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Foreign Exchange Transaction

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Working of foreign exchange transactions The method of quoting rates The method of calculating cross rates Basis of exchange rates The factors affecting exchange rates

FE transaction: it arise basically for meeting

different FC needs of banks customers The following types of customers would require purchasing FC in exchange for local currency: importers, travelers, foreign airlines, local airlines, exporters etc The following----selling FC in exchange for local currency: exporters, beneficiaries o home remittances, advertising agencies, investors etc

In free exchange markets when buying foreign

currencies from customers, the bank will evaluate at what rates it can sell that FC in the market, i-e. local inter-bank, foreign inter-bank or the central bank It will then deduct or add an exchange margin i-e profit margin The two way Quote: in the FEM, FC are the commodities being bought and sold and the exchange rate is the price The market always quote a 2-way price Bid (to buy) Offer (to sell)

Methods of Quoting ERs: In most countries,

the quotations are expressed in terms of variable units of the local currency for one constant unit of FC For example, in Pakistan, quotations to the public are expressed as: OMR i-e pound 1= Rs.118.15 118.30 dollar 1 = Rs. 60.25 60.35 This is called a direct quotation (price quotation) Buy at a low price and sell at a high price

Cross Rates: Cross rate may be defined as an

exchange rate that is calculated from two other rates For example, Pak Rs/Eur rate may be calculated from Rs/Eur and Eur/$ = rs/$

Calculation of cross rate may inolve: 1. both exchange rates quoted direct 2. both ER quoted indirect 3. one is direct the other is indirect

In the London Exchange Market, the ER are

quoted with reference to Pound Sterling (base currency) and in New York and other major FEM almost all FC are quoted with ref: to $ (base currency) Mexican importers need Japanese Yen to pay. Both are quoted against $ Jap Yen = 121.13/$ and Mex; ps9.19/$ The cross rate = 121.13/$ div 9.19/$=13.1806/ps The cross rate could also be calculated as the reciprocal

Inter market Arbitrage: cross rates can be

used to check on opportunities for inter market arbitrage. Suppose the following ER are quoted:

City bank quote $ per Eur: $0.9045/e Barclays bank q $per PS: $1.4443/L Dresdner bank q Eu per PS: e1.6200/L

The cross rate b/w CB and BB is: $1.4443/L div $0.9045/e = e 1.5968/L This CR is not the same as DB Quotation of e1.6200/L, so an opportunity exists to profit from arbitrage b/w the three markets