Lecture-6

Day and Dates: Friday 27.03.2020,

Monday 30.03.2020
International Business
B.Com (H), Semester VI
Unit-III
International Financial Environment
Prepared By
Dr. Kapil Harit
Assistant Professor,
Shaheed Bhagat Singh College,
University of Delhi, Sheikh Sarai, New Delhi-110017
 What is Spot Market?
• Spot Market, also known as “physical market” or
“cash market” is a financial market where financial
securities like stocks, currencies, commodities are
bought and sold for immediate delivery.
• Most of the spot market trades are settled or
delivered on two business days after the trade
date (T+2) but many of the counterparties opt for
settlement ‘right now’.
• The settlement price or the rate is called the spot
price. An investor who wishes to own stocks of a
company immediately will buy the stock in the spot
market which will allow him/her to own the stocks
with immediate effect.
Dr. Kapil Harit, SBSC, University of Delhi 2
 What is Spot Market?
• In finance, a spot contract, spot transaction, or
simply spot, is a contract of buying or selling
commodity, security or currency for settlement
(payment and delivery) on the spot date, which is
normally two business days after the trade date.
The settlement price (or rate) is called spot price
(or spot rate).
• Spot market handles only spot/current
transaction. The rate of exchange is one that
prevails at the time the transaction takes place.

Dr. Kapil Harit, SBSC, University of Delhi 3

 What is Spot Market?
Example
• WTI or Brent Crude oil is traded at the spot
price but the delivery is done only after a
month or so. Since it is a commodity, the
delivery usually takes time. Whereas in the
case of stocks, it is delivered immediately
once the payment is made and the
ownership gets transferred as well

Dr. Kapil Harit, SBSC, University of Delhi 4

What is Spot Market?

Dr. Kapil Harit, SBSC, University of Delhi 5

 Types of Spot Market
• The cash market can be either exchange-traded or traded over the
counter. It depends on where the trade takes place. Exchange
brings together buyers and sellers in one place and facilitates
trading whereas an over the counter trade happens with a closed
group of participants which does not have a central location.
• The following are components of the spot market.

Dr. Kapil Harit, SBSC, University of Delhi 6

 Types of Spot Market
1. Exchange-Traded
• Exchange provides the spot rate at which the securities are
traded.
• Buyers and sellers of financial securities are brought
together at a central place in exchange.
• Trades done via an exchange carry limited risk when
compared to trades executed over the counter due to the
less risk of a counterparty defaulting.
2. Over Counter
• Over the counter, trades are carried out between a limited
group of counterparties.
• Over the counter, trades weigh more risk than trades.
• The trades executed over the counter are usually traded at
the exchange rate.
Dr. Kapil Harit, SBSC, University of Delhi 7
 Examples of Spot Market
Example #1
• John owns a fabric business in New York and is looking for suppliers
dealing with good quality fabrics at a competitive rate. He looks upon the
internet and finds a Chinese supplier giving almost 40% discount on bulk
orders of over $ 10,000. The payment needs to be made in CNY and John
might save big if the current market rate for USDCNY is high.
• He checks the current USDCNY rate which is 7.03 which is higher than
usual value. But looking at the discount the supplier is giving, John
decides to execute a foreign exchange to convert the CNY equivalent of
$10,000.
USDCNY = 7.03
Purchase amount = $ 10,000
CNY amount = $ 10,000 * 7.03
CNY Amount= 70,300
• The foreign exchange spot transaction settles or is delivered after 2 days
(T+2) and John is able to make the payment which allows him 40%
savings on his purchase.

Dr. Kapil Harit, SBSC, University of Delhi 8

 Examples of Spot Market
Example #2
• Steve is looking to invest $ 5,000 in the stock market. He is unsure of how he
should start. He starts a Demat account with one of his trusted banks. He checks
into the various stocks being traded over the market. Due to fear of losing his
money, he is interested to put his money only into the blue-chip stocks. He buys
100 shares of Apple at $ 200.47. He makes the payment for it and has 10 shares
of Apple in his account; the spot market also allows immediate settlement. This
allows Steve to get ownership of Apple shares on the same day. Steve also looks
for other penny stocks which he thinks might turn up into a good performer. He
invests $ 2,000 in two different penny stocks.
• Now, Steve has $ 1,000 ready to be invested. He decides to invest in currencies.
He looks at the market trends and invests in the Chinese yuan expecting it to go
up due to the news surrounding China’s economic growth. He assumes the
Chinese Yuan to perform well in the long term and hence invests the remaining $
1,000 in currency.
• The trade settles in 2 days and the account will be delivered with Chinese Yuan.

