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What is Foreign Exchange Market

In narrow terms, Forex simply means foreign currency or money other than the domestic currency or money In Broader Terms, Forex Means Study of all the currencies of the countries of the World How they are exchanged or traded with each other Exchange rates and how they are set The Exchange markets The Participants

Forex Market Features

The Market Has No Physical Presence. It Is The Largest Market On The Planet Earth . It Is Mostly Speculative In Nature. It Is A 24 Hour Market. Some New York banks maintain 2 shifts (one arriving at office at 3 am when London and Frankfurt are open). Large New York banks also have branches in Tokyo, Frankfurt, and London. Thus, they are in contact with all financial centers 24 hours. Daily Turn Over 1.75 To 2.00 Trillion Dollar Per Day Daily Turn Over Indian Market @ USD 35 Billion It Is A Market Connected By Advanced Communication Channels Like S.W.I.F.T. It Is An Extremely Active And Also An Unpredictable Market. The Market Is Truly Global As Trades Take Place Across Continents. Most Deals Are On Spot Basis. The Market Is Deep, Liquid And Efficient. Deals Are Screen Based. Market Is Volatile Because Of Floating Nature Of Exchange Rates

Foreign Exchange Market

 Interbank Market-Whole sale Market Market Central Banks, Commercial Banks,
Financial Institutions & Corporate (Union States)  The Average Lot Size - USD 1 - 5 Mn  Indian Lot Size - USD 0.25 1.0 Mn

Retail Market
Tourists Individual needs Forex in the form of TC, Drafts Importer Exporters The amount is small in this market

Foreign Currency Accounts

Nostro Account Nostro account is an account maintained by a bank in India with a bank abroad i.e.S.B.I. may maintain an account with CitiCiti-Bank New York or with HSBC in London for $ operations and Sterling operations respectively. While corresponding with the Citi or HSBC SBI would refer its account with former two as Nostro account, means our account with you. All foreign exchange transactions are routed through Nostro accounts.  Vostro Account A foreign bank may open rupee account with an Indian bank. while corresponding with the foreign bank maintaining an account with it, the Indian bank would refer to the account as Vostro account meaning your account with us .Bank of Baharin and Kuwait may open an account with Union Bank of India and draw drafts on the account. On presentation of drafts, the Indian bank would pay to the debit of the foreign banks account with it. For exchange control purposes such accounts are known as non-resident bank accounts non

Forex Terms



SwiftSwift-Society for world wide Interbank Financial Telecommunication. It is replaces paper by electronic fund transfer by secure SWIFT Codes ,thereby reduces Transaction costs. It is supported by 1200 professional organizations throughout the world CHIPSCHIPS-Clearing House for Interbank Payment system is a US Based electronic payment system CHAPSCHAPS-Clearing House for Automated payment system is a UK based electronic payment system ReutersReuters- Reuter is a London based organization established in the year 1851.First Electronic trading screen which gives real time quotes was established in the year 1973 by Reuters TelrateTelrate- Telrate is an American organization established in 1969 to deal in screen based trading for foreign exchange EuroclearEuroclear- Euroclear is a Brussels based organization, involved in large scale bond clearance CEDELCEDEL-Cedel is in Luxembourg, involved in large scale bond clearance Fedwire The transactions at NY-Forex market ultimately get settled NYthrough Fedwire.It is a communication network that links the computers of about 7000 banks to the computers of Federal Reserve Banks

