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International Banking
(Module A) ± PART-I
Foreign Exchange
Tanushree Mazumdar, IIBF
þ Exchange rates
þ Risk management and basics of
þ Documentary letters of credit
þ Facilities for exporters and importers
þ Correspondent banking and NRI
þ RBI and exchange control in India, EXIM
Bank, ECGC
þ International transaction in cash requires two
distinct purchases
‡ Purchase of foreign currency
‡ Purchase of good/service with the FC
þ Term foreign exchange is used to denote
foreign currency
þ Foreign exchange market exists to cater to the
demand for foreign currency/currencies
ë  Exchaa

þ èrganisational setting within which
individuals, governments and banks buy
and sell foreign currencies
þ ènly a small fraction of daily transactions
in foreign exchange involve trading of
þ Most foreign exchange transactions
involve transfer of bank deposits
þ Deposits, credits and balances payable in
foreign currency
þ Drafts, travellers¶ cheques, letter of credit or bill
of exchange expressed or drawn in Indian
currency but payable in foreign currency
þ Drafts, travellers¶ cheques, L/Cs, etc. drawn by
banks, institutions or persons outside India but
payable in Indian currency
þ The above definition is as per FEMA (1999)
þ Denotes the price or the ratio or the
value at which one currency is
exchanged for another
þ Exchange rate is very dynamic
þ The foreign exchange market is round-
the-clock market due to different time
þ Major participants- central banks,
commercial banks, forex brokers,
corporations, individuals
ëac ac xchaa 
þ Major banks that act as market-makers
always give two-way quotes; gives depth
and volume to the market
þ Fundamental reasons
þ Technical reasons
þ Speculation
ëam aa 
þ Balance of payments->surplus-
þ Growth rate of the economy-> higher
growth->depreciation of currency
þ Fiscal policy-> financing of fiscal deficit
influences exchange rate
þ Monetary policy->loose monetary policy-
> depreciation of exchange rate
jch caa 
þ Freedom or restrictions on capital
movements can affect exchange rates to
a large extent
þ Among other factors there are:
‡ Huge trade surpluses of oil exporting
‡ Capital moving from low-yielding currencies to
high yielding currencies (interest differential)
þ Self-fulfilling prophecies
‡ Anticipation of depreciation of a currency can
cause dealers to sell that currency
þ Speculation serves to provide depth and
liquidity to the forex market
þ Acts as a cushion as well- contrarian
traders exist in the market
j  xchaa  
þ O - Settlement of funds on the
same day (date of the deal).
þ j - Settlement of funds takes place on
the next working day of the date of the
þ   - Settlement of funds takes place on
the second working day following the
date of the deal
j  xchaa  
þ Forward- Delivery takes place on V 
day after the date of the deal
þ In the forex market all rates that are
quoted are generally spot rates
þ When delivery takes place beyond the
spot date then it is a forward transaction
and the forward rate is applicable
þ Forward rate = Spot rate + Premium (-
ë  aa 
þ If the forward value of a currency is higher than
the spot value the currency is said to be at a
þ If the above is reversed the currency is said to
be at a discount
þ The forward premium/discount is based on
interest rate differentials of the two currencies
þ Direct and indirect quotes of exchange rate-
direct quote, local currency is variable
M  Exchaa 
þ Cross rates- To obtain rates for a
particular currency pair when they are
not available directly
þ Bid and offered rates- In USD/INR
39.40/41 the bank is bidding for USD at
Rs. 39.40 and offering to sell USD at Rs.
Excha hm c
þ All foreign exchange calculations have to be
worked with care and accuracy and several
rules have to be kept in mind
þ Chain rule- is used to attain comparison or
ratio between two quantities which are linked
together through another or other quantities.
Equation in the form of a chain is derived.
þ Per cent and per mille- Per 100 units/per 1000
Exam  auha  
þ Muery: If we have to remit French Francs
to France from India how do we go about
it? (We have to arrive at cross rates
between FRF and INR.)
þ Mumbai interbank market:
‡ US $ 1 = Rs. 41.2550/2650
þ London Market
‡ US $ 1 = FRF 6.0500/6.0550
þ At what rate can one buy FRF against rupees?
þ How many Rs----- = FRF 1?
þ FRF 6.0500 = US $ 1
þ US $ 1 = 41.2650, therefore,
þ FRF 6.0500 = US $ 1 = Rs. 41.2650
þ Hence, FRF 1 = 41.2650/6.0500
þ èr FRF 1 = Rs. 6.8206
ë  aa  
þ Xalue date: It is customary, in foreign
exchange market, to quote a rate to do the
deal but exchange the currencies not on the
same day but generally afterwards.
þ Forward rate: Has two components
‡ Spot rate
‡ Forward points or forward differentials

