Terms used in Foreign Exchange

1. Repo/ready forward: [opp – reverse repo]Means of funding by selling a

security sold on SPOT basis and repurchasing on forward basis.

2. Currency risk: Risk of value of an investment in

some other country’s currency coming down in terms of domestic currency

3. Country risk:Risk of not being able to invest at

will due to countries changing attitudes on foreign investment/ war revolution,…

4. Tariff: Tax levied on goods traded internationally

→Import duty -on import (to support domestic production)

→ Export duty – to discourage exports.(less frequently imposed)

→ Transit duty – on goods passing through the country

5. Ad valorem duty: % of value of goods6. Specific valorem duty: flat duty based on

number of units, not value of goods.7. BOP: “

A systematic record of all economic transactions between residents of a given country and the rest of the world, carried out over a particular period.(usually a year) →eco, transactions include ‘invisible transactions’ like-

banking, insurance, transport services

8. BOT: Merchandise imports and exports (visible trade - follows Double entry system)

Transaction↑ purchasing power – exports – credit(capital inflow)

Transaction↓ purchasing power – imports - debit (capital outflow/lending)

9. Exchange rate: rate at which conversion takes place. Value of one currency in terms of another.

10.International monetary system: movement in which each exchange rate over a period of time involves,

1. conversion of currencies to one another 2. transfer of funds across nations

for - i. International trade in goods and services.ii. Liquidation/ acquiring of financial

assets.iii. Creation and repayment of individual credit.

Spot rate :rate at which one currency is converted into another on a particular day

Forwards : a contract (obligation) between two parties, to exchange currency or goods,at some specific date in the future

Options : contracts that give option to buy or sell underlying asset at a particular price on or before a specified period

The holder has a right and not obligationBoth pay a “premium”, which they loose if

they fail

Call option : right to buy an underlying asset at a specified price, on or before a particular time by paying a premium

Put option : Right to sell an underlying asset at a specified price, on or before a particular time by paying a premium

• Option writer • Bearish : seller (usually writes)• Bullish : buyer

Types of option

• European style option : exercised only on expiry date/ maturity date

• American style option : at any time before or on due date

• Swaps :simultaneous purchase and sale of foreign exchange for two different value dates. Happens between banks, govts, and business

• Arbitrate : buying currency low and selling high at the same time

• LIBOR : London Interbank Operating Rate of Interest

Integration effect :Freedom and opportunity to raise funds from

and to invest anywhere in the world, through any type of investment

Transmission effect :As a result of freedom anything affecting

financial markets in one part of the world, quickly and automatically affect the rest of the world

Integration increases the transmission effect

Reason for integration?1. Technology : speed, reduced cost,

co- production of activities2. Inflation & interest rates : changes in different

instrumentsi. Development of new financial instruments like

euro dollar market, interest rate swaps, currency swap, future and forward contract,..

ii. Liberalisation of regulations in financial markets

iii. Increased foreign ownership

• LERMS : (Liberalised Exchange Rate Management System)

• After the liberalisation in 1992, dual exchange system was followed in India. One fixed by RBI and other by market.

• It was the beginning of moving towards market oriented rate

• 40/% of the amount was to be converted at RBI rate and the rest by market rate