4 forex mkt

8/2/2019 4 forex mkt

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FOREIGN EXCHANGE

MARKET, EXCHANGE RATE

DETERMINATION &

CURRENCY DERIVATIVES

CHAPTER - 4


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Foreign Exchange MarketIt is the market in which currencies arebought and sold against each other.

It is an Over-the-Counter market.


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Functions of Foreign ExchangeMarkets

To transfer

purchasing powerbetween countries

To obtain or providecredit frominternational tradetransactions

To minimizeexposure to risk of


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Participants of the ForeignExchange Markets

The foreignexchangemarket consistsof two tiers

Interbank or

WholesaleMarket

Client or Retail

Market

5 categories ofparticipants operatewithin these 2 tiers:

Bank & Non-Bank foreignexchange dealers

Individuals and firmsconducting commercialand investmenttransactions

S eculators &


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Foreign Exchange Market:Transactions

Spot Transactions

Forward Transactions

Swap Transactions


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Foreign Exchange Market:Transactions

Spot Transactions:

Purchase of foreign

exchange with delivery andpayment between banks totake place normally on the

second following business day


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Forward Transactions:

An outright forward transactionrequires delivery at a future value date ofa specified amount of one currency for aspecified amount of another currency.


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Swap Transactions:

It refers to the simultaneous purchase and

sale of a given amount of foreign exchange fortwo different value dates.


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Exchange Rate QuotationsDirect Quote:

Home currency price of a certain amount of

foreign exchangeRupee Dollar Quote:

Rs.52/ US $

Indirect Quote:Amount of foreign currency per unit of homecurrency

Rupee Dollar Quote:

US$ 0.01923/ Re.


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Buying and Selling RatesBuying Rate/ Bid Rate: Bank buys aforeign currency at this rate

Selling Rate/AskRate: Bank sellsforeign currency to its customers

Spread: Ask Rate Bid Rate x100Ask Rate


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The first rate of the quote (known as bid) isthe rate at which the bank buys left hand

currency,the second rate of the quote (known as ask)is the rate at which the bank sells the left

hand currency.1 $ = Rs.40.10 / Rs.40.15It is direct quote with reference to India.$ is left hand currency. So it is rate of $.


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Spread size depends upon:Strength of the currency

Type of transaction

Demand & supply positionof the currency with thetransacting bank


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Cross Currency QuotesInternational Quotes (also known ascross currency quotes). In this case,both the currencies are foreigncurrencies. Examples of internationalquotes in India:

1$ = 0.5488

1 = $ 1.8222

1 Euro = $ 1.2000


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NumericalsExample (A)Convert the following direct quotes (in India) into indirect quotes:

1$ = Rs.40 1 = Rs.82

Answer:

Indirect quotes (in India) Re. 1 = $ 1/40 i.e. $ 0.0250

Re. 1 = 1/82 i.e. 0.0122

Example (B)Convert the following indirect quotes (in India) into direct quotes:Re. 1 = $ 0.0222

Re. 1 = 0.0122

Answer:

Direct quotes (In India) 1$ = Rs.1 / 0.0222 i.e. Rs.45

1 = Rs.1/ 0.0122 i.e. Rs.82


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Q.No.1:

Convert the direct quotes into indirect quotes:

(a) 1$ = Rs.40.00 / 40.05

(b) 1 = Rs.82.00/82.07

(c) 1Euro = Rs.56.00/ 56.18

Answer

(a) $1 = Rs.40.00 40.05

Re.1 = 1/40.05 - 1/40.00

= $ 0.02496879 - 0.02500000(b) 1 = Rs.82.00/82.07

Re.1 = 1/82.07 - 1/82.00

= 0.0121847 - 0.01219512

(c) 1 Euro = Rs.56.00 56.18

1 Re. = Euro 1/56.18 1/56.00


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Q. No.2: Calculate how many rupees Shri Ras Bihari Ji Ltd., aNew Delhi based firm, will receive or pay for its following fourforeign currency transactions:

(i) The firm receives dividend amounting to Euro 1,12,000 fromits French Associate Company.

