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Table of Content FOREIGN EXCHANGE MARKET.......................................................

3
General.............................................................................................................................3 Foreign Exchange Market................................................................................................3 Players in Foreign Exchange Market...............................................................................3 What is 24 Hours market .............................................................................................! "i#e o$ the Forex Market..................................................................................................! %ature o$ Foreign Exchange Market &ransactions...........................................................! &y'es o$ Forex &ransactions............................................................................................( )ccount an* Exchange Positions+...................................................................................., -e.ersal /$ )ccount an* Exchange Positions ...............................................................0

FACTORS AFFECTING EXCHANGE RATES..................................11 ORGANIZATION OF FOREX (TREASURY OFFICE OF AN AUTHORIZE! !EA"ER # ................................................................13 RISKS IN FOREIGN EXCHANGE $USINESS..................................1%
Foreign Exchange 1ealings+..........................................................................................2( .......................................................................................................................................2( "'ecial Features o$ Forex 1ealings3Markets..................................................................2( Foreign Exchange -isks+................................................................................................24 Position or Exchange -ate -isk.....................................................................................24 5imits "et u' to 6ontrol Position -isk...........................................................................24 6re*it or 6ounter Party -isk..........................................................................................20 Mismatche* Maturities35i7ui*ity -isk+ 8.......................................................................29 /'erational -isk ............................................................................................................22 5egal -isk.......................................................................................................................22 "o.ereign -isk ..............................................................................................................22

FOR&AR! CONTRACT#..................................................................'3
For:ar* Points+..............................................................................................................24 For:ar* Exchange 6ontracts.........................................................................................2! For:ar* Purchase 6ontract ;FP6<.................................................................................2! For:ar* "ales 6ontract ;F"6<.......................................................................................2( 6om'onents o$ a For:ar* Exchange 6ontract...............................................................2( 6ancellation o$ For:ar* Exchange 6ontract.................................................................24 =roken 1ate For:ar* Exchange 6ontracts....................................................................2, ":a''ing o$ For:ar* 6urrency ....................................................................................20

NON(RESI!ENT ACCOUNTS .........................................................3'


>ntro*uction+ ..................................................................................................................32 %/%8-E">1E%& >%1>)%"+ .......................................................................................32 %/%8-E">1E%& 1EP/">& )66/?%&"+.................................................................33 &@PE" /F %/% -E">1E%& =)%A )66/?%&" + ..................................................33 Pro.i*ing Housing 5oan in >%- to %->s3 P>/s ...........................................................30 F/-E>G% 6?--E%6@ %/% -E">1E%& )66/?%&" B=)%A"C..........................49 )*.ances against 6%- B=C *e'osits+.............................................................................42 %/% -E">1E%& =)%A )66/?%&"+.......................................................................43 -E">1E%& F/-E>G% 6?--E%6@ )66/?%&" BF/- -E&?-%>%G >%1>)%"C 4(

ED6H)%GE E)-%E-" F/-E>G% 6?--E%6@ )66/?%&"+.............................44 >ntro*uction ...................................................................................................................!9 General %ote+.................................................................................................................!9 -ecei't o$ Foreign Exchange in >n*ia ...........................................................................!2 -e'atriation o$ Foreign Exchange Ey a -esi*ent o$ >n*ia+............................................!2 6urrent )ccount &ransactions .......................................................................................!2 Foreign 6urrency )ccounts o$ -esi*ents in >n*ia ........................................................!3 Possession an* retention o$ Foreign Exchange Ey -esi*ents o$ >n*ia ..........................!4 -etentionF -e'atriationF an* "urren*er o$ Foreign Exchange .......................................!4 -emittance o$ Foreign Exchange $rom >n*ia+................................................................!!

FOREIGN EXCHANGE# HE!GING OF RISKS.................................%) (FRA* + S&A,S+ FUTURES+ O,TIONS .........................................%) FOREIGN EXCHANGE !ERI-ATI-ES............................................%.
For:ar* -ate )greements+.............................................................................................!0 6om'ensatory PaymentG..............................................................................................(9 For:ar* -ate )greement ;F-)<....................................................................................(9 "W)P"...........................................................................................................................(2 6?--E%6@ "W)P"....................................................................................................(4