þ Forward rate is the rate when the value of the

deal is fixed beyond the spot date i.e. beyond
the second working day after the deal
ë  aa  
þ Forward transactions are necessary in the
foreign exchange market as they serve number
of purposes like:
‡ ène can hedge or cover an existing future financial,
commercial or trade related exchange risk
‡ These types of deals, in combination with spot deals,
are used for money market operations through µswap¶
‡ Taking a view of the market, these can be used for
ë  aa  
þ When a currency is costlier in the future
(forward) as compared to the spot, the
currency is said to be at a premium vis-à-vis
another currency
þ In µdirect rate¶ premium is added to both the
buying and selling rate whereas discount is
þ In µindirect rate¶ premium is deducted and
discount is added to the buying and selling
ë  aa  
þ Base currency is the currency which is being
bought and sold and the other currency is
þ Forwards are quoted as follows
‡ Spot/1 month 17/18
‡ Spot/ 2 months 35/37
‡ Spot/ 3 months 53/56
þ If forward differentials are in the ascending
order (1st figure is lower than the 2nd) the base
currency is at premium
ë  xcha aac 

þ Arbitrage: Is an operation by which one
can make risk free profit by undertaking
offsetting transactions.
‡ Can be in interest rates: borrow in one centre
and lend in another
‡ Can be in exchange rates: Buy a currency in
one market and sell in another
þ Arbitrage keeps exchange rates uniform
in all markets
ë  Exchajaac 

þ Merchant rates: Muotes offered to merchants
(importers, exporters) by banks.
þ Inter-bank rates: The rates quoted by banks for
dealing in the inter-bank market.
þ Merchant quotations: In India all merchant
quotations for foreign currencies shall be in so
many rupees for one unit of foreign currency
except for Japanese Yen, Italian Lira and
Belgian Franc (Rs/100 units of the currency)
þ All quotes are in four decimal places with the
last two digits in the multiple of 25
÷  m ac 
þ Telegraphic Transfers (TT) of funds are done
from one centre to another by way of
instructions through telex, telegram or SWIFT
(Society for Worldwide Interbank Financial
Transfer). èf late SWIFT is becoming popular
þ Mail Transfer (MT) of funds is done by way of
instructions sent by mail. An MT is an order in
writing on the correspondent bank/branch
abroad to pay the beneficiary the sum
÷  m ac 
þ Demand draft (DD): A DD is an order in writing
on the correspondent bank/branch abroad to
pay the beneficiary the sum mentioned therein.
þ Fedai prescribed types of rates of merchant
‡ TT (buying)- clean inward remittances
‡ Bill (buying)- purchase/discount of export bills
‡ TT (selling) clean outward remittances
‡ Bill (selling) remittance for import bills
þ RBI has issued Authorised Dealers (AD)
licences to banks, all India financial
institutions and a few co-operative banks
to undertake foreign exchange
transactions in India
þ It has also issued Money Changer
licences to a large number of established
firms, companies, hotels, shops, etc.
þ Money changers help facilitate encashment of
foreign currencies of foreign tourists
þ Entities authorised to buy and sell foreign
currency notes, coins and travellers¶ cheques
are called full fledged money changers
þ Those authorised only to buy are called
restricted money changers
þ FEDAI (Foreign Exchange Dealers¶
Association of India) is a non-profit making
body formed in 1958 with the approval of RBI
þ Its members are authorised dealers and it
prescribes guidelines and rules of the game for
market operations, merchant rates, quotations,
delivery dates, holidays, interest on defaults,
þ FEDAI also advises RBI on market related
issues and supplements RBI on strengthening
the market