Forex Market (1)

8/3/2019 Forex Market (1)

1/49

FOREIGN EXCHANGE

MARKET


2/49

FOREIGN EXCHANGE MARKET

FOREX market: foreign currencies are bought and sold

Ex: If an Indian importer imports goods from USA and has to makepayments in US dollars

Organizational setting : individuals, governments and

banks

A quantity of one currency by paying a quantity of anothercurrency

Helps international trade and investment

Helps business convert one currency to another

Formed during the 1970s


3/49

DEFINITION OF FOREIGN EXCHANGE

As per FEMA (1999): Foreign exchange refers to;

Deposits, credits and balances payable in foreign currency

Drafts, travellers cheques, letter of credit or bill of exchangeexpressed or drawn in Indian currency but payable inforeign currency

Drafts, travellers cheques, L/Cs, etc. drawn by banks,institutions or persons outside India but payable in Indiancurrency


4/49

TIME ZONES

The foreign exchange market is round-the-clock market

due to different time zones


5/49

Its trading volumes

The extreme liquidity of the market

Its geographical dispersion

Long trading hours - 24hours a day The low margins large volume

Unique


6/49

Trading Characteristics

Over the counter market (OTC)

No single unified foreign exchange market

Interconnected marketplaces

The main trading centers London

New York

Tokyo

Hong Kong

Singapore


7/49

Trading Characteristics

No Insider information

Actual monetary flows, changes in GDP growth, Inflation,interest rates, budget and trade deficits or surpluses andother macro-economic conditions : effect forex

Major news is released publicly often on scheduled dates


8/49

Major Players

Travellers Tourists

Retail Market

Commercial banks

Forex brokers Central bank MNCs, Individuals, SMEs

WholesaleMarket/InterBank Market


9/49

Retail Market

The travellers and tourists exchange one currency foranother in the form of currency notes or travellers cheques


10/49

WHOLESALE MARKET

COMMERCIAL BANKS

Behalf of clients

Retail level : through inter bank market or throughspecialized brokers

Bulk level : through inter-bank wholesale market orinternational banks and brokers

FOREX BROKERS Agents : facilitate trading between dealers


11/49

WHOLESALE MARKET

CENTRAL BANKS

Maintaining the exchange rate at desired level

MNCs MNCs are participating in forward exchange market

INDIVIDUAL

Investment and commercial activities


12/49

Regulatory Structure

FEMA, 1999 regulates the foreign exchange market in India

Before this Act, The Forex market in India was regulated bythe RBI through the Exchange Control Department, by theFERA, 1947

After independence, FERA was introduced as a temporarymeasure to regulate the inflow of the foreign capital

The Economic and Industrial development led to the urgentneed of foreign currency

On the recommendation of the Public Accounts Committee,GOI passed the Foreign Exchange Regulation Act,1973 andgradually this act became famous as FEMA


13/49

Contd..

RBI has issuedAuthorised Dealers (AD) licenses to banks,all India financial institutions and a few co-operative banks toundertake foreign exchange transactions in India

It has also issuedMoney Changerlicenses to a large

number of established firms, companies, hotels, shops, etc. Money changers help facilitate encashment of foreign

currencies of foreign tourists

Entities authorized to buy and sell foreign currency notes,coins and travellers cheques are calledFull Fledged moneychangers

Those authorized only to buy are calledRestricted moneychangers


14/49

Category of license(Number)

Entities Major Activities

Authorized Dealers(87)

Commercial Banks - 84;State Co-operative Bank -1;Urban Co-operative Bank2

All permissible currentand capital accounttransactions

Financial Institutions

(9)

Financial Institutions 4

(EXIM, IFCI, SIDBI,CCIL)Factoring Agencies 5

Activities related to

financing of internationaltrade undertaken bythese institutions

Full Fledged MoneyChangers(879)

Department of PostUrban Cooperative Bank 9Other FFMCs 869

Sale/Purchase of foreignexchange for private andbusiness visits abroad

Others(1)

Thomas Cook India Ltd. Specified non traderelated current account

transactions


15/49

Structure of the FOREX

Forex market in India consists ofthree tier system

The first consists of transactions between RBI and theAuthorized Dealers(ADs)

Second tier is the inter bank market in which the ADsdeal with each other

Third tier consists of transactions between ADs and theircorporate customers

The daily turnover in the Indian foreign exchange market iscurrently estimated to be between USD 1.5 3 billion


16/49

FEDAI

FEDAI (Foreign Exchange Dealers Association of India) isa non-profit making body formed in 1958 with the approvalof RBI

Its members are authorized dealers Prescribes guidelines and rules of the game for market

operations, merchant rates, quotations, delivery dates,holidays, interest on defaults, etc.