INTEREST RATE CA,S+ F"OORS+ CO""ARS................................// FOREIGN EXCHANGE+ HE!GING OF RISK 0O,TIONS 1 FUTURES2........................................................................................./.
/P&>/% ........................................................................................................................(, For:ar* Purchase 6ontract H3s 6all /'tion..................................................................(,

CURRENCY O,TIONS TERMINO"OGY..........................................)3 !ETERMINANTS OF ,REMIUM# ( ..................................................)3


?ses o$ /'tions+.............................................................................................................43

IN!IAN SCENARIO#..........................................................................)% FUTURES CONTRACT ....................................................................)/


6urrency Futures+ "ettlement+........................................................................................4,

FOREIGN EXCHANGE MARKET

General
The term market normally refers to a physical place where buyers and sellers come together to deal in specific goods and / or services. The payments may be settled in the market or in some other place. Traditionally stocks and bonds are being traded in the floor of stock exchange and despite the increasing trend towards trading on the Net or through Computer Terminals; tock !arkets continue to exist physically. " yet another important type of market is the market for food grains# popularly known as $!andi % in &ndia and this also exists physically. The physical markets for various goods and services are characteri'ed by $Timings(# i.e. these markets follow certain time schedule and deals are conducted during the pre decided timings.

)oreign *xchange !arket


This market is different from the other markets referred above .the )oreign *xchange !arket is not confined to a physical place and is# in fact# a global market. &t is +uite common for the trading parties in this market to be situated in different countries# unlike the physical markets for goods and services. "nother important difference between the )orex !arket and the Commodities !arket is that the )orex market is a ,- .ours market which is not the case with the other market.

/layers in )oreign *xchange !arket


The players in this market are spread all over the country and abroad. They are of three categories as follows0

12 /rimary /rice makers 3 Commercial banks# Central banks # )inancial &nstitutions 2 who +uote buying and selling prices for various foreign currencies in which they deal# ,2 econdary /rice !akers 3*xchange .ouses# and !oney Changers2 who

+uote their own prices based on prices derived from /rimary /rice makers# 42 /rice Takers 3!erchants# Customers of banks2 who enter into buying and selling of currencies with the above two categories of institutions. -2 peculators0 They are the George oroses and 5arren 6uffets of the world who are resourceful enough to take speculative positions in foreign currencies and are sometimes accused of bringing about down fall of a domestic currency 2 George oros was accused by some outh *ast "sian Countries for the problems faced by their currencies during the late 1778s2. "ll the )orex market participants deal with each other by using various means of communication such as Telephones/ )axes/ Computers etc. The participants may deal with each other directly or through 6rokers. These )orex 6rokers speciali'e in bringing together the seller and buyer institutions and thus enable a deal to happen # irrespective of where the institutions are located# The brokers earn commission on the deals enabled by them but do not participate in buying and selling on their own account.

5hat is $,- .ours market%9


ince all ma:or currencies of the world are traded in )orex market and trading parties are located from *ast to 5est# at any point of time during the day# the )orex market deals are happening somewhere or the other. )or instance# ; <ollar deals happen only in N= T>= ; closed for the day. <ollar accounts of the &ndian 6anks and these deals actually happen when the &ndian )orex market is already imilarly 6anks in ?apan close for business before the banks in &ndia start operations for the day.

i'e of the )orex !arket


Tokyo# .ong @ong# ingapore# Aondon# /aris# Burich# New Cork are most <ollars on the New Cork market

prominent Centers where foreign currencies are dealt by global players. )or example# a 6ank in &ndia may deals with ; or in the Aondon !arket. These important centers fall in different time 'ones and give the )orex market participants to deal continuously in the market. 3 ome of the &ndian banks offer their customers access to the ; market till late evening in &ndia2. The total daily turnover in the )orex !arket in all centers is in excess of ; <ollars Three thousand billions out of which Aondon !arket registers turnover of almost one thousand billion ; <ollars. The most traded currency is the ; <ollar and perhaps the *;>= comes close second. <ollar

