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AUTHOR: MR KISHOR KALYAN MUSHRIF

BASICS OF FOREIGN EXCHANGE

Definition of Foreign Exchange Instruments used in Foreign Exchange Transactions [Foreign Currency Notes and Coins, Demand Drafts, Telegraphic Transfer, Personal Cheques, Travelers’ Cheques, Bills of Exchange]Foreign Exchange Rates Nostro Accounts,Account Position and Exchange Position,Vostro Accounts,Mirror Accounts.

DEFINITION OF FOREIGN EXCHANGE:Foreign Exchange is defines as legal tender of another country. To give an example, in India, the Indian Rupee is the legal tender ie the currency for settlement of all trade, commercial, and other legal considerations between two residents of India.On the other hand, if the two contracting parties reside in two different countries, say one each in India and the USA, neither the Indian can ask the American counterparty to accept payment in INR nor can the American ask the Indian to accept payment I US Dollars. For the Indian party the US Dollars are foreign exchange and for the American the INR is foreign exchange. Indian needs to receive payment in INR and the American needs to receive the payment in US Dollars.

As per the Foreign Exchange management Act 1999, the term Foreign Exchange means foreign currency and includes,1] Deposits, credits, and balances payable in any foreign currency,2] Drafts, Travelers’ Cheques, bills of exchange, expressed or drawn in INR but payable in any foreign currency,3] Drafts, T C s, bills of exchange drawn by banks, institutions or persons outside India but payable in India in Indian Currency.

FOREIGN EXCHANGE INSTRUMENTS:

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The following instruments are used in foreign exchange transactions:1] Foreign Currency Notes and Coins,2] Personal Cheques expressed in Foreign Currency and drawn on a foreign bank 3] Demand Drafts 4] Bills of Exchange,5] Travelers’ Cheques,6] Telegraphic Transfer 7] Mail Transfer.

1] Foreign Currency Notes and Coins: U S Dollar notes and coins are foreign exchange in every country other than the U S A . Indian Rupees are foreign exchange outside India because neither currency can be used as a legal tender outside the country of domicile of he currency.

2] Personal Cheques in Foreign Currency: A cheque issued by an account holder on bank of America New York Branch and expressed in US Dollars in a foreign exchange instrument for the payee if he is a resident of India or any country other than the U S A.Similarly a cheque issued in INR and payable by a bank branch in India is a foreign exchange instrument for the payee if he is not a resident of India.

3] Demand Drafts: A demand draft issued by a branch of a bank in USA payable in INR / US Dollars/ Any other currency by the branch of a bank in India is a foreign exchange instrument. Similarly a demand draft issued by an Indian branch of a bank payable in USD / INR/ Any other currency by a branch of a bank overseas in a foreign exchange instrument.

4] Bills of Exchange: A bill of exchange drawn by a drawer in India and made payable in INR or a foreign currency by a drawee located overseas is a foreign exchange instrument. Similarly a bill of exchange drawn by an overseas drawer on an Indian drawee and made payable in INR / any foreign currency is a foreign exchange instrument.

5] Traveler’s Cheques: When an Indian hotel receives from American tourist travelers’ cheques expressed in US Dollars or in INR and issued by an overseas bank branch, the hotel receives foreign exchange instrument. Similarly a Dubai based hotel accepts travelers’ cheques in INR or any other currency from an Indian tourist, the hotel receives foreign exchange instrument.

6] Telegraphic Transfer:

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AUTHOR: MR KISHOR KALYAN MUSHRIF When a resident of India receives In INR or in foreign currency a Remittance in Telegraphic form through the banking channel from an overseas remitter, he receives foreign exchange instrument. Similarly when an Indian resident remits in INR or in a foreign currency certain amount of money to an overseas beneficiary by telegraphic means through banking channel, the overseas beneficiary receives foreign exchange instrument.

7] Mail Transfer: When a resident of India receives in INR or in Foreign Currency a remittance through banking channel, not in telegraphic form but by means of an instrument exchanged between the remitting and the receiving banks through mail he receives foreign exchange instrument. Similarly when a resident of India remits in INR or in foreign currency certain amount of money to an overseas beneficiary through banking channel by means of Interbank mail, the overseas beneficiary receives foreign exchange instrument.

NOTE: As per Indian exchange control regulations, a resident of India receiving from abroad or remitting abroad INR by means of DD/ MT/ TT deals in foreign exchange.

NOSTRO ACCOUNT: [OUR ACCOUNT WITH THEM]When a bank in India maintains a bank account in another country, denominated In a foreign currency such an account is known as a NOSTRO account [of the Indian bank]. Thus the US Dollar Account maintained by A B C Bank Ltd, Mumbai with say, B T C New York is the NOSTRO [USD} account of A B C Bank Ltd. The NOSTRO account balance of A B C Bank Ltd may be in Credit or in Debit. If it is a credit balance, it can be withdrawn / transferred by A B C Bank Ltd by converting it into another currency of its choice. If the NOSTRO account is in debit, A B C bank Ltd owes the US Dollars with overdraft interest to the B T C, New York.NOSTRO accounts are checking accounts between two banks and don not earn any interest on credit balances maintained in them. All credits to the NOSTRO account of A B C Bank l Ltd with BTC New York represent inflows of U S Dollars for A B C Bank Ltd and similarly all debits to the NOSTRO Account represent outflows of foreign exchange.Thus, NOSTRO Accounts, wherein balances are freely convertible into other currencies and are also freely repatriable are used by Banks to DEAL IN FOREIGN EXCHANGE.When a Bank receives credit in its NOSTRO USD account From another bank, the said bank receives foreign exchange and when under its instructions the NOSTRO account is debited and payment effected to another party, the bank is said to have paid foreign exchange.The A B C Bank Ltd Mumbai can use various instruments to credit or debit its NOSTRO account with an overseas bank. The most common Foreign Exchange Instruments used by the bank are Demand Drafts, Traveler’s Cheques, Bills of Exchange, Telegraphic Transfers, Mail Transfers etc.

