health, aside from factors such as interest rates and inflation, foreign exchange
rates are the most watched, analyzed and manipulated economic measures. They
impact the real return of a foreign investment and the balance of trade of a
country- such is its importance.
Exchange rates are simply the value of one currency in comparison to another.
But due to its volatile nature, it can be quite confusing to someone who transfers
money overseas regularly. Here, we have listed 7 factors that influence the
constantly changing exchange rates:

1. Interest And Inflation Rates


Inflation is the rate at which the cost of goods and services rise over time. Interest
rates indicate the amount charged by banks for borrowing money. These two are
linked by the fact that people tend to borrow and spend more when the interest
rates are low, which results in increase in costs. These rates are direct indicators
of current and future economic performance of a country and can influence the
decisions of forex investors and traders through the globe. An increase in interest
rate is usually followed by a rise in the value of the local currency. This happens
usually because the economy is growing too fast and central banks are trying to
slow inflation.

2. Current Account Deficits


The current account is the balance of trade between a country and its trading
partners. It describes the difference in value between the goods and services
trades with other countries. If a country buys more than it sells then the balance
of trade is deficit. It directly affects the exchange rate since a country will need
more foreign capital, thus diminishing the demand for local currency. This excess
supply of local currency drives down its value against foreign currency.

3. Government Debt
This is the total national or public debt owed by the central government. A
country with large amount of government debt is less likely to attract foreign
investment and acquire foreign capital, leading to inflation. It may also happen
that existing foreign investors will sell their bonds in the open market if they
foresee an increase in government debts. This will result in an over supply of the
local currency, thus diminishing its value.
4. Terms Of Trade
Terms of Trade is the ratio of export prices of a country to its import prices. When
export prices of a country rise at a greater rate than its import prices, its terms of
trade improves. This in turn results in higher revenue, higher demand for the
country’s currency and increase in the value of the currency. This cumulatively
results in appreciation of the exchange rate of currency.

5. Economic Performance
One of the many factors that affect the economic performance of a country is its
political stability. A country, which has a stable political environment, attracts
more foreign investment and vice versa. Increase in foreign capital results in
appreciation in the value of its domestic currency. Such stability also directly
affects the financial and trade policy, thus eliminating any uncertainty in the value
of its currency.

6. Recession
During a recession, a country’s interest rates are likely to fall, thus decreasing its
chances to acquire foreign capital. This in turn weakens the currency of the
country in question, therefore weakening the exchange rate.

7. Speculation
Investors demand more of a country’s currency when its value is expected to rise;
so as to make a profit in the near future. As a result, the value of the currency
rises due to its increased demand. Which in turn results in a rise in the exchange
rate as well.

With so many factors involved, exchange rates are subject to fluctuations and that
can be quite distressing for people who transfer money overseas frequently.
Though watching the rates of a currency corridor can give you a fair idea of the
best time to make transfers, it’s best to stay updated about the real-time
exchange rates.

If you plan to transfer money abroad, sign up for InstaReM rate watch and you
can choose to transfer money when the tide is in your favor.

We offer the same rates as on Google or Reuters that means our rates are devoid
of any profit margins. With InstaReM, what you get is what you see.
Methods of Exchange Control
In order to achieve goals of exchange control, two main methods are applied
which are as under:-

 Unilateral methods
 Bilateral methods

1. Unilateral Methods

In unilateral methods of exchange control, a government applies exchange


control without consultation with other governments. These methods are
discussed are as under;

1. Exchange Pegging

It is the method of exchange control. Exchange pegging refers to the policy of


fixing the exchange value of the current according to some desired rate. When it
is fixed higher than market rate, it is “Pegging up”. but if fixed lower than market
rate, it is known as “pegging down”.

2. Clearing Agreement

Another method of exchange control is clearing agreement. It is an undertaking


between two countries to exchange goods and services in accordance with a
predetermined or specified rate of exchange. This method is applied to check
fluctuation in exchange rate and to maintain equilibrium in balance of payments.

3. Standstill Agreement

In this agreement the relationship between two countries in terms of capital


movements remains unchanged. Debtor country is allowed to repay her loan in
installments or the short term loan is converted into long term loan.

4. Compensation Agreement

According to this agreement, goods of just equal value are exported and imported
from each other country. Hence, no balance is left and no foreign exchange is
involved.
5. Payment Agreement

In this method, creditor country will export more and more to Creditor County
and the creditor country will import less and less from debtor country to settle
the accounts.

6. Foreign Exchange Rationing

Government has the right to direct all the exports and other investors to
surrender all foreign exchange with the central banks. Foreign exchange, so
collected can be rationed by fixing quota of amount and rate of foreign exchange.

7. Blocking of Foreigner Accounts

During emergency, a country may block or restrict the foreigners to transfer their
funds in their home accounts. But rarely this step is taken by the countries.

8.Bilateral Methods

In bilateral methods of exchange control, a government applies exchange control


with mutual understanding and consultation of the other government. These
methods are discussed are as under;

9.Clearing Agreement

When two countries agree to settle their accounts in their home currencies,
through their central banks, this method is known as clearing agreement.

What is Endorsement -

Endorsement means signing at the back of the instrument for the purpose
of negotiation. The act of the signing a cheque, for the purpose of transferring to
the someone else, is called the endorsement of Cheque.
Section 15 of the Negotiable Instrument Act 1881 defines endorsement. The
endorsement is usually made on the back of the cheque. If no space is left on the
Cheque, the Endorsement may be made on a separate slip to be attached to the
Cheque.
Endorsement in Blank / General -
An endorsement is said to be blank or general when the endorser puts his
signature only on the instrument and does not write the name of anyone to
whom or to whose order the payment is to be made.

Special Endorsement
An endorsement is 'special' or in 'full' if the endorser, in addition to his
signature also mention the name of the person to whom or to whose order the
payment is to be made. There is direction added by endorse to the person
specified called the endorsee, of the instrument who now becomes its payee
entitled to sue for the money due on the instrument.

Restrictive Endorsement – Which restricts further negotiation.

Partial Endorsement – Which allows transferring to the endorsee a part only


of the amount payable on the instrument.

Conditional Endorsement – Where the fulfilment of some conditions is


required.