Dr. Kapil Harit, SBSC, University of Delhi 9

 Some Important Points about Spot Market
• Unlike a spot trade, a futures contract gives the investor the
obligation to buy or sell the financial security at a pre-agreed
price and a future date.
• Money changes hands at a later date, that futures prices
demonstrate where part of the market expects the price of
an asset to go while the spot price is the price at that
moment.
• A futures transaction in which a commodity is expected to
be delivered or settled in less than a month is also part of
the cash market. It may have been sold at the spot price but
the ownership is transferred only at a future date which is
not immediate.
• The physical market is regulated by local regulations.
• The price quoted for a purchase or sale on a spot market is
called as the Spot Price.
Dr. Kapil Harit, SBSC, University of Delhi 10
 Advantages of Spot Market
• The spot market is more flexible than a futures market since
the spot market can be traded on lower volumes (1,000
units) whereas a futures market requires higher volumes
(usually 100,000 units, the exception in very few
instruments).
• A spot market is quick and the delivery is usually with two
days.
• A spot market is straight forward unlike a futures market.
• The physical market facilitates immediate trading with a
transfer of funds and ownership in a short span of time.
• It is most favored by traders due to its flexibility and ease of
trading rather than the futures market which can be
complex and time-consuming.
Dr. Kapil Harit, SBSC, University of Delhi 11
 Spot Rate
Definition:
• “Spot Rate” is the cash rate at which immediate
transaction and/or settlement takes place between
the buyer and seller parties. This rate can be
considered for any and all types of products
prevalent in the market ranging from consumer
products to real estate to capital markets. It gives
the immediate value of the product being
transacted.

Dr. Kapil Harit, SBSC, University of Delhi 12

 Spot Rate Examples
Example #1
• Joe goes to the market to purchase 10gm of 24k bullion gold. The
seller bids the same at $450.00. This rate is the spot rate. If Joe buys
the bullion at this rate, the transaction gets settled.
Example #2
• In the above example, considers that the seller offers Joe with a deal.
His view is that the market will be bullish in future and gold rates will
rise. He suggests Joe book the bullion today at $455.00 and collect the
same after 1 month. Rates after 1 month would be around $475.00.
• This type of agreement is a forward contract, whereby the buyer can
book the product at a rate which is a little higher than spot rate
(including the seller’s premium) also called the forward rate, and take
the delivery later thus making profits from the then spot rate.
Example #3
• It can be measured for Currency exchanges as well. Below is a table
which demonstrates conversion rates of various currencies against
USD.

Dr. Kapil Harit, SBSC, University of Delhi 13

 Different Aspects of Foreign Exchange Market
Spot Rates as on Closing of 18th April 2019

Source: www.yahoofinance.com
• The above table reflects the rate to be paid by each
other currency to purchase U.S. Dollars. These are
called spot rates because at that specific instance, or
at that spot, this is the exchange rate. It may vary at
different timings of the day and on other days as
well. Actually, it continuously changes in bps at
every second.
Dr. Kapil Harit, SBSC, University of Delhi 14
 Advantages: Spot Rate