The A B C Bank Ltd may buy and sell foreign exchange from / to its corporate and individual customers or from /to other banks in the foreign exchange market. The buying and selling of foreign exchange is done at appropriate Rate of Exchange

FOREIGN EXCHANGE RATES AND FOREX POSITIONS:

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A B C Bank Ltd Mumbai “ DEALS “ in foreign exchange through its NOSTRO account in the foreign currency, which it buys or sells. Thus A B C Bank Ltd uses its BTC New York Account to deal in US Dollars and it will use its Sterling Pound account with a bank in U K to deal in that currency.The term dealing in foreign exchange refers to the bank buying and selling various foreign exchange instruments from counter parties. Like other dealers in consumer / industrial goods, a forex dealer undertakes buying and selling of forex to make profit. The Banks use following rate types to deal in foreign exchange:

BUYING RATES: TT, Bills, Travelers’ Cheques, Foreign Currency Notes and Coins SELLING RATES: TT, Bills, and Traveler’s Cheques.

When a bank buys or sells foreign exchange it is not necessary that its NOSTRO balance be immediately affected. Therefore by applying buying or selling rate and undertaking appropriate foreign exchange transaction the bank creates one of the following positions:ACCOUNT POSITION: When the Nostro account is credited or debited leading to a change in the NOSTRO balance the Account Position is affected. Thus when A B C Bank Ltd receives a Foreign Currency TT from another bank and ABC Bank’s BTC New York account is credited with the amount of TT it results in Account Position for A B C Bank Ltd.EXCHANGE POSITION: When A B C Bank Ltd quotes appropriate buying or selling rate to a counterparty and purchases or sells foreign exchange it results in an Exchange Position for the bank. This may not necessarily affect its NOSTRO Balance simultaneously. Thus when A B C Bank Ltd buys Foreign Exchange in the form of a personal cheque payable abroad in anticipation of collecting the proceeds in course of time and getting the same credited to its NOSTRO account, A B C Bank creates Exchange Position in its books.

BUYING RATES:1] T T BUYING RATE: This applies to purchase of foreign exchange instruments against which the bank has received funds in its NOSTRO account . It also applies to cancellation of outward remittance already sent by the bank.Thus TT Buying Rate applies to: Purchase of Inward TT/ DD / MT in foreign currency, Purchase of Foreign Currency Cheque sent for collection and realised, and cancellation of outward TT / MT/ DD.When A B C Bank Ltd Mumbai receives Inward Fcy TT in USD from another overseas bank, A B C bank receives the TT message from the Remitting bank and also receives actual USD funds in its BTC New York NOSTRO account which it purchases from the beneficiary of the T T.Thus TT Buying Rate is applied to convert an Account Position into an Exchange Position.2] BILLS BUYING RATE: This is applied to purchase of Foreign Currency Personal Cheques payable abroad or to purchase of foreign currency bills of exchange payable abroad. The application of Bills Buying Rate results in the customer [beneficiary of the cheque or drawer of the bill of exchange] being paid INR equivalent of the foreign

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AUTHOR: MR KISHOR KALYAN MUSHRIF currency by A B C Bank Ltd before it receives the proceeds of the cheque / bill of exchange from the overseas drawee. Thus Bills Buying Rate is applied to create an EXCHANGE POSITION in the books of the A B C Bank Ltd. [This position gets converted into Account Position when the cheque/ bill of exchange is paid and credited to the NOSTRO account of A B C Bank Ltd].

3] TRAVELER’S CHEQUES BUYING RATE: A foreign currency traveler’s cheque is like a Personal Cheque but it is drawn by the Issuing bank and not by an individual account holder. The application of T C Buying Rate results in the customer [beneficiary of TC] being paid INR equivalent of the Fcy amount of the T C s by A B C Bank Ltd before it receives proceeds of the T C s from the issuing bank. Thus T C Buying Rate creates Exchange Position in the books of A B C Bank Ltd.

4] FOREIGN CURRENCY NOTES AND COINS BUYING RATE: When A B C Bank Ltd buys FCNC from its customer / foreign tourist. it pays INR equivalent of the FCNC to the tourist on the spot . The A B C Bank may subsequently send the currency to BTC New York for crediting its NOSTRO account [in theory this is fine, but in practice this is not done].Thus BUYING Rate is applied to an instrument where the A B C Bank Ltd has already received credit to its NOSTRO account [as in case of Fcy DD/MT/TT or realisation of Fcy Cheque sent for collection] or where in course of time the proceeds of the Fcy Instrument will be credited to the NOSTRO account [as in case of Fcy Personal Cheque/ TC / FCNC]Thus application of Buying Rate signifies an existing Inflow of Foreign Exchange or a potential Inflow being purchased by A B C Bank Ltd.

SELLING RATES:

1] T T SELLING RATE: This rate applies to all selling transactions where bank sells foreign currency Telegraphic Transfers, Demand Drafts, Mail Transfers to its customers. The bank receives INR funds and issues any one of these Foreign Currency Instruments to the applicant as per his requirement .All these instruments are known as Clean Instruments because they are not issued in connection with any Trade transactions. TT Selling Rate creates Exchange Position first and when the DD/ TT/ MT is actually paid it results in Account Position.

