Foreign Exchanga Mkt

8/14/2019 Foreign Exchanga Mkt

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The Foreign Exchange Market


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The Foreign Exchange market, also referred to as the

"Forex" or "FX" market is the largest financial market inthe world, with a daily average turnover of US$1.9

trillion 30 times larger than the combined volume

of all U.S. equity markets.

"Foreign Exchange" is the simultaneous buying of one

currency and selling of another. Currencies are traded in

pairs, for example Euro/US Dollar (EUR/USD) or US

Dollar/Japanese Yen (USD/JPY).

Foreign Exchange Market:The market where one

countrys currency is traded for anothers.

Foreign Exchange Market


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International Foreign Exchange Market

It is the oldest and largest financial market in the worldmorethan $1 trillion.

Participants: importers, exporters, traders, foreign exchangebrokers, speculators, portfolio managers.

FEM is essentially OTC market: No central location FEM has no central trading floor where buyers and sellers

meet. FEM extends from Tokyo and Sydney in the East to New

York and San Francisco in the West. Is open twenty-four hours a day, except for short gaps on

weekends.

Global banks account for about two-thirds of the marketvolume, while foreign exchange brokers and dealers accountfor approximately 20 percent.

Speculative transactions account for more than 95 percent of the turnover of FEM.


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Foreign Exchange Market in India

Very small market Key participants: RBI, authorized Banks, and Business

undertakings.

FEM in India is a Controlled market by RBI

Business undertakings can participate in the FEM in India

only to the extent that they need cover for exchange exposure

arising from merchant transaction (can not involve in

speculative transactions)

Banks are permitted to have net overbought or oversold

subject limits notified by the RBI.


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How a Foreign Exchange Transaction is

Conducted


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1. OTC-type: no specific location

2. Most trades by phone, telex, or SWIFT

SWIFT: Society for Worldwide Inter-bank Financial

Telecommunications

Location of the Foreign Exchange Market

1. Wholesale Level (95%) - major banks

2. Retail Level - business customers.

Participants in the Foreign Exchange

Market


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Participants in the Foreign Exchange Market

Commercial & Investment Banks (Inter-bank market)

amounts > $1m, typically $10m liquid market (vis--vis loans) with limited credit exposure

for clients and themselves

allows bit players to economize on transactions costs

Central Banks non-commercial motives relatively small portion of trading volume may intervene to address perceived economic/financial imbalances

Hedge Funds partnership of high net-worth individuals highly leveraged global investing add liquidity, flexibility, and sometimes instability to FX markets


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Corporations mostly act through intermediaries

Individuals tourists ~ insignificant volume

Intermediaries Brokers mostly service commercial banks and trading houses

anonymous

connected to many banks ~ shop for best price (exchange rate)

Direct Dealing through dealing system

quotes valid for 20 sec.


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Exchange Control Regimes

Fixed Exchange Rate vis--vis One Currency (Official parity)

This was adopted under Bretton-woods Agreement in 1945

allows bit players to economize on transactions costs

Fixed Exchange Rate vis--vis a Basket

This system adopted after 1972

A target parity for a basket of currencies was adopted

European Currency Unit (ECU)

Basket is revised every five years

Flexible Exchange Rates

Form 1996 most of the countries adopted


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Exchange Rates

Exchange Rate = Relative Price of Currencies Exchange Rate: The price of one currency expressed in terms of

another.

Direct Quote (Natural or Right Quote/American Terms): The

exchange rate for a foreign currency is quoted in terms of the

number of units of local currency that are equal to a unit of the

foreign currency. (Rs.45 for one dollar)

dollar price of 1 unit foreign currency; $/FX1 = dollars perunit foreign exchange

used in futures market


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Indirect Quote (Reverse or Left Quote/European Terms): The

exchange rate for a foreign currency is quoted in terms of the

number of units of foreign currency that are equal to a unit of the

local currency. ($2.25 for Rs. 100)

foreign currency price of $; FX/$1

used in Cash market. Most currencies quoted this way,except

Spot Exchange Rate: The rate applicable to transactions in

which settlement (delivery) is made in two business days after the

date of transaction.

Forward Exchange Rate: The exchange rate fixed today but the

settlement is at some specified date in the future.


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How to Read a Currency Quote

Currency Pair

Base Currency

Quote Currency

Bid Price Ask Price

SIMPLE !!


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Foreign Exchange Exposure (Risk)

Foreign Exchange Risk:The risk that the value ofa future receipt or obligation will change due to

variations in foreign exchange rates.

Types of Foreign Exchange (Risk) Exposure

Transaction exposure

Translation exposure

Economic exposure (Operating)


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Types of Foreign Exchange Risk Exposure

Transaction Exposure: The risk that the revenues

or costs associated with a transaction expressed in terms

of the domestic currency changes due to exchange rate

variations.

Translation Exposure: Foreign exchange riskresulting from the conversion of a firms foreign-

currency-denominated assets and liabilities into the

domestic currency value.

Economic Exposure: The risk that changes inexchange values might alter todays value of a firms

future income streams


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Hedging Foreign Exchange Risk

Hedging:The act of offsetting or eliminating riskexposure.

Covered Exposure:A foreign exchange risk that

has been completely eliminated with a hedging

instrument.

Forward contract for foreign exchange

Derivative instruments


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Foreign Currency Accounts

Nostro Account (our account with you): The foreign

currency account maintained by banks in India with

banks aboard.

The currency of the account depends on the currency

of the country where the account is maintained

All foreign exchange transactions are routed throughNostro accounts.

Maintenance of minimum balance is necessary.

It is just like current account

Vostro Account (your account with us): Foreign banks

may open rupee accounts with Indian banks.

The account is also known as non-resident account.


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Vostro Account (your account with us):

Foreign banks may open rupee accounts with Indianbanks.

The account is also known as non-resident account.

Documents

Foreign Exchanga Mkt