Types Of Deals In Forex Markets

 Cash/Ready Basis  Tom Basis  Spot Basis  Forward Basis



Arbitrage is the simultaneous taking of a position in two or more markets in order to exploit a valuation discrepancy between the pricing of assets in the different markets SBI quotes 46.72/74 ,BOB Quotes 46.75/77 then buy from SBI and sell to the BOB (The Market Quotes 46.73/75) SBI must be in over-bought position and hence it discourage the $ overseller to her and encourage the $ buyer from her by giving the lower quote than the market BOB must be in short position and hence it discourage the $ buyers from her and encourage the $ seller to her by giving the higher quote than the market Mumbai Quotes 1$= 46.78/79 INR, London Quotes 1= 86.63/64 INR and New York Quotes 1= 1.8485 /1.8490 $ Sell 100,000 buy INR i.e.86,63,000 Sell these INR buy $ (8663000/46.79)=$185,146.40 Sell these $ against the ( 185,146.40/1.8490) = 100,133.25 Put Cost 33.25 ,Net gain will be 100 i.e. 0.1 %

Cross Currency Rates

 We know that USD being the currency of
intervention only USD/INR exchange rate is available in the Indian Forex Market and exchange rates of rupee with all other foreign currencies are derived from this rate  Suppose Mphasis earned 1mio in Briton ,now they want to remit the same to India then first they have to sell these 1mio in London against the $ and those $ will be sold in Mumbai against INR  Suppose London quotes1=1.8505 USD and Mumbai quotes 1$= 46.7500 INR

Forwards Transations


The transaction in which the exchange of currencies takes place at a specified future date subsequent to the spot date is known as Forward Transaction. The exchange rate of settlement is called as forward rate The forward rate has two components Spot rate Forward Points Forward points are also called forward differentials between the pair of currencies provided capital flows are freely allowed Forward Transactions Theoretically the forward price of the currency can be equal to the spot price and in such case a situation this is called at par. But this happens rarely When a currency is costlier in future as compared to spot, the currency is said to be at a premium vis--vis another currency. vis{Fwd rate > Spot rate} When a currency is cheaper in future as compared to spot, the currency is said to be at a discount vis--vis another currency. vis{Fwd rate < Spot rate}

Factors Determining Forward Margin


of Interest  Demand and Supply  Speculation of Spot rate  Exchange Regulations

Basis for Merchant Rates

When the bank buys FE from the customer, it expects to sell the same in the interbank market at a better rate and thus make a profit out of the deal. In the interbank market, the bank will accept the rate as dictated by the market. It can,therefore,sell foreign exchange in the market at the market buying rate for the currency concerned. Thus the interbank buying rate forms the basis for quotation of buying rate by the bank to its customer. When the bank sells FE to the customer, it meets the commitment by purchasing the required foreign exchange from the interbank market. It can acquire FE from the market at the market selling rate.Therefore,the interbank selling rate forms the basis for quotation of selling rate to the customer by the bank.

TT Buying Rate


This is the rate applied when the transaction does not involve any delay in realization of the foreign exchange by the bank. In other words, the Nostro account of the bank is would already have been credited .The rate is calculated by deducting from Interbank buying rate the exchange margin as determined by the bank So any transaction where no delay is involved in the bank acquiring the Forex will be done at the TT Rate Payment of demand drafts, mail transfers, TTs drawn on the bank where banks Nostro account is already credited Foreign bills collected. When a foreign bill is taken for collection, the bank pays the exporter only when the importer pays for the bill and the banks Nostro account abroad is credited

Bill Buying Rate

     In case of exports, the exporter sends the goods and draws document like BoE against which the payment is to be received as per the agreement between the buyer and seller. Here the exporter does not offer Forex immediately rather offers documents for his claim to get Forex at a future date and this claim is discounted, purchased or negotiated by the AD. The AD can dispose of the Forex only when he receives the same in his Nostro A/C Hence the rate quoted by AD will be by adjusting the spot rate by loading forward margin for the period during which Forex is expected to be received by the bank When a bill is purchased, the rupee equivalent of the bill value is paid to the exporter immediately.However,the proceeds will be realized by the bank after the bill is presented to the drawee at the overseas center. In the case of a usance bill, the proceeds will be realized on the due date of the bill which includes the transit period and the usance period of the bill. If a sight bill on New York, the realization will be after a period of about 25 days (Transit period). The bank would be able to dispose of the Forex only after this period.Therefore,the rate quoted to the customer would be based not on the spot rate in the interbank market but on the interbank rate for 25 days forward. If the bill purchased is 30 days usance bill, then the bill will realize after about 55 days.Therefore,the bank would be able to dispose of Forex only after 55 days. The rate to the customer would be based on the Interbank rate of 55 days forward