2] BILLS SELLING RATE: When a customer wants to pay an overseas supplier for goods imported from the latter, the bank sells foreign exchange to him at the Bills selling rate. The instrument issued is either telegraphic Transfer or Demand Draft but the transaction is sale of foreign exchange against trade document and hence this remittance is not treated as a Clean Remittance.

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AUTHOR: MR KISHOR KALYAN MUSHRIF Bills Selling Rate results in creation of Exchange Position which is converted into Account Position when the specific Fcy Instrument [ TT/DD/MT] is paid .

3] T C SELLING RATE: When a customer wants to go abroad he needs to carry Foreign Currency Travelers’ Cheques with him. This is facilitated by bank selling him T C s in foreign currency.When a bank sells Fcy TC s to its customer it is required to issue Fcy DD in favour of the Bank whose T C s are sold by it.[ Thus, A B C Bank Ltd may be selling T C s of American Express Bank and every time A B C Bank sells the T C s it has to Issue Fcy DD favoring American Express Bank for amount of T C s sold].T C Selling Rate leads to creation of Exchange Position for A B C Bank Ltd and When the DD issued by A B C Bank Ltd is paid, it results in creation of Account Position.

4] FCNC SELLING RATE: When an individual wants to go abroad he may want to carry foreign currency notes with him. His bank may sell Foreign Currency to the individual against payment in INR. The bank holds stock of foreign currency, which it buys from other customers and sells foreign currency from this stock. This transaction does not lead to creation of Exchange or Account Position at any point of time.

FOREX DEALS AND FOREX POSITIONS:Dealers in foreign exchange do not buy or sell forex always in such a way as to affect the exchange and account position simultaneously. The dealers carry out two types of deals, namely, Merchant Deals and Inter Bank Deals.1] Merchant Deals: In these deals banks deal with customers such as corporate, importers, exporters, individuals etc. banks buy /sell foreign exchange to their customers generally in Ready / Cash market or in Forward Market.

2] Inter Bank Deals: In these deals banks deal with each other in Ready / Cash, TOM, SPOT, FORWARD market. The counterparty bank may be within the same centre or may be in an overseas centre.Depending upon when Exchange Position and Account Position take place, the following Deal Types take place.

READY / CASH DEAL: In these deals exchange rate quotation and delivery of currencies take place on the same value date. Selling Fcy TT is an example of Ready / Cash Deal because quoting a TT Selling Rate and Debit to NOSTRO Account of the bank selling the Foreign Exchange take place on the same value date.

TOM DEAL: In the case of this deal the exchange rate between dealt currencies is fixed today but delivery of the currencies takes place on the immediately succeeding working day.

SPOT DEAL: IN case of these deals the exchange rate is fixed today for delivery on the immediately succeeding second working day.

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AUTHOR: MR KISHOR KALYAN MUSHRIF FORWARD DEAL: In case of these deals, the exchange rate is fixed today for delivery to take place beyond the SPOT value date.In view of these types of forex deals, the Foreign Exchange market is divided into four segments. In the Interbank Market, major turnover takes place in the Forward Markets.

In many markets the term Ready Deal denotes CASH/ TOM/SPOT transactions and Forward Deal denotes transactions, which are settled beyond SPOT. VOSTRO ACCOUNTS [THEIR ACCOUNT WITH US]

When a bank operating abroad maintains an INR account with a bank in India, the Indian bank refers to this INR account as a Vostro Account [i.e. their account with us]. Thus between two banks A and B what is NOSTRO account of Bank A with bank B is VOSTRO account for bank B of bank A.Indian Rupee is not a freely traded currency due to local exchange control regulations. Therefore VOSTRO INR accounts of foreign-based banks with banks in India can be maintained only for permissible INR transactions of the foreign banks. These permitted transactions comprise Fcy Remittances denominated in INR, payment foe permitted trade transactions etc but do not include Speculation in INR.Though VOSTRO accounts are in INR, the credit balances in these accounts are freely repatriable abroad in any foreign currency of choice of the foreign based bank. Therefore any Credit to VOSTRO account increases remittable balance and is therefore equivalent to Outflow of Foreign Exchange. Similarly any debit to VOSTRO account reduces remittable balance and is therefore equivalent to Inflow of Foreign Exchange.

Just as NOSTRO accounts have to be adequately funded by Indian Banks so also VOSTRO accounts have to be funded by the Foreign Banks. The Indian bank may fund a USD NOSTRO account by buying USD against INR or any other surplus Foreign Currency. The counterparty bank from which USD are bought may be in India or in a foreign centre.

Similarly the foreign bank may fund an INR VOSTRO account by buying INR against a surplus currency. However, USD may be bought and sold in any part of the world, whereas INR can be bought and sold only in India.

MIRROR ACCOUNTS:

This is maintained by the local [Indian] bank for accounting of inflows and outflows of forex taking place from NOSTRO account of the bank. Whereas USD NOSTRO account shows the actual funds position and actual credits and debits leading to the funds position and is maintained in the books of the bank in USA, the MIRROR [OF NOSTRO] Account is maintained in the books of the local [Indian] Bank.

PURCHASE OF FOREIGN CURRENCY: When an Indian bank receives credit in its NOSTRO account by way of Inward Remittance, it buys the Fcy from the Beneficiary of the Remittance at TT Buying Rate and pays him in INR and passes following accounting entries:

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Debit: MIRROR of NOSTRO Account [Fcy Amount of Remittance @ TT Buying Rate] Credit: Beneficiary.