• The parties are confirmed with the rate and value of

the product for which the transaction is to be made.
• Spot rate gives the actual movement of markets.
• There is no speculation involved in the calculation of
this rate.
• There is no effect from market dynamics like volatility,
time value, interest rate changes, etc. since buyer and
seller both are sure about the current scenario in the
market with no reason of any doubts of future market
movement.
• Study of spot rates for a particular period may help in
market price trend analysis for the particular product.
Dr. Kapil Harit, SBSC, University of Delhi 15
 Disadvantages: Spot Rate
• Spot rate may prove to bring lesser profit to a buyer of the
product in case of bearish markets. Current spot rate may be
higher due to which the buyer pays more today than tomorrow.
• Financing requires other products as well which deal with future
rates and speculation.
• Spot rate brings exchange risks to individual, corporate and other
finances, since the current rate may not be equivalent to the rate
at the time of settlement.
• Floating rates may create the difference in the actual calculation
as they fluctuate and may be different at the time of settlement.
• It also depends upon market situations which include political
scenarios, war conditions, an act of God situations and other
environmental activities. Although this may not be directly
related to product performance, it actually affects its price in the
market. However, in such scenarios, almost the entire market gets
affected.
Dr. Kapil Harit, SBSC, University of Delhi 16
 Limitations: Spot Rate
• It can be beneficial at a particular instance, but it lacks the ability
to forecast futuristic rates and movement of the market.
• It depends upon the demand for that particular product in the
market, higher the demand -higher is the price. However, if
demands vary in future, price changes. Hence, for a buyer who has
a bullish view may face losses based on spot rate purchases. This
can, however, be hedged by any derivative product which has a
future rate of interest as one of its components.
• It is very dynamic. For liquid products in the market, it changes
every second (sometimes even millisecond). Hence, the buyer has
to be extremely focused on purchase and settlement of its desired
deal, as small changes in basis points can also have big impacts for
some deals depending upon other factors.
• It is the basic rate. Investors can deal in spot rate contracts which
are based on a specific rate, and give a conservative income upon
a sale. This limitation can be overcome by investing in more
dynamic products which deal with futuristic rates.
Dr. Kapil Harit, SBSC, University of Delhi 17
 Important Points to Note About Change in Spot Rate

• Increase in spot rate reflects the acceptance of the

product in markets and vice-versa.
• Volatile spot rate signifies instability of performance of
the product in the market. It increases the overall risk
of the portfolio and may also affect the performance of
other assets in the portfolio.
• Increases in the spot rate denote a bullish market, and
vice-versa. However, it is important to understand the
dynamics of such securities prevalent in that instance.
• Delta, which is the first order derivative, depends upon
changes in the price of the product and is one of the
key indicators of market movement for most of the
securities.
Dr. Kapil Harit, SBSC, University of Delhi 18
 Factors Determining Spot Exchange Rates
1. Balance of Payments
2. Inflation
3. Interest rate
4. Money Supply
5. National Income
6. Resource Discoveries
7. Capital Movements
8. Political factors
Dr. Kapil Harit, SBSC, University of Delhi 19
 Settlement of Transactions in Forex Market
1. Balance of Payments: Balance of Payments represents the
demand for and supply of foreign exchange which ultimately
determine the value of the currency. Exports, both visible and
invisible, represent the supply side for foreign exchange. Imports,
visible and invisible, create demand for foreign exchange. Put
differently, export from the country creates demand for the
currency of the country in the foreign exchange market. The
exporters would offer to the market the foreign currencies they
have acquired and demand in exchange the local currency.
Conversely, imports into the country will increase the supply of
the currency of the country in the foreign exchange market.
2. Inflation: Inflation in the country would increase the domestic
prices of the commodities. With increase in prices exports may
dwindle because the price may not be competitive. With the
decrease in exports the demand for the currency would also
decline; this in turn would result in the decline of external value
of the currency.
Dr. Kapil Harit, SBSC, University of Delhi 20
 Settlement of Transactions in Forex Market
3. Interest rate: The interest rate has a great influence
on the short – term movement of capital. When the
interest rate at a centre rises, it attracts short term
funds from other centers. This would increase the
demand for the currency at the centre and hence its
value. Rising of interest rate may be adopted by a
country due to tight money conditions or as a
deliberate attempt to attract foreign investment.
4. Money Supply An increase in money supply in the
country will affect the exchange rate through causing
inflation in the country. It can also affect the exchange
rate directly. Dr. Kapil Harit, SBSC, University of Delhi 21
 Settlement of Transactions in Forex Market
5. National Income: An increase in national income reflects increase in the income
of the residents of the country. This increase in the income increases the demand
for goods in the country. If there is underutilized production capacity in the
country, this will lead to increase in production. There is a chance for growth in
exports too. But more often it takes time for the production to adjust to the
increased income. Where the production does not increase in sympathy with
income rise, it leads to increased imports and increased supply of the currency of
the country in the foreign exchange market. The result is similar to that of
inflation, viz., and decline in the value of the currency.
6. Resource Discoveries when the country is able to discover key resources, its
currency gains in value. A good example can be the have played by oil in exchange
rates. When the supply of oil from major suppliers, such as Middles East, became
insecure, the demand fro the currencies of countries self sufficient in oil arose.
Previous oil crisis favoured USA, Canada, UK and Norway and adversely affected
the currencies of oil importing countries like Japan and Germany. Similarly,
discovery oil by some countries helped their currencies to gain in value.