FEDAI also advises RBI on market related issues andsupplements RBI on strengthening the market


17/49

INDIAN FOREX MARKET

C A G A


18/49

EXCHANGE RATE

The price of one currency viewed in relation to anothercurrency

EXAMPLE-

Re/$ 44.76 means 44.76=1USD


19/49

FACTORS AFFECTING FOREIGN EXCHANGE

Fundamental reasons

Technical reasons

Speculation

FUNDAMENTAL REASONS


20/49

FUNDAMENTAL REASONS

Balance of payments-> surplus-> appreciation

Growth rate of the economy-> higher growth->depreciationof currency

Fiscal policy-> financing of fiscal deficit influencesexchange rate

Monetary policy->loose monetary policy->depreciation ofexchange rate

TECHNICAL REASONS


21/49

TECHNICAL REASONS

Freedom or restrictions on capital movements can affectexchange rates to a large extent

Among other factors there are:

Huge trade surpluses of oil exporting countries

Capital moving from low-yielding currencies to highyielding currencies(interest differential)

SPECULATION


22/49

SPECULATION

Self-fulfilling prophecies

Anticipation of depreciation of a currency can causedealers to sell that currency

Speculation serves to provide depth and liquidity to theforex market


23/49

DIRECT QUOTE

X units Of Domestic Currency equal One Unit Of Foreigncurrency

Example-

Rs 44.20 Per USD Is a Direct Quote For USDIn India

INDIRECT QUOTE

The domestic currency is the commodity which is beingbought and sold. Commodity comes first and price next

EXAMPLE-

Re1= .02 USD

BID AND ASK


24/49

BID AND ASK

The Banks Quote Of Bid AndAsk Is From The BankersPerspective.

Bid= Buy

Ask=sell

IF THE BID RATE FOR USD IS 40 IT MEANS THAT THEBANK IS READY TO BUY 1$ FOR Rs.40

IF THE ASK RATE IS FOR USD IS 41, IT MEANS THATTHE BANK IS (ASKING IF SOMEONE WILL BUY)SELLING 1$ FOR Rs.41


25/49

Intervention Currency

The Foreign currency in which rates are quoted against the

domestic currency. In India the intervention currency is USD

T t


26/49

Two way quote

BID QUOTE AND ASK QUOTE

Ex: Re/$-40.42 41.63

Rs.40.42-bid(buying)-( Bank point of view)

Rs.41.63-ask(selling)

Rs.40.42=1$ means the quote is in India

Yen33= Re.1 means the quote is in Japan

If you want to buy, if you have $, you will getRs.40.42

If you want to sell Rs. and buy $ you part withRs.41.63


27/49

Spread

ASK MINUS BID=SPREAD

EX. 40-41

SPREAD=Rs.41-40=Rs.1

Factors:

Stability of the exchange rate

depth of the market-volume of transaction

High volume(deep market)-narrow spread

Low volume (thin market)-wider spread


28/49

Foreign Currency Accounts

ForeignCurrency

Accounts

NOSTRO

Account

VOSTRO

Account

LORO

Account


29/49

NOSTRO ACCOUNT- It is the account maintained by anyIndian Bank abroad in foreign currency. The Latinmeaning of NOSTRO is Our account our money withyou

VOSTRO ACCOUNT-This is the account which foreign

bank maintains in India in Indian Rupee. Latin meaningof VOSTRO is your account your money with us

LORO ACCOUNT - It is an account where third partyaccount is maintained. The Latin meaning of LORO

account is there account with you MIRROR ACCOUNT- As clear from the name itself it is

the mirror of the nostro account maintained in foreigncurrency and rupee also for the reconciliation purpose


30/49

ForexTransaction

Purchase

Bank

AcquireForeign

Currency

Part withHome

Currency

Sale

Bank

AcquireHome

Currency

Part withForeign

Currency


31/49

Types of Transaction and market

The dealer deals in Forex market and the sub markets: Cash market: Value date- T+0

Tom market: Value date- T+1

Spot market: Value date- T+2 (sale & purchase of currency

for immediate delivery; settlement within 2 days) Forward market:- T+n (settled on future specified date -

decided upfront; Over the Counter market)

Future market:- T+n (settled on future specified date-

decided upfront; Mark to Market, exchange traded) Options market-T is decided by option buyer based on or up

to the maturity at the strike price


32/49

Types of Transaction and market

Swaps market: T+n decided upfront and exchange of cashflow in two different currencies.

Packing Credit Foreign Currency(PCFC)/Foreign Currency Non-Resident (Bank)FCNR(B)

and External Commercial Borrowing (ECB) loans Money market operations: The surplus foreign currency

fund as well as rupee swapped into foreign currency isplaced in money market to earn interest

Cross Currency Market: Apart from USD/INRother currencies are quoted, traded and rates are given asby the market maker


33/49

DEALING ROOM

The forum where all transactions related to foreign exchange in abank are carried out

All professionals who deal in Currencies, Options, Futures andSwaps assemble in the Dealing Room

The dealing room chief manages and co-ordinates all theactivities and acts as link pin between dealers and highermanagement

Reasons for concentration of entire information andcommunication system in a single room:

enable dealers to have instant access to the rates quoted atdifferent places

To communicate and know the limits of each counterparty. Thishelps in making arbitrage gains