SALE OF FOREIGN CURRENCY: When an Indian bank remits Foreign Currency, it sells the Fcy to the remitter at TT Selling Rate and pays off the Beneficiary to the Debit of its NOSTRO Account and passes the following accounting entries:

Dr: Customer [Fcy amount @ TT Selling Rate]Cr.: MIRROR of NOSTRO Account

Thus, all credits to NOSTRO Account represent Inflows of Foreign Exchange and these are purchased by the bank to the debit of MIRROR of NOSTRO Account. All Debits to NOSTRO Account represent outflows of foreign exchange and the INR proceeds of such sale are credited by the bank to the MIRROR of NOSTRO Account.

FOREX TRANSACTIONS: ACCOUNTING AND FUND FLOWS

We shall study the following foreign exchange transactions, the accounting procedure and flow of funds related to each of the following transactions now:

1] SALE OF FOREIGN EXCHANGE

Issue of Telegraphic Transfer Issue of Demand Draft Issue of Travelers’ Cheques

2] PURCHASE OF FOREIGN EXCHANGE

Purchase of Inward Telegraphic Transfer Purchase of Demand Draft Purchase of Fcy Cheque payable abroad

3] SALE OF FOREX AGAINST IMPORTS

4] PURCHASE OF FCY BILL OF EXCHANGE [EXPORT BILL]

1] SALE OF FOREIGN EXCHANGE

Sale of foreign exchange by an Authorised Dealer involves the following steps:

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AUTHOR: MR KISHOR KALYAN MUSHRIF A] Quoting of an appropriate exchange rate,B] Debiting customer account /cash with INR equivalent of Foreign Exchange sold C] Issuing appropriate Forex Instrument,D] Outflow of forex funds from the appropriate NOSTRO account of the Authorised Dealer.

All sales of clean instruments [TT, DD, TC] leads to creation of Exchange Position first and when the respective instruments are paid it leads to creation of Account Position for the A D who sold the forex. The AD acts as the facilitator to make payment in foreign exchange to an overseas beneficiary on behalf of local customer who pays for the forex in local currency.Accounting Procedure for Recovery of Local Funds [Sale Transaction]Dr: CASH or Dr: SB / CA/ CC of customer [Fcy amount @ Selling Rate]Cr.: Mirror of Nostro Account [for Fcy Sold]Cr.: P and L accounts Commission Cr.: P and L accounts Telex/ Cable Charges

Thus when A B C Bank Ltd issues DD/ TT in USD it credits the appropriate MIRROR of USD Account in its books. If it sells USD T C s the ABC Bank issues DD favouring the TC Issuing bank [say American Express Bank] . This creates Exchange Position. When the Forex Instrument is paid ABC Bank’s NOSTRO account is debited and Exchange Position is converted into Account Position.

OUTWARD FOREIGN CURRENCY TT [SALE]

In a TT sale there are two flows of funds, one in INR between the Remitter and the Remitting bank and another in Foreign Currency from NOSTRO account of Remitting Bank to the NOSTRO account of the Beneficiary’s bank.

T T REMITTANCE: How does the transaction take place?EXAMPLE1: Remitter: R [In India] , Beneficiary: B [ IN USA ] TT Currency : U S Dollars Remitting Bank: A B C Bank Ltd MumbaiRemitting Bank’s Nostro account with: XYZ Banking Corporation, New York Beneficiary’s Bank Account with: DEF Banking Corporation, New York.ABC Bank Ltd Mumbai sends SWIFT MT 103 to DEF Banking Corporation New York authorizing it to pay B and also advises DEF Banking Corporation about having instructed XYZ Banking Corporation to reimburse it with the amount of TT . ABC Bank Ltd sends MT 202 to XYZ Banking Corporation New York asking it to pay DEF Banking Corporation New York the cover for TT. Thus the purchaser of Fcy TT pays INR in India to the Remitting Bank. The Remitting Bank transfers USD from its NOSTRO account to paying bank’s NOSTRO account in New York and the beneficiary is paid in USD.EXAMPLE 2: Remitter R [IN India] , Beneficiary B [ In London ] TT Currency: US Dollars.

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AUTHOR: MR KISHOR KALYAN MUSHRIF Beneficiary to receive Stg Pounds from his bank in London.Remitter’s Bank account with: ABC Bank Ltd Mumbai ABC Bank’s NOSTRO USD account with: XYZ Banking Corporation New York Beneficiary’s Bank account with: Midland Bank Ltd London Midland Bank London’s NOSTRO USD account with: Midland Bank, New YorkA B C Bank Ltd Mumbai sends MT 103 Message to Midland Bank London asking it to pay USD to B.ABC Bank sends MT 202 message to XYZ Banking Corporation New York, asking it to credit Midland Bank London USD account with Midland Bank New York.Midland Bank London buys USD from Beneficiary B and pays him in Sterling Pounds. Thus a payment originated in INR in India, leads to transfer of USD funds between Remitting and Paying bank. In turn, the Beneficiary receives Sterling Pounds, the local currency of his country of residence.

OUTWARD FOREIGN CURRENCY DD [SALE] Fcy DD Transaction: How does Fcy DD work?The remitter [R], The Beneficiary [ B ] Currency of DD : U S Dollars Remitting bank: A B C Bank Ltd Mumbai Drawee bank: XYZ Banking Corporation, New York Remitter pays A BC Bank Ltd in INR; The bank issues a US Dollar DD payable by XYZ Banking Corporation, New York. Remitter sends the DD to the Beneficiary who deposits it in his bank. The Beneficiary’ s bank presents the DD to XYZ Banking Corporation, which debits USD account of ABC Bank Mumbai in its books and pays the beneficiary’s bank in clearing house funds.