Dr. Kapil Harit, SBSC, University of Delhi 22

 Settlement of Transactions in Forex Market
7. Capital Movements:Short term movement of capital
may be influenced buy the offer of higher interest in a
country. If interest rate in a country rises due to increase
in bank rate or otherwise, there will be a flow of short
term funds into the country and the exchange rate of the
currency will rise. Reverse will happen in case of fall in
interest rates.
8. Political Factors: Political stability induced confidence
in the investors and encourages capital inflow into the
country. This has the effect of strengthening the currency
of the country. On the other hand, where the political
situation in the country is unstable, it makes the investors
withdraw their investments. The outflow of capital from
the country would weaken the currency.
Dr. Kapil Harit, SBSC, University of Delhi 23
 TYPES OF SPOT RATES
• Bid Rate- one currency can be purchased in
exchange for another
• Offer Rate- one currency can be sold in
exchange for another

Dr. Kapil Harit, SBSC, University of Delhi 24

 TYPES OF SPOT DEALS
• Rand/USD deals
• USD/Foreign currency deals
• Rand/Foreign currency deals
• Foreign currency/Foreign currency deals

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 MECHANICS OF SPOT TRANSACTIONS
Step 1: Currency transaction: verbal agreement, U.S. importer
specifies:
– a. Account to debit (his acct)
– b. Account to credit (exporter)
Step 2: Bank sends importer contract note including:
– amount of foreign currency
– agreed exchange rate
– confirmation of Step 1.
Step 3: Settlement:
– Correspondent bank in Hong Kong transfers HK$ from
importers account to exporter’s.

Dr. Kapil Harit, SBSC, University of Delhi 26

 Nastro A/c and Vostro A/c
• The accounts held by a domestic bank with a bank
abroad are called “ Nostro accounts” or “due from
accounts” (Our A/C with u : IOB’s a/c with New
yorkbank)
• The accounts held by a foreign bank with a domestic
bank are called as “Vostro Accounts”or “due to
accounts”. (Your a/c with us : Scottish bank’s a/c with SBI
)
• Loro accounts(their a/c) third party a/c(London bank
paying to a french bank by crediting the amount in the
french bank’s a/c held with US bank)

Dr. Kapil Harit, SBSC, University of Delhi 27

 Vehicle Currency
• Connecting link between domestic currency and all
other international currencies.
• External value of domestic currency gets established in
local forex mkt with a universally accepted major
currency. & when rates of any other currency is
required, the local mkt quote of major currency & other
quote of major currency with the third currency is used
to get the desired cross rate.
• For eg..If INR is to be exchanged with Thai Baht , Indian
Banks will not have Baht hence we shall have one quote
for USD and INR and another for USD and Baht . Then
calculate the requisite currency price in effect to the
trade. In such case USD is called Vehicle Currency.
Dr. Kapil Harit, SBSC, University of Delhi 28
 Currency Indication
• Currencies are indicated by three letter symbols. The
standard symbols for some of the most traded
currencies are:
• EUR–Euros
• USD–United States Dollar
• CAD–Canadian Dollar
• GBP–British Pound
• JPY–Japanese Yen
• AUD–Australian Dollar
• CHF–Swiss Franc