Selling Rates

When a bank sells Forex it receives local currency from the customer and parts with forex.the sale is effected by issuing a payment instrument on the correspondent bank with which it maintains the Nostro account. Immediately on sale, the bank buys the requisite Forex from the market and gets its Nostro account credited with the amount so that when the payment instrument issued by it is presented to the correspondent bank it can be honored by debit to the Nostro Account. Therefore, for all sales on ready/spot basis to the customer the bank resorts to the interbank market immediately and the base rate is the interbank spot selling rate. However depending upon the work involved i.e. the sale involves handling of documents by the bank or not TT Selling Rate This is the rate to be used for all transactions that do not involve handling of documents by the bank. The TT selling rate is calculated on the basis of interbank selling rate. The rate to the customer is calculated by adding exchange margin to the interbank rate. Bills Selling Rate This rate is to be used for all transactions which involve handling of documents by the bank i.e. payment against import bills. The bills selling rate is calculated by adding exchange margin to the TT selling rate. That means the exchange margin enters into the bills selling rate twice, once on the interbank rate and again on TT selling rate

Factors Affecting Spot Rates



Balance of Payment BoP represents the demand for and supply of Forex which ultimately determine the value of the currency If BoP of a country is at deficit then the value of currency falls while if the BoP of a country is at surplus then the value of currency gains Inflation Higher the inflation higher would be the domestic prices of goods and commodities that may not be competitive in export market



Interest Rates The interest rate has a great influence on the short term movement of capital. When there is rise in interest rate in one centre ,it attracts the short term funds from other centres. Monetary Policy An Increase in money supply in the country will affect the exchange rate through causing inflation in the country. The total money supply in the country represents the value of total goods, commodities and services in the country and external value of the currency will be derived from it



National Income An Increase in National Income in the country will increase the demand for goods in the country. If there is underutilized production capacity in the country, this will lead to increase in production, but if there is no immediate increase in production vis--vis with income then it leads to visincreased imports and increased supply of the home currency in the Forex market. Thus an increase in national income will lead to an increase in investment or in consumption and accordingly its effect on the exchange rate will change Central Bank Intervention Buying and selling Forex in the market by the central bank with a view to increase the supply or demand, thereby affecting the exchange rate is known as intervention. The central banks all over the world play a crucial role in maintaining the Forex markets in an orderly manner.Thus,at the time of violent fluctuations central banks of different countries act together and intervene in the markets It is said that the fear of intervention in the Forex market by the central bank of the country is more important and effective, than the actual intervention





Resource Discoveries Discovery of North Sea oil by Briton helped GBP to rise against USD Speculation In Forex market there is lot of speculative activity. If a few big speculators start buying a currency in an aggressive manner, others may follow suit. And the currency may strengthen in the short run. This is known as Bandwagon effect. effect. Similarly, if a few big speculators start selling a currency in an aggressive manner, others may also join them for making a quick buck by 'riding the' market' the currency may weaken in the short run. Capital Movement Bright investment climate and political stability may encourage portfolio investments in the country. This leads to higher demand for the currency and upward trend in its rate. Poor economic outlook may mean repatriation of the investments leading to decreased demand and lower exchange value for the currency of the country Political Factors As financial Flows seeking safe and better returns, the political stability in the country plays a vital role. Both FDI & Particularly FII are sensitive to political conditions prevailing in the country Exchange Control Exchange control is generally aimed at controlling free movement of capital flows and therefore affects the exchange rates. Sometimes countries exercise exchange control through exchange rate mechanism by keeping the exchange rate of currencys at artificial level