OUTWARD FCY TC ISSUE [SALE]A] FLOW OF INR FUNDS B] FLOW OF FCY FUNDS 1] Payment by ABC Bank Ltd to TC Issuing Bank [AMEX New York] 2] Reimbursement by TC Issuing Bank [AMEX New York] to Encashing Bank Fcy T C Issue Transaction: How does it work?Resident of India going abroad approaches ABC Bank Ltd for Fcy T C s. A B C bank stocks and sells Amex T C s. After selling T C s against INR, ABC Bank Ltd Issued USD DD on its NOSTRO account in favour of AMEX New York being payment for T C s sold. AMEX New York claims payment of the DD in clearing house funds from the Drawee bank [NOSTRO correspondent of ABC Bank Ltd] When the Indian resident goes abroad he encashes the T C s in Hotels, departmental stores etc, and these entities, in turn deposit the T C s with their banks for receiving credit there against.The banker to the encashing party sends the T C s to its Nostro Correspondent in New York for collection and credit to its USD account with the latter.

2] PURCHASE OF FOREIGN EXCHANGE:Purchase of a foreign currency by an A D involves the following steps :1] Quoting an appropriate Exchange Rate to the customer,

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AUTHOR: MR KISHOR KALYAN MUSHRIF 2] Debiting the MIRROR account of a NOSTRO Account if the funds have been already received by the AD in his NOSTRO account: as in case of Inward Fcy TT / DD / MT or realisation of Fcy cheque sent for collection,This leads to conversion of an Account Position into an Exchange Position.OR 3] Debiting an Asset Account in the books of the AD if Fcy funds are to be received at a future date, as in case of Purchase of Fcy Cheque or Fcy Bill of Exchange payable abroad.This leads to creation of an Exchange Position first which in course of time gets converted into an Account Position.

PURCHASE OF FCY TT:How Does TT Purchase Work: Remitter R in London Remitting Bank in London Remitter asks his bank to sell him USD against Stg Pounds.1] Remitting bank receives Stg Pounds from Remitter and sends MT 103 to paying Bank in India.Remitting Bank sends MT202 to its Nostro USD Correspondent and transfers USD cover for TT to the Paying Bank’s Nostro Correspondent in New York.Inflow of Fcy Funds in the NOSTRO Account of Paying Bank 2] Paying Bank in India buys the Fcy amount of TT from the Beneficiary and pays him in INR Outflow of INR [In India] 3] The paying Bank in India sells off USD to “ Another Bank “ and receives INR there against.Outflow of Fcy Funds [from NOSTRO account of Paying Bank] 4] Inflow of INR Funds TRANSACTION:Remitter R in London, Remitting Bank in London,Beneficiary B in India, Paying Bank in India.Remittance in US Dollars.

1] Remitter R pays Sterling Pounds to remitting bank in London, which sells him USD TT. Remitting Bank sends MT 103 to paying Bank in India and MT 202 to its Nostro USD Correspondent in New York.Remitting bank’s Nostro USD Correspondent credits Nostro account of paying Bank with USD cover for the TT.2] Paying Bank in India purchases USD at TT Buying Rate from Beneficiary B and pays him in INR.3] Paying Bank sells off USD to “Another Bank “against INR. Paying Bank sends MT 202 to its NOSTRO USD Correspondent in New York to transfer the USD to NOSTRO account of “ Another Bank “ “Another Bank “pays for USD in INR.

FLOW OF FUNDS [INWARD FCY DD PURCHASE]In the case of Inward Fcy DD Purchase the flow of funds is as follows:1] Inflow of Fcy Cover from the Drawer of DD to the Drawee of the DD.2] Outflow of INR against purchase of Fcy amount of DD from Drawee bank to payee of the DD

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AUTHOR: MR KISHOR KALYAN MUSHRIF 3] Outflow of Fcy amount of DD from Drawee bank to “ Another Bank “ to whom the USD are sold.4} Inflow of INR from “ Another Bank “ to Drawee Bank..

TRANSACTION:1] Remitter [Purchaser of DD] pays Sterling Pounds to the “ Drawer “ of the DD [Issuing bank]. Issuing bank gives the Purchaser a DD denominated in USD in favour of a Beneficiary named by the Purchaser of the DD .The Drawee is a bank in India.2] Issuing Bank sends MT202 to its USD Correspondent in USA to transfer cover funds to the Nostro Account of the Drawee bank.3] Purchaser sends the DD to the Beneficiary in India who in turn presents it to the Drawee Bank for obtaining payment in INR. 4} Drawee bank purchases the USD Cover from the Beneficiary and pays him INR at TT Buying rate.5] Drawee bank sells off the USD to “Another Bank “in India against INR. Drawee bank transfers USD from its NOSTRO USD account to the NOSTRO account of “Another Bank “.“Another Bank “pays the Drawee bank in INR REALISATION OF FCY CHEQUE SENT FOR COLLECTION Collection of Foreign Currency Cheque payable abroad requires the following activities, funds flow to take place 1] Payee deposits the cheque with the A D for collection,2] A D books contingent liability in his books for approximate INR value of the cheque,3] A D sends the cheque for collection to an appropriate correspondent bank with a request to credit the proceeds of the cheque to the NOSTRO Account of the AD upon realisation of the cheque,4] The Correspondent bank presents the cheque to the drawee bank for payment,5] The correspondent bank credits proceeds of the cheque to the Nostro Account of the AD under advice to the latter,6] Upon receipt of credit intimation, the A D buys the Fcy amount realised at TT Buying rate and pays the Payee in INR,7] A D sells off the proceeds of the cheque to “ Another Bank “ against INR.