Dr. Kapil Harit, SBSC, University of Delhi 29

 Currency Indication
• The majors holding 75% of all market operations on Forex
are the EUR/USD, GBP/USD, USD/CHF and USD/JPY. The
USD is considered a major currency pair because it is
represented in all currency pairs. The pairs which do not
include the USD are called cross currency pairs or cross
rates.
• The following are the cross rates that are actively traded:
• EUR/CHF=euro-franc
• EUR/GBP=euro-sterling
• EUR/JPY=euro-Yen
• GBP/JPY=sterling-Yen
• AUD/JPY=Aussie-Yen
• NZD/JPY=kiwi-Yen
Dr. Kapil Harit, SBSC, University of Delhi 30
 Currency Indication
• Central bank such as RBI play a very important
role in the foreign exchange markets. They
participate in the foreign exchange market to
regulate currencies as per their economic
requirement.
• Central banks control the money supply, inflation
and/or interest rates. Commercial companies
trade in small quantities as compared to banks or
speculators. Their trades have a relatively short-
term impact on the market rate.

Dr. Kapil Harit, SBSC, University of Delhi 31

 FOREX QUOTATIONS
• A currency pair is denoted by the 3-letter SWIFT codes (ISO code)
for the two currencies separated by an oblique or a hyphen .
• e.g. USD/CHF: US Dollar-Swiss Franc GBP/JPY: Great Britain Pound-
Japanese YenUSD-SEK: US Dollar-Swedish Kroner
• The first currency in the pair is the “base” currency; the second is
the “quoted” currency.
• The exchange rate quotation is given as number of units of the
quoted currencyper unit of base currency.
• Thus in USD/CHF, US dollar is the base currency, Swiss franc is the
quoted currency. In GBP/USD, British pound is the base currency,
US dollar is the quoted currency.
• Thus a USD/INR quotation will be given as number of rupees per
dollar, a GBP/USD quote will be given as number of dollars per
pound.
Dr. Kapil Harit, SBSC, University of Delhi 32
 Direct Quote and Indirect Quote
• Direct Quote: Foreign Exchange rate expressed in terms
of domestic currency per unit of foreign currency is
called as Direct Quote. For instance, 54.32 Rs. / $ is a
direct quote in India.
• Indirect Quote: Foreign Exchange rate expressed in
terms of foreign currency per unit (or per hundred units)
of domestic currency is called as Indirect Quote. For
instance, 2.0894 $/100 Rs. Is an indirect quote in India.
• American terms :expressed as no. of $ per unit of
another currency. $ 1.5613 / £
• European terms :no of units of another currency in
terms of dollar. SFr 1.4500/$
Dr. Kapil Harit, SBSC, University of Delhi 33
 Direct Quote and Indirect Quote
• A quotation consists of two prices.
Bid / ask
• Bid Price : the price at which the dealer giving the
quote is prepared to buy –is “bidding for” –one unit
of the base currency against the quoted currency. It
is the amount of quoted currency the dealer will give
in return for one unit of the base currency .
• ask or offer rate : price at which the dealer is willing
to sell –is “offering” –one unit of the base currency.
It is the amount of quoted currency the dealer will
want to be paid in return for one unit of base
currency.
Dr. Kapil Harit, SBSC, University of Delhi 34
 BID AND ASK RATE
• Bid is the amount of quoted currency the dealer will give
in return for one unit of the base currency. (Trader is
ready to pay base currency to buy foreign currency his
quote to buy one $.)
• The ask or offer is the price at which the dealer is willing
to sell –is “offering” –one unit of the base currency.
(Trader is ready to give one currency if you pay him. i.e.
His quote is sell one $.)
• cross rate : An exchange rate between the two
currencies, neither of which is the US dollar. (“neither of
them is a vehicle currency”).
• It is a rate between third pair of currencies, by using the
rates of two pairs,Dr.inKapilwhich one currency is common. 35
Harit, SBSC, University of Delhi
 BID ASK SPREAD
• The difference between bid rate and ask rate (offer rate)
is called as bid ask spread (bid offer spread).
• In normal market trader expects “to be hit” on both
sides of his quote in roughly equal amounts. This means
he assumes there is approximately equal demand to buy
and sell the currency.
• It is margin to cover transactions’ costs and other costs.
• It covers normal profit on capital invested in dealing
function.
• If trader is being hit on one side more than the other
side, then this spread indicates his encouragement /
discouragement on either side
Dr. Kapil Harit, SBSC, University of Delhi 36
 BID ASK SPREAD in percentage terms
The spread is generally expressed in percentage by the
equation: If Bid is at discount (i.e. lower) to ask rate
(a) Spread = Ask Rate –Bid Rate X 100
Ask Rate
If Ask is at premium (i.e. higher) than Bid
(b) Spread = Ask Rate –Bid Rate X 100
Bid Rate
Expressing Bid as a discount over Ask is more
commonly practiced and hence we shall adhere to
formula(a) for our calculations.