(ii) The firm pays interest amounting to 2,00,000 Yens for its

borrowings from a Japanese Bank.(iii) The firm exported goods to USA and has just received USD

3,00,000.

(iv) The firm has imported goods from Singapore amounting toSingapore Dollars (SGD) 4,00,000.

Given: 1$ = Rs.40.00/40.05

1 Euro = Rs.56.00/56.04

1 SGD = Rs.24.98/25.00

100 Yens = Rs.44.00/44.10


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Answer 2:

(i) Foreign Exchange rate: 1 Euro = Rs.56.00/56.04The firm shall be selling Euros; the bank shall be buying the

Euros @

Rs.56.00. The firm will receive 1,12,000 x 56 i.e. Rs.62,72,000.

(ii) Foreign Exchange rate: 1 Yen = Re.0.4400/0.4410

The firm shall be buying the Yens; the bank shall be selling theYens @ Re. 0.4410. The firm will pay 2,00,000 x 0.4410 i.e.Rs.88,200.

(iii) Foreign Exchange rate: 1$ Euro = Rs.40.00/40.05

The firm shall be selling $; the bank shall be buying the $ @Rs.40.00. The firm will receive 3,00,000 x 40 i.e. Rs.1,20,00,000.

(iv) Foreign Exchange rate: 1 SGD = Rs..24.98/25.00

The firm shall be buying the SGD; the bank shall be selling theSGD @ Re. 25.00. The firm will pay 4,00,000 x 25.00 i.e. Rs.1,00,00,000


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Q.No.3: Calculate how many British pounds a London-based-

firm will receive or pay for its following four foreign currencytransactions:

(i) The firm receives dividend amounting to Euro 1,00,000 fromits French Associate Company.

(ii) The firm pays interest amounting to 2,30,000 Yens for its

borrowings from a Japanese Bank.(iii) The firm exported goods to USA and has just received USD3,00,000.

(iv) The firm has imported goods from Singapore amounting toSingapore Dollars (SGD) 4,00,000.

Spot rates (per Pound)

Euro 1.59/1.60

Yen 230/234

USD 1.99/2.00


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Answer 3:

Answer (i) FER 1 = 1.59/1.60 Euro

The bank is selling . Hence, applicable rate is ask i.e. 1=1.60

The firm receives: 1,00,000/1.60 i.e. 62,500.00

Answer (ii) FER 1 = 230/234 YENS

The bank is buying . Hence, applicable rate is bid i.e. 1 =230 Yens

The firm pays: 2,30,000 /230 i.e. 1,000.

Answer (iii) FER 1 = $1.99/2.00

The bank is selling . Hence , applicable rate is ask i.e. 1 =$2.00

The firm receives: 3,00,000/2.00 i.e. 1,50,000


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Spot Rates & Forward Rates

Purchase and sale of one currency against other currencymay be either on spot basis or for future delivery. In spottransaction, the currencies are delivered either immediately(the same day) or within two days from the date of

transaction. The exchange rate of a spot transaction is calledas Spot Rate.

A future delivery transaction is one in which a contract is

made between two parties for purchase and sale of the onecurrency against 1 other at a stipulated future date at a rateagreed upon at the time of contact. In such contacts,deliveries of currencies are made on the stipulated futuredate. The exchange rate of a future delivery transaction is

called as Forward Rate.


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Forward Margin Premium or

DiscountThe forward rate for a currency may be costlier orcheaper than its spot rate. The difference between the

forward rate and spot rate is known as forward marginor swap points. If a currency is costlier in future ascompared to spot, it is said at premium.

Example

Spot : $ 1 = Rs.40,Six months Forward: $ 1 = Rs.42.00.

$ is at premium.

If a currency is cheaper in future as compared to

spot, it is said to be at discount.


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For quantifying premium / discount of a currency (whether

home currency or foreign currency), we should

(i) find Forward price of that currency

(ii) find Spot price of that currency

(iii) apply the following formula:

% change in price ofA currency Forward price Spot price

= ------------------------------------ x 100Spot price of that currency


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Rules for adding/ subtracting

Premium/ DiscountForward rates are quoted at premium or discount in relation to the spotrates.