ACCOUNTING FOR FCY CHEQUES FOR COLLECTION A] BOOKING OF CONTINGENT LIABILITY DR: ODBF Lodged [Outward Demand Bills Foreign Lodged]CR: ODBF for Collection [INR equivalent of Fcy amount of cheque at TT Buying Rate of date of lodgment of cheque]B] REALISATION OF FCY AMOUNT OF CHEQUE Dr: Mirror of Nostro Account [Fcy amount realised at TT buying Rate on date of payment to payee]Cr.: P and L a/c Commission Cr.: P and L a/c Exchange Cr.: SB / CA/ CC of the “payee “

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1] FLOW OF INSTRUMENT Drawer of the Fcy cheque sends it to the Payee who deposits it with the AD

The AD sends the cheque to his Nostro Correspondent bank, which presents it to the Drawee for payment.2] FLOW OF FUNDS [Fcy] Drawee pays the Ad’s correspondent bank in clearing funds and the correspondent bank credits the fcy proceeds of the cheque to the Nostro account of the AD. 3] FLOW OF FUNDS [POST REALISATION]: INR The A D credits payee with INR equivalent of the Fcy amount of the cheque at TT Buying rate.4] FLOW OF FUNDS [SALE OF CHEQUE PROCEEDS BY AD] AD sells Fcy amount of cheque to “Another Bank “which pays him in INR locally.AD sends MT202 to his Nostro Correspondent transferring the amount to “Another Bank’s “Nostro account. Another Bank pays INR to the AD.PURCHASE OF FCY PERSONAL CHEQUE PAYABLE ABROAD Purchase of Fcy Cheques payable abroad for a Payee in India by the Authorised Dealer requires the following activities, funds flow to take place:1] The Payee tenders the Fcy Cheque to the AD for purchase [i.e. immediate credit subject to final payment of the cheque],2] The A D quotes an appropriate Fcy Buying rate,3] A D debits a Fcy Cheque Purchase [Asset] Account with INR equivalent of Fcy amount of the cheque at the Fcy Buying rate 4] AD recovers interest and other charges and credits net proceeds to the account of the payee with him,5] AD sends the cheque to an appropriate Nostro Correspondent for realisation [the process being the same as collection of Fcy Cheque],6] AD receives credit advice from the correspondent bank-indicating realisation of proceeds of the cheque [same as in case of cheque sent for collection],7] A D reverses the Asset in his books to the debit of Mirror of Nostro account at the original Fcy Buying rate,8] AD sells off the Fcy received either in the CASH market. Alternately, AD may have booked Forward Sale Contract at the time of purchasing the cheque and now he meets his commitment to the counterparty by making the Fcy available to the latter.ACCOUNTING PROCEDURE:Dr: Fcy Cheque Purchase Account Cr.: P and L Acct Discount Cr.: P and L acct Postage Cr.: SB/CA/CC acct of Payee.Discount: Refers to interest on the INR Asset for the Transit period [i.e. period between purchase of cheque by the AD and receipt of advice by the Ad of credit of proceeds of the cheque to his Nostro Account]Postage: Postal/ Courier Charges incurred by the AD in sending the cheque to the Nostro Correspondent.Cr.: SB/CA/CC of payee: Net proceeds of the cheque are credited.

FLOEW OF INSTRUMENTS, FUNDS [PURCHASE OF FOREIGN CURRENCY CHJEQUE]

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1] FLOW OF INSTRUMENT Drawer of the cheque sends it to the Payee and the payee deposits it with the AD. The AD sends the cheque to his correspondent maintaining the Nostro Account. 2] FLOW OF FUNDS [PURCHASE OF CHEQUE] INR FLOW AD applies appropriate Buying rate and creates Fcy Cheque Purchase Asset in his books and after recovery of interest and postage etc credits net proceeds to the SB/ CA/CC of the Payee.3] FLOW OF FUNDS [FCY]The Drawee of the cheque in the overseas centre pays the proceeds of the cheque to the Nostro Correspondent of the AD in Clearing House funds . The Nostro Correspondent credits the Account of the AD with the cheque proceeds under advice to the latter.4] FLOW OF FUNDS [SALE OF REALISED PROCEEDS]The AD sends MT 202 to the Nostro Correspondent for transferring the cheque proceeds to “ Another Bank’s “ Nostro account and receives INR from “ Another Bank “.

PURCHASE / DISCOUINT OF FCY EXPORT BILLS BY THE AD Purchase of Fcy Export Bill payable on DEMAND and Discounting of Export Bill payable at a future date are very similar transactions and require the following activities and funds flow:1] The Exporter tenders the Fcy bill of exchange to the AD for Purchase or for Discounting and immediate credit of net INR proceeds to the account of the exporter.2] AD quotes an appropriate Fcy Buying Rate,3] AD debits an appropriate bill asset account with INR equivalent of Fcy amount at the buying rate,4] AD recovers discount, exchange, postage etc being bank’s charges payable by the exporter at the time of Purchase / Discounting of the Fcy Bill of Exchange.5] AD sends the Export Bill with the Fcy Bill of Exchange to the collecting bank for presentation to the drawee for acceptance and payment or payment as the case may be.6] The Collecting Bank presents the Bill to the drawee for payment [if it is payable on demand] or for acceptance and payment [if it is a Usance bill of exchange and yet to be accepted by the drawee] or for payment at maturity [if it is a Usance bill of exchange and is already accepted by the drawee.]7] The AD may have sold forward the bill proceeds taking into account an appropriate Transit Period or he may sell for CASH the bill proceeds. Either of which happens on realisation of the proceeds of the export bill. The AD transfers the Fcy proceeds from his Nostro account to that of “Another Bank “ whom he has sold the Fcy and receives INR from the counterparty bank.

