Presented By:-Akshay SagoleChetan ShahGopal ShivhareJagjit Singh PanesarKunal VaderaSneha Mondal

FOREIGN EXCHANGE RATE- FIXED- FLEXIBLE

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CHETAN

FOREIGN EXCHANGE

Foreign Exchange refers to the rate at which the currency of one country is bought and sold in terms of currency of another country

Now……….

The question arises here is ‘why does the need for buying and selling of foreign currency arise’?

FOREIGN EXCHANGE RATE

In foreign trade, goods and services are traded across national boundaries but the currency of one country is not acceptable in another country

The price of one currency in terms of another is called the Exchange Rate

EXCHANGE RATE

There are two different conditions under which the rate of exchange will determined

(i) When foreign Exchange market works freely(ii) When foreign Exchange market is controlled

and regulated

T

STRUCTURE OF FOREIGN EXCHANGE MARKET

FUNCTIONS OF FOREIGN EXCHANGE MARKET(i) The foreign Exchange market transfers funds

(foreign currency) from one country to another where they are needed in the settlement of payments

(ii) It provides short-term credit to the importers and, thereby, facilitates the smooth flow of goods and services from one country to another

(iii) The spot and forward market work in such way that it helps often in stabilizing the foreign Exchange rate

SNEHA MONDAL

Types of Foreign Exchange Market

• Spot Market– Transactions settled within 2 days

• Forward Market– Agreement to transact after 90days of deal

Nature of Transactions in Foreign Exchange Market

• Hedging– Settle exchange rate in advance– Covers risk of exchange rate fluctuation

• Arbitrage– Act of simultaneous purchase and sale of different currency in two or

more exchange markets– Works as stabilizing factor in foreign exchange markets.

• Speculation– Buying and selling currency under uncertain condition to make profit– “Buy forward and Sell on the spot” & “Sell Forward and Buy on the

spot”

Exchange Rate Regime

• The exchange-rate regime is the way a country manages its currency in relation to other currencies and the foreign exchange market.

• Closely related to monetary policy and the two are generally dependent on many of the same factors.

Types of Exchange Rate

• Floating/ Fluctuating exchange rate• Fixed exchange rate• Pegged Float• Dollarization

Floating/ Fluctuating exchange rate

• Currency's value is allowed to fluctuate according to the foreign exchange rate.

•  Belize(Located on the north eastern coast of Central America ) is an example of floating exchange rate.

•  Mundell-Fleming Model( fixed exchange rate, free capital movement, and an independent monetary policy )

• Fear of Floating

Fixed Exchange Rate

• Value of currencies kept constant• Worth of its currency in terms of either a

fixed weight of gold, a fixed amount of other currency or a “basket of other currencies”

• The central bank of a country remains committed at all times to buy and sell its currency at a fixed price. The central bank provides foreign currency needed to finance payment imbalances.

Types of Fixed Exchange Rate

• The Gold Standard• Price Specie Flow Mechanism• Reserve Currency Standard• Gold Exchange Standard

Pegged Float

• Crawling Bands: the rate is allowed to fluctuate in a band around a central value, which is adjusted periodically

• Crawling pegs:  the rate itself is fixed, and adjusted as above.

• Pegged with horizontal bands:The currency is allowed to fluctuate in a fixed band (bigger than 1%) around a central rate.

Dollarization

Dollarization occurs when the inhabitants of a country use foreign currency in parallel

to or instead of the domestic currency. The term is not only applied to usage of the

United States dollar, but generally to the use of any foreign currency as the national

currency.

AKSHAY SAGOLE

FACTORS DETERMINING ECONOMIC VALUE OF CURRENCY

• Import and export– Payment in dollars

– Forexample:-• 1$=1Rs

–But current 1$ = 50Rs–Finally govt. will have no “$”

What if???