The rules for adding or subtracting discount / premium are as follows:

(i) If left hand currency is at premium, the amount of premium is addedto the right hand currency.

(ii) If left hand currency is at discount, the amount of discount is

subtracted from the right had currency.

There are two possibilities regarding discount / premium:

A) Which currency is at premium/ discount this may be given or thiscan be interpreted.

B) Amount of forward margin i.e. swap points given. If forward margin isin ascending order, it represents premium of left hand currency; if it is indescending order, it represents discount of left hand currency.


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Example A: A person has to pay $ 13750 after three months today. SpotRate: Re l = $ 0.0275. Rupee is likely to depreciate by 5% over three

months. What is likely forward rate?Answer:

Rupee is left had currency. It is at discount. Amount of discount shouldbe deducted from right hand currency for estimating the forward rate. Henceforward rate is:

Re. 1 = $ 0.0275 - $ 0.0275 (5/100) i.e. 0.026125.

Example B:Spot 1 $ = Rs. 40.00 / 40.10

1 month forward .10 /.11

2 months forward .12/.13

3 months forward .14/.15

Calculate 1 month, 2 months and 3 months forward rates.

Answer:

1 month forward 1 $ Rs. .40.10/ 40.212 months forward 1 Rs. 40.12 46.23


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Q.No.4 You are given the following $ quotes:

Spot Rs 40.50/40.602 months forward 0.10/0.20

3 months forward 0.20/0.10


(a) Calculate 2 months, 3 months and 4 monthsforward rates.

(b) What amount you will pay in rupees for purchasing5,00,000 USD?

(c) How many Dollars you will sell to get Rs.5, 00,000?(You have enough Dollars)

(d) Calculate % of discount/premium of Dollars on 3months and 4 months forward rates.

Assume (i) You are buying $ (ii) You are selling $.


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Answer

(a) Spot 1 $ = Rs40.50/40.602 months forward 0.10/0.20



2 m forward rate: 1$ = Rs.40.60 /40.80

3 m forward rate: 1$ = Rs.40.30 /40.50

4 m forward rate: 1$ = Rs.40.75 /40.90

(b) FER 1$ = Rs.40.50 / 40.60

You are buying $. The bank is selling $. The applicable rate is Rs.40.60

Amount payable in Rupees = 5,00,000 x 40.60 = Rs.2,03,00,000

(c) FER 1$ = Rs.40.50 / 40.60

You are selling $. The bank is buying $. The applicable rate is Rs.40.50

Amt. payable in $. =5,00,000/40.50 = 12,345.70

(d)(i) You are buying $.


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Q.No.5: The following foreign currency rates, per

Pound, are being quoted in London Market:Spot 3 months forward 4 months forward

USD 1.6200/1.6220 0.30/0.40 c 0.40/0.30 c

Canadian Dollars 1.9000/1.9010 0.40/0.50 c

0.50/0.40 cJapanese Yens 200/205 1/2 2/1

How many Pounds a person will pay for purchasing(i) 1,00,000 USD on spot (ii) 1,00,000 Canadian Dollars

on 3 months forward and (iii) 1,00,000 Japanese Yens on4 months forward?


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Answer 5:

(i) 1 = $ 1.6200/1.6220

Bank is purchasing . The applicable rate : 1 = $1.62

The person has to pay (1,00,000 /1.62) i.e. 61,728.40

(ii) Spot rate: 1 =CD 1.9000/1.9010

Swap points = 0.40/0.50 cents

= 0.0040/0.0050 CD

3 months forward rate: 1 = CD 1.9040 /1.9060

Bank is buying . Applicable rate 1 = CD 1.9040

The customer has to pay: (1,00,000 /1.0940) = 52,521

(iii) Spot rate: 1 = 200/205 Yens

4 months Swap points = 2/1 Yens

4 months forward rate: 1 = JY 198/204

Bank is buying . Applicable rate 1 = JY 198

The customer has to pay: (1 00 000 /198) = 505 05

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