Foreign exchange management

WHAT IS FOREX?

The foreign exchange market (FOREX) is a worldwide decentralized over-the-counter financial market for the trading of currencies.

In simple words, it is a place where one currency is exchanged with another currency based on fluctuation rates.

Codes for selected Currenciesrequired for quotes USD – US Dollar EUR – Euro GBP – British Pound IEP – Irish Pound JPY – Japanese Yen CHF – Swiss Franc CAD – Canadian Dollar AUD – Australian

Dollar SEK – Swedish Kroner MEP – Mexican

Peso DKK – Danish Kroner NZD – New

Zealand $ INR – Indian Rupee SAR – Saudi Riyal

CHARACTERISTICS OF FOREIGN EXCHANGE MARKET

2. Only market open 24 hours -        FX Market is a 24 hour market

-    It starts when a calendar business day opens in Sydney, Tokyo, Hong Kong, Singapore and then moves to Middle East to Europe to New York to the West Coast of United States where the calendar business comes to a close

-   FX Market operates seven days a week (Middle East Markets function on Saturdays and Sundays)

-      Effectively it is a 24 hour a day / seven days a week / 365 days a year Market!

Currency appreciation/depreciation

Increase in foreign currency price From Rs.46 to Rs.48/ USD Foreign currency appreciation Home currency depreciation From USD 0.0217 to USD 0.0208/ Re

©2004 Prentice Hall 8-6

A Day of Foreign-Exchange Trading

Foreign exchange markets

Organisational setting within which individuals, governments and banks buy and sell foreign currencies.

Only a small fraction of daily transactions in foreign exchange involve trading of currency.

Most foreign exchange transactions involve transfer of bank deposits.

Foreign Exchange Markets

  Spot markets Forward markets Futures markets (In India, yet not

permissible) Options markets Swaps markets

Foreign exchange market

Foreign exchange market

Retail wholesale

Bank and money changes

(currencies and bank note, cheques)

Interbank(Bank account

or deposits)

Central bank

Indirect(Through broker)

Spot

Direct

Forward Derivatives(Future options etc.)

Interbank Foreign Exchange Trading

About 90% of foreign exchange trading is in the Interbank part of the market.

Interbank Foreign Exchange Trading

Provides continuous information on the foreign exchange market—

Talking with traders at other banks.

Observing prices (exchange rates) being quoted.

Foreign Exchange and Forward Contracts

What is a forward foreign exchange contract?

(An agreement to exchange one currency for another on some date in the future at a price set now [the forward exchange rate]).

Participants of FE Market

The participants in the foreign exchange market are:-

Individuals Firm Banks Governments International Agencies

How a Foreign Exchange Transaction is Conducted

Balance of Payments B of P – is a record of the value of all

economic transactions between residents of a country

Need and Importance of Foreign Exchange Markets 

Foreign exchange markets represent by far the most important financial markets in the world. Their role is of paramount importance in the system of international payments. In order to play their role effectively, it is necessary that their opera tions/dealings be reliable. Reliability essentially is concerned with contractual obligations being honored. For instance, if two parties have entered into a forward sale or purchase of a currency, both of them should be willing to honors their side of contract by delivering or taking delivery of the currency, as the case may be.

Types of foreign exchange rates

Ready/cash- Settlement of funds on the same day (date of the deal).

Tom- Settlement of funds takes place on the next working day of the date of the deal.

Spot- Settlement of funds takes place on the second working day following the date of the deal.

FOREX SYSTEM IN BANKING

FOREX

import export

REMITTANCE

EXPORTIMPORT

Outright sale basic

Consignment basic

physicalnon-

physical

Merchandise and

software

©2004 Prentice Hall

Theory of Purchasing Power Parity (PPP)

The prices of tradable goods, when expressed in a common currency, will tend to equalize across countries as a result of exchange rate changes

Occurs because process of buying goods in a cheap market and reselling them in expensive market affects demand for (and price of) the foreign currency and the market price of the good in the two product markets in question

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©2004 Prentice Hall

The prices these Mexican shoppers pay for foreign-made goods are affected by fluctuations in the value of the peso in the foreign-exchange market

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