34/49

FRONT OFFICE AND BACK OFFICE


35/49

THE FRONT OFFICE

Dealers working directly in the market and located in theDealing Rooms of big banks

They meet clients regularly and advise them regarding thestrategy to be adopted with regard to their treasury

management Role of the Front Office is to make profit from the operations

on currencies

The operations of front office are divided into several units:Sections for money markets and interest rate operations for

spot rate transactions

forward market transactions

currency options dealing in futures


36/49

THE FRONT OFFICE

The role of dealers is two fold: to manage the positions of clients

To quote bid-ask rates without knowing whether aclient is a buyer or seller

Dealers buy or sell on behalf of the clients and makeprofit for the bank

They take into account: the position that thebank has already taken and the effect that aparticular operation might have on that position

They also need to consider the limits fixed by thebank with respect to each single operation or singlecounterparty or position in a particular currency


37/49

THE BACK OFFICE

Activities: Managing the information system,accounting, control, administration, and follow-up ofthe operations of Front Office

It conceives of better information and control systemrelating to financial operations

Ensures an effective financial and managementcontrol of market operations

The Front Office and Back Office function in asymbiotic manner, on equal footing


38/49

Global Scenario


39/49

Contd.

Of the $4 trillion daily global turnover

trading in London accounted for around $1.36 trillion(34.1%), making London the global center for foreignexchange

For second and third places respectively, trading in NewYork accounted for 0.67 trillion (16.6%), and Tokyoaccounted for 0.24 trillion (6.0%)


40/49

Ten most active traders


41/49

On the spot market, according to the BIS study, the mostheavily traded products were:

EUR/USD: 27%

USD/JPY: 13%

GBP/USD: 12%


42/49

Indian Forex Market Scenario

Forex average daily turnover was contributing

0.23% of total global turnover -2001

0.34% in 2004

It became 0.69% in 2007

The break-up of the transactions are as follows:

42.6% transactions are on spot market

27.5% in outright forward market

29.8% under the forex swap market


43/49

2005-06 2006-07 2007-08

Bank of India 182.31 224.08 306.58

Bank of Baroda 178.19 239.28 278.79

Canara Bank 154.78 173.1 153.64

Union Bank of India 149.77 198.39 261.2Punjab NationalBank

122.1 176.72 211.39

Income of Public Sector Banks (Forex)


44/49

FOREX RISK MANAGEMENT

Forex market is one of the most volatile financial market

The various kind of risk linked to the Forex markets are:

MARKET RISK

OPERATIONAL RISK

CREDIT RISK


45/49

MARKET RISK

Exchange risk: Appreciation or depreciation of currencies

Arises due to mismatch of amounts of assets and liabilitiesas well as from the mismatch of maturity dates of assets orliabilities

Open position Risk: The main source of Forex risk is openposition in individual currencies

It is completely un-hedged exposure in a particularcurrency

Mitigated by doing complete cover operations, immediatelyin the same currency by taking opposite position


46/49

MARKET RISK

Gap Risk: Period mismatch in the currency pair result in interest rate

risk Eg bank has long position in USD/INR for three months while short

in USD/INR for six months for the same amount, so this createsexchange / interest rate risk (IRR) or gap risk

Interest rate risk may be of:

Basis Risk: Imperfect correlation between the indices of underlyingassets and liabilities

Yield curve risk: Different rate shock for different bucket

Re-pricing risk: Due to mismatch in asset & liability duration

Settlement Risk: Such risk arises from time differences betweentrading zones i.e debit and credit are not synchronized

Country Risk: Also called sovereignty risk. This arises when theexposed country will not be able to honour obligation due to shortageof foreign exchange or political risk


47/49

OPERATIONAL RISK

This covers the entire gamut of Forex transaction. It maybe divided into those arising from:

Risk arose through work and document flow

Non-compliance of guidelines & procedure specified for

dealing & settlement Fraudulent attempt or practices

Technology enabled risk (Hardware & software)

Legal Risk is a risk where the transaction is not valid

and enforceable, under the applicable (relevant localand other international) law

Event Risk: unexpected/ sudden happening like 26/11terror attack in Mumbai


48/49

CREDIT RISK

Arises from the possibility of a counter-party makingdefault in payment either interest or principal or both

Also includes non-performance of obligation even for theoff-balance sheet contracts

Mitigated by fixing the limits (either by tenure wise orproduct wise or both) of operations per clients, based onthe creditworthiness of the client by doing the rating ofcounter-party

Mitigation can be done by better credit appraisal, carefulanalysis of cash flow of the counterparty business, etc


49/49

The corporates may be permitted to take a hedgeupon declaring the existence of an exposure

Allowing exporters to retain 100 per cent of theirexport earnings in any foreign currency with an

Authorised Dealer (AD)

The Reserve Bank should invite detailed proposalsfrom banks for offering rupee-based derivatives

should refocus exchange control regulation and guidelines onrisks rather than on products

frame a fresh set of guidelines for foreign exchange andderivatives risk management

Recommendations for increasing Volume

Forex Market (1)

Documents

Transcript of Forex Market (1)