Nature of )oreign *xchange !arket Transactions


There are four types of )orex transactions that take place in the global )orex !arket. ince the ; based banks and banks in most of *uropean countries work from !onday to )riday# the banks in &ndia freely deal in )orex during these days and deal in )orex only in a limited fashion on aturdays. 12 The first category of transactions refers to trade related# merchant initiated and other transactions carried out by individuals. These refer to >emittances# 6ooking of )orward *xchange Contracts and deliveries there under# 6uying

and elling of )oreign currency Negotiable &nstruments such as TCs# Che+ues# <rafts # and 6ills of *xchange. Corporate borrowings and repayment of foreign currency loans also fall under this category of transactions. These transactions are very large in number but the aggregate amount of these transactions forms a small D of the daily turnover in the )orex !arket. ,2 The second type of transactions deals with speculation. The number of players in this category is much less than the players of first type. These transactions are generally very large in value and are not backed by trade .!ost of these transactions relate to )orward *xchange Contracts # though speculative transactions in Next day and spot delivery markets are also possible. The Traders in speculative deals generally speciali'e in various currencies and also in types of deals. )or instance# within a bank%s treasury one dealer may deal only in /=T ; <ollars whereas another dealer may speciali'e in the )orward *xchange !arket for *;>= against ; <ollar. 5hile dealing in speculative transactions# &nstitutional <ealers have to work within Aimits set up by their &nstitutions and are not allowed to overtrade. 42 The third type of )orex transactions relate to payments by Governments to each other# drawdown and repayments of &!)/"<6 loans# and flows of foreign "id from donor countries to receivers. Though the values of such transactions are generally large# their share of daily turnover of )orex market is limited# -2 The fourth type of transactions in the )orex !arkets is very less in fre+uency and numbers but can be +uite high in individual values. These transactions are of the nature of intervention by the central bank of a country in the domestic foreign exchange market. The main purpose of this type of transactions is to support the <omestic currency against one or more foreign currencies or to ensure gradual appreciation / depreciation of the domestic currency.

Types of )orex Transactions


There are four types of )orex transactions which take place between banks# between banks and Customers etc. These are#

12 C" . Transactions# ,2 T=! Transactions# 42 /=T Transactions# -2 )=>5">< Transactions. These transactions can be undertaken by any of the )orex market participants depending upon his re+uirements. 12 C" . Transactions0 These refer to buying and selling of )oreign exchange for same value date against another currency. )or example0 a merchant in !umbai approaches his "uthori'ed <ealer with a re+uest to sell him ; <ollars one million on C" . basis. The "< recovers &N> value of remittance at >eady ; </&N> rate from the customer and pays out ; < one million from his N= T>= account on same Ealue date. Thus if the customer is debited the &N> e+uivalent on !onday 1Fth !ay ,88G# the N= T>= account of the "< is debited with ; < 1 million on same day i. e. 1F th !ay ,88G. ,2 T=! Transactions0 These refer to dealing in foreign exchange at a rate fixed today for <elivery Tomorrow. Thus a )oreign &nstitutional &nvestor may obtain a 6uying rate for ; < 1 !illion from the bank for >emittance to be received tomorrow from its .ead =ffice in New Cork. =n receipt of the remittance next day# the bank converts it into &N> at the rate agreed today. 42 /=T Transactions0 This refers to dealing in foreign exchange at rate fixed

today for delivery after two working days. Thus the )&& which sells huge volume of shares on the N * today expects clear funds after two days in its bank account and wants to remit them back to .= in ; transaction# it obtains /=T &N>/; < 3 elling2 rate. -2 )=>5">< Transactions0 This refers to )orex deals to be settled sometime after the /=T date. There are two types of )orward <eals # namely 12 )ixed date )orward and # ,2 =ption date )orward. "2 " )ixed date )orward contract is for delivery of contract currency on the date fixed in the contract itself. Thus a bank and a customer may enter a )ixed date )orward sales Contract for delivery ,G th ?une ,88G of ; < 1 lac at 1 ; < H &N> -4.4,G8. The contract must be settled by the two parties on the <ollars. )or this

above date by the merchant offering &N> and the bank offering the ; <ollars. " )ixed date )orward /urchase contract# must# similarly# lead to the merchant offering the contracted amount of ; < and the bank paying him the &N> at the exchange rate fixed in the contract. 62 "n =ption )orward Contract is deliverable during a month of delivery. Thus a !erchant may enter into a )orward /urchase Contract for ; < against &N> for third !onth delivery at the contracted exchange rate. Aet us take an example <ate of Contract0 1Fth !ay ,88G /eriod of Contract0 4 !onths =ption of <elivery0 Third !onth. >ate0 1 ; <H &N> -4.G7 "mount 0 1 !illion ; < Type of Contract0 /urchase Contrac The calculation of Contract /eriod starts from the being pot date in this case2 1st !onth0 17!ayI1J?une "ugust Thus the customer must deliver the entire contract amount of ; < 1 !illion during the period 17yh ?uly ,88G to 1Jth "ugust ,88G. &n &ndia he can deliver the )orward currency on aturday also. " )orward *xchange transaction may be between the 6ank and the customer and based on underlying trade transaction. =n the other hand# the transaction may be between banks and speculative in nature. &n the daily turnover in Global )orex market# a ma:or portion of transactions in terms of value relate to )orward Contract deliveries. , nd !onth0 17?uneI1J?uly 4 rd !onth0 17th ?uly I1J /=T <ate 317th !ay ,88G