ACCOUNTING PROCEDURE:A] PURCHASE / DISCOUNTING OF EXPORT BILL:Dr: Foreign Currency Bill Purchase / Discount Account [Fcy amount of the bill of exchange at the appropriate buying rate]

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AUTHOR: MR KISHOR KALYAN MUSHRIF Cr.: P and L Account Discount [Interest for transit period]Cr.: P and L Account Postage Fixed amount of postage/ courier charges]Cr.: P and L Account Exchange [as a % of INR value of the bill]Cr.: CC/ Ca of Exporter.B] REALISATION OF FCY EXPORT BILL [PURCHASE /DISCOUNTED]Dr: Mirror of Nostro Account [original Asset amount]Cr.: Foreign Currency Bill Purchase / Discounted Account.[Assumption: Bill realised for full value of foreign currency]

FLOW OF INSTRUMENTS AND FUNDS 1] FLOW OF FUNDS The exporter / drawer tenders the export bill to the AD for Purchase / Discounting.The bank credits his CA/ CC with net proceeds in INR after creating a bill asset in its books. 2] FLOW OF INSTRUMENT The exporter / drawer of the Bill of Exchange submits the bill to the AD for purchase/ discount and collection of proceeds from the drawee. The AD [Remitting Bank] forwards the export bill to the Collecting Bank, which presents it to the drawee for payment or acceptance and payment.3] FLOW OF FUNDS [Fcy] [Realisation of Export Bill]The drawee pays up the bill proceeds to the Collecting bank and receives the documents from it. The Collecting Bank remits proceeds to the Remitting Bank’s Nostro Correspondent and sends an MT “Advice of Payment to the Remitting Bank.4] FLOW OF FUNDS [SALE OF REALISED PROCEEDS The Remitting Bank upon receipt of bill proceeds makes the Fcy available to “Another Bank “and receives INR from the latter. The Remitting Bank sends MT to its Nostro Correspondent authorizing transfer of Fcy to “Another Bank “.

SALE OF FOREIGN EXCHANGE AGAINST IMPORT BILL [RECEIVED FOR COLLECTION]In case of an Import Bill being retired by the importer through an AD the following Steps are required:1] Overseas seller submits the Export bill to his bank for presentation to the Indian importer for payment or acceptance and payment,2] The Remitting Bank forwards the bill to the AD who acts as a collecting bank,3] The AD presents the Import Bill to the Indian importer [the Drawee] for payment or acceptance and payment on maturity date.4] The AD quotes appropriate Selling rate to the Importer,5] The Importer pays INR funds to enable the AD to remit Fcy amount of the bill to the Remitting Bank,6] The AD authorises his Nostro Correspondent to pay the Fcy amount of the import bill to the Nostro Correspondent of the Remitting bank,7] The AD sends an advice of payment to the Remitting Bank.8} AD‘s Nostro account is debited and the Remitting Bank’s Nostro account is credited.

ACCOUNTING PROCEDURE

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AUTHOR: MR KISHOR KALYAN MUSHRIF Dr: CA/ CC of Importer [INR equivalent of Fcy amount of Import Bill + Remitting Bank’s Charges + AD’s charges]Cr.: Mirror of Nostro Account [INR Equivalent of Bill amount and Remitting Bank’s Charges]Cr.: P and L account Commission Cr.: P and L account Exchange 1] FLOW OF DOCUMENTS The Overseas Seller / Drawer tenders the Trade Document / Export Bill to his bank for collection from the Indian Importer / Drawee. The Remitting bank forwards the Trade Document to the Collecting Bank [AD in India] The AD presents the Import Bill to the Drawee [ Indian Importer for acceptance and payment or payment as the case may be .2] FLOW OF FUNDS [INR]The Drawee pays up INR equivalent of Fcy amount of Import Bill to the AD [Collecting bank] to remit Fcy ti the Remitting bank.3] FLOW OF FUNDS [FCY] The AD [Collecting bank] sends MT 420 an Advice of payment to the Remitting bank and a MT 202 a payment message to the AD’s correspondent. The payment message authorises payment of Fcy amount from AD’s Nostro account to the Remitting bank’s Nostro account towards payment of the import bill.

FOREIGN EXCHANGE MARKETS

INTRODUCTION[Nature of Forex Market, Market participants: Price makers, Secondary Price makers, Price Takers, Forex Brokers, Speculators, Central banks etc]The Foreign Exchange market is truly GLOBAL and very large one. It is estimated to have a daily turnover in excess of USD 2000 BILLIONS and the turnover is growing all the time. The currencies of various countries are traded against each other in this market. The Foreign Exchange deals between parties arise mainly out of the following activities:1] Trade Transactions,2] International Capital Flows,3] Repayments of loans,4] Fresh loan flows,5] Speculative Transactions in currencies.