Dr. Kapil Harit, SBSC, University of Delhi 37

 Spot Rate Quotations -Examples
• USD / CHF Spot: 1.4550 / 1.4560
• The dealer will buy 1 USD and pay CHF 1.4550 in
return. His “bid” rate for USD is CHF 1.4550. He
will sell one USD and would want to be paid CHF
1.4560 in return. His “offer” or “ask” rate for one
USD is CHF 1.4560.
• GBP/EUR Spot: 1.3025/1.3035
• Bid rate : Dealer will pay 1.3025 Euros per GBP
when buying GBP
• Offer rate: Dealer will want to be paid 1.3035
Euros per GBP when selling GBP.
Dr. Kapil Harit, SBSC, University of Delhi 38
 Spot Rate Quotations -Examples

For most currencies, quotations are given in

European terms, that is, the base currency is
the US dollar. The major exceptions rate EUR,
GBP, AUD and NZD (New Zealand Dollar).
These are quoted in American terms, that is,
USD becomes the quoted currency against
these. In market parlance, a “cross rate” and
so is EUR/INR. In the US< financial press gives
quotations in both European and American
terms.
Dr. Kapil Harit, SBSC, University of Delhi 39
 Spot Rate Quotations -Examples
Quotations in inter-bank markets are usually
given up to five or six significant digits or four
decimal places. The last digit thus corresponds
to (1/100)thof (1/100)thunit of the quoted
currency. Thus in the USD/CHF bid rate quoted
above, the last two digits, viz. “50” correspond
to 0.0050 CHF. In the GBP/EUR offer rate the
last digit corresponds to 0.0005 EUR. The last
two digits are called “points” or “pips”.
Dr. Kapil Harit, SBSC, University of Delhi 40
 Spot Rate Quotations -Examples
• The difference between the offer rate and the
bid rate is called the “bid-offer spread” or the
bid-ask spread”. We say the bid-ask spread in
the USD/CHF rate is 10 points or 10 pips. If the
GBP/EUR rate moves to 1.3028/38, we say the
GBP has moved up three pips. For small
denomination currencies like the JPY or the
Italian Lira, quotes are given up to 2 decimals
only. In such cases a point or pip has the value
0.01 or (1/100)th of the quoted currency.
Dr. Kapil Harit, SBSC, University of Delhi 41
 Spot Rate Quotations -Examples
• The quotations are usually shortened as
follows:
• USD/CHF: 1.4550/1.4560 will be given as
1.4550/60.
• When two dealers are conversing with each
other this may be further shortened to 50/60.
The first three digits, viz. 1.45 are known as
the “big figure” and professional dealers are
supposed to know what the big figure is at all
times.
Dr. Kapil Harit, SBSC, University of Delhi 42
 Cross rate : chain rule
• When bid & ask rate is given
– (B/C) bid = (B/A)bid * (A/C) bid ………………(1)
– (B/C) ask = (B/A) ask * (A/C) ask……………….(2)
• Therefore
–(B/A) bid = 1 ÷(A/B) ask
–(B/A) ask = 1 ÷(A/B) bid

Dr. Kapil Harit, SBSC, University of Delhi 43

Cross Rate: Chain Rule

Dr. Kapil Harit, SBSC, University of Delhi 44

Thank You
Dr. Kapil Harit
09897508717
kapilharit2005@gmail.com

Dr. Kapil Harit, SBSC, University of Delhi 45