• Military force– Saudi Arabia, Kuwait, Libya, Iraq

• Resources available in country– Iron, steel, petrol, advance-technology

– unique production capability

– Japan (TV, quality-goods )

• Debt on country– Payment of interest and loan in dollars

– India was 0 debt country till independence

– 1$=1Rs in 1947 – 1$=50Rs 2012

Categories of exchange rate

• Flexible exchange rate – It is determined by market forces i.e.

demand and supply

CONTENTS

– 1952:-7– 1947:-1

JAGJIT

• DETERMINATION OF ER IN – FREE MARKET– REGULATED MARKET

FREE MARKET

Demand for FX

Demand for foreign goods, services &

securities

Speculators willing to build their FX reserves

Supply of FX

Supply of foreign goods, services &

securities

Speculators willing to get rid of their FX

reserves

1$= Rs.48 1$=Rs.45 S W W S

ER

Prices of foreign goods

Demand of foreign goods

Demand for foreign

exchange

FREE MARKET

ROUGH WORK

Exc

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ate

(Rs.

Per

$)

$ demanded per time unit (million)

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D1

D

D2

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45

48

US

Demand$

SupplyRs.

India

India’s demand for $ increases

• Rise in domestic prices Rise in ERIncreases demand for FX Demand curve shifts

upwardsFall in exports Supply curve shifts leftward

• ROI (domestic) > ROI (foreign) Fall in ERCapital inflow increasesCapital outflow decreases

FREE MARKET

Increased supply for FX

FREE MARKET

• Rise in real income (domestic) Rise in ERIncrease in imports Increased demand

for FX

• Rise in real income (abroad) Fall in ERIncrease in exports Increased supply for

FX

REGULATED MARKET

• ER is fixed by the Central Bank

• Flexibility, if any, usually 10%

• Currency’s par value

• Central Bank undertakes the buy & sell of FX

in the FX market

• Any change in ER is made by the Central

Bank

• Devaluation

• Revaluation

REGULATED MARKET

Exc

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ate

(Rs.

Per

$)

$ demanded per time unit (million)

D

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S’

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D’

D’’

D’

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REGULATED MARKET

GOPAL

Factors affecting Foreign Exchange Value

• If a country’s imports are higher, the demand for foreign currency in this country will be high. Higher demand for foreign currency means high value of foreign currency and low value of the domestic currency.

• This is a typical case for underdeveloped countries which rely on imports for development needs. The current account balance (deficit or surplus) thus reflects the strength and weakness of the domestic currency.

 International trade

Capital movements• International investments in the form of

Foreign direct investment (FDI) and Foreign institutional investments (FII) have become the most important factors affecting the exchange rate in today’s open world economy.

• Countries which attract large capital inflows through foreign investments, will witness an appreciation in its domestic currency as its demand rises. Outflow of capital would mean a depreciation of domestic currency.

Change in prices

• Domestic inflation or deflation affects the exchange rate by affecting the demand and supply of domestic currency in the foreign exchange market.

• For example, if prices in India go up, making Indian goods costlier, the demand for Indian goods will go down. When exports go down, the demand for rupee will fall, causing depreciation in its exchange value.

Speculations• Uncertainties are always there in the financial market. • If the speculators expect a fall in the value of a

currency in the near future, they will sell that currency and start buying the other currency that they expect to appreciate. The selling of the former currency will thus increase its supply in the foreign exchange market and bring down its value. The other currency appreciates as its demand increases.

 Strength of the economy-

• If the economic fundamentals of a country are strong, the exchange rate of its domestic currency remains stable and strong

• Fiscal balance, international current account balance, international liabilities, foreign exchange reserves, resilience to international trade fluctuations, GDP, inflation rate all are indicators of a country’s economic strength.

Government policies-•  In countries where there is fixed or managed float,

the central bank becomes an important player in the foreign exchange market.

• The bank influences the value of the currency by its market operations like buying and selling of bills and currencies.

• The bank rate also influences the exchange rate by influencing investments and thereby the demand and supply of the domestic currency.

Stock exchange operations

• Stock exchange operations in foreign securities, debentures, stocks and shares, influence the demand and supply of related currencies, thus influencing their exchange rate.

 Political factors

• Political scenario of the country ultimately decides the strength of the country. An economy with a strong, positive image will obviously have a strong domestic currency. This is the reason why speculations rise considerably during the parliament elections, with various predictions of the future government and its policies.

•   In 1998, the Indian rupee depreciated against the dollar due to the American sanctions after India conducted the Pokharan nuclear test.

KUNAL

• ADV & DISADV OF FIXED & FLEXIBLE

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