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AUTHOR: MR KISHOR KALYAN MUSHRIF

The Forex market operates differently from commodity markets and stock markets in the sense that this market does not have an institutionalized framework. In this market, the buyers and sellers mostly sit in various dealing rooms of banks, corporate, central banks etc. The buyers and sellers trade with each other over telephones or computers. They are able to access up to the moment currency prices and various financial data due to the various financial information providers such as the Reuters. NATURE OF FOREIGN EXCHANGE MARKET:There are four components of this market as follows:1] Spot Market [For Immediate delivery of currencies],2] Forward market [For Future Deliveries beyond Spot Date],3] SWAPS [Simultaneous buy and sell transactions],4] Derivatives Market [Futures, Options, FRAs, etc].The Foreign Exchange market has close ties with the local money markets. These result from different interest rates prevalent in these two markets. When interest rates are higher in one market than the other, funds flow from low yield market to higher yield market. These funds flow result in SPOT transactions as well as Forward Sales against Spot Purchases, which are known as a kind of SWAP.ARBITRAGE TRADING:When exchange rates are even slightly different between two market centres the trader can benefit from buying in one market and selling in the other market. The Arbitrage Trader is a watcher of these slight differences in exchange rates which arise out of “Imperfections “in the Forex markets.FOREX MARKET PARTICIPANTS:The main participants in Forex markets are Central Banks, Commercial banks, Importers, Exporters, Investment banks, Retail Investors, International Financial Institutions, etc. They use the Forex market for a variety of reasons, which can be as follows, and many more too:Transfer of value from one country to another, to hedge against currency exposures, to speculate for trading profit, To Invest in overseas markets etc.PRIMARY PRICE MAKERS:These are the professional dealers who offer buy and sell quotes if so requested. They may be willing to either buy or sell foreign currencies if the volumes being traded are reasonable and in conformity with market practices. When a bank A asks another bank B to quote a price the bank B may quote both Buy and Sell prices, bank A may not take interest in the prices quoted by bank B or may deal at one of the quotes in which case it actually buys or sells to B at the price quoted by the bank B .The Banks / Dealers / Primary price makers are most actively involved in the Forex market and are usually aware of the current and expected market trends of demand and supply for a currency. When we take into account the huge size of the Forex market and the small number of Primary Price makers, it becomes quite clear as to why even the biggest of the Primary Price makers are unable to determine the movements in the Forex market and the extent of these movements.A few important characteristics of this category are that, they make market prices, take counterparty risk, and are generally willing to deal in the market almost any

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AUTHOR: MR KISHOR KALYAN MUSHRIF time during the dealing hours in the local market. Because the Primary price makers take trading risks in the dealing process, they can make profit.SECONDARY PRICE MAKERS:These entities are different from the Primary Price Makers in that though they do make prices, they do not deal in the Forex markets on a Buy – Sell basis. Entities such as Hotels, Restaurants, and Departmental Stores buy foreign exchange from their customers for settlement of their bills. They, in turn, sell the foreign exchange to the Primary Price makers, generally banks. In India, Full Fledged Money Changers and Restricted Money Changers specialise in buying from and selling to retail public and in turn buy from / sell to Authorised Dealers.PRICE TAKERS These seek prices from Primary or Secondary Price makers and deal for their own business requirements. These entities do not reciprocate and do not make market prices. These may be individual travelers buying their foreign exchange requirements from a bank / full-fledged moneychanger / restricted moneychanger etc. These may be importers or exporters covering their foreign exchange transactions with Authorised Dealer etc.Sometimes a large bank may play the role of a price taker, as in case where it deals in a currency in which it is not active.FOREIGN EXCHANGE BROKERS Dealers or Primary Price makers can deal with each other directly by telephone/ telex or by way of using computerised dealing systems. More often than not they deal with each other indirectly, i.e. through Forex Brokers. The Forex Brokers facilitate anonymous dealing between two Primary Price makers.The business of Foreign Exchange Broking leads to dissemination of current price information among participants in the market. The Forex Broker also brings buyers and sellers together and earns commission on deals booked through him. The Forex Brokers are not allowed to trade the market on their own account and they are expected to follow certain code of conduct, such code may be voluntarily decided by a Professional Body of which the brokers are required to be members. In some countries, such code may be laid down by Regulatory Authorities and may be mandatory for all Forex Brokers to follow.When a Deal is done the Forex Broker advises the buyer and the seller of Forex that the deal has been concluded. Thus only the Broker knows when a deal is being made the identities of the parties to the dealThere are a good number of large Brokerage Houses which have global presence and as a result these are in a position to advise their client banks round the clock..SPECULATORS These cannot be defined and whether a Forex Market participant speculates or does not speculate depends upon his course of action and purpose for such action at that point of time.1] An Importer or Exporter who delays covering his foreign exchange transaction is treated as a speculator,2] A bank that takes active trading positions in the market is a speculator,3] Individuals dealing in foreign currencies without covering their position are speculators,The pure trading in foreign exchange market without an underlying commercial transaction comprises a very large proportion of traded volumes in the Forex

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AUTHOR: MR KISHOR KALYAN MUSHRIF Market. It is large speculative deals, which can lead to significant price movements in the market. The most important contribution of Speculation to Forex Market is the liquidity and market efficiency, which it provides. CENTRAL BANK The Central bank of a country plays important role in foreign exchange market. In the early stages of development of foreign exchange market of a country, the Central bank may be the Regulator as well as the dominant market Participant too. In India, the Reserve bank of India has been playing, from time to time, one or more various roles in the Forex market as follows:1] Administration of Exchange Control,2] Buying and Selling of Foreign Exchange from /to Authorised Dealers,3] Take care of Foreign Exchange Reserves and Borrowings as well as Repayments on behalf of the Central Government,4] Maintenance of value of INR against a basket of currencies / Controlling the rate of depreciation of INR over a period of time.In some countries the Central bank of the country monitors the Buy and Sell transactions in foreign exchange in individual details,The Central bank may also Buy and Sell foreign Exchange from /to the Primary Price makers such as banks,Sometimes Central Banks such as the Bank of England, the Bundesbank and the Federal Reserve Bank intervene in the market in consultation and collaboration with each other with a view to remove erratic fluctuations and restore stability in the Forex market. In India the Reserve bank of India sometimes ensures desired buy/ sell action by the S B I with a view to influence Forex Market trends.

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