"ccount and *xchange /ositions0

There are two types of )orex Transactions# namely 6uying

and

elling.

6uying refers to the bank buying the )orex from the counterparty and elling refers to the bank selling )orex to the counterparty. These transactions may be for C" ./ T=!/ /=T or )=>5">< deliveries. "ll of the foreign currency transactions have top go through T5= /= &T&=N # namely# "CC=;NT /= &T&=N and *KC."NG* /= &T&=N. " bank may purchase a foreign currency che+ue payable abroad today for its customer and give away &N> at the buying rate for ; < against &N> today. This transaction immediately results in the creation of an *KC."NG* /= &T&=N in the books of the bank. 5hen the che+ues sent for collection is paid and proceeds credited to the Nostro account of the >emitting bank# it results in "CC=;NT /= &T&=N. =n the other hand# the bank may issue a foreign currency << for its customer. )or this transaction# the bank +uotes selling rate # and recovers &>N e+uivalent of the << amount 3 creating *KC."NG* /= &T&=N 2 and in due course # the << is presented to the <rawee bank and debited to the N= T>= account of the issuing bank 3 creating "CC=;NT /= &T&=N2. &n case of all )orward *xchange Contracts# the banks +uotes *xchange rate at the time of entering the contract and creates )orward *xchange /osition in its books and only when the currency is delivered# it leads to "CC=;NT /= &T&=N.

>eversal =f "ccount and *xchange /ositions


*very purchase of foreign currency is covered by sell of e+ual amount and every sell is covered by purchase. ;ltimately every account position is reversed and every exchange position is reversed by an e+ual and opposite position. Aet us understand this by a simple example. *K"!/A*0 "n "< receives telegraphic Transfer for ; < 1 !illion for value 14 th !ay and receives credit in its N= T>= account from the >emitting bank. Thus an "ccount /osition is created first.

The " < +uotes a Cash buying rate for ; < against &N> and purchases the ; < and gives away e+uivalent &N> to the 6eneficiary of the remittance 3Creating an *xchange /osition2 Now the "< disposes off the ; < 1 !illion by selling a ; < >emittance to

another customer / bank. The "< receives &N> 3*xchange /osition2 and sends 5&)T !essage to the correspondent to pay off the buyer of the ; <. This results in "ccount /osition. " 6ought /osition 3after the N= T>= account is credited2 is =ffset by a /osition 3leading to debit to N= T>= account. 2 old

FACTORS AFFECTING EXCHANGE RATES


The year 17L4 was a watershed year in financial systems of the world# when many countries started floating their exchange rates. &n a free market# it is the demand for and supply of the currency which should determine exchange rates but demand and supply by themselves depend on many factors which are ultimately the cause of exchange rate fluctuations. The most important factors affecting exchange rates of currencies are as follows0 &. 6alance of /ayments &&. trength of an *conomy# &&&. )iscal /olicy# &E. &nterest >ates E. !onetary /olicy# E&. /olitical )actors E&&. *xchange Control# E&&&. Central 6ank &ntervention. &K. peculation K. Technical factors K&. *xpectations of the )orex market players. 1M

6alance of /ayments: Comprises $6alance of Trade( Nthe difference

between values of total imports and total exportsM# by adding imports and exports of services to the $6alance of Trade( we obtain ( 6alance on Current "ccount $ and thirdly grants# aids# foreign investments etc. when accounted for# all 4 factors together give the $6alance of /ayments $ of a country. &f a country has favourable 6alance of /ayments# it means that foreign exchange supply is more than the demand for it and hence foreign currencies will be cheaper visIOIvis the domestic currency and if the balance of payments is adverse foreign currencies will tend to be costlier than domestic currencies. ,M

trength of the *conomy :

The relative strength of the economy# the

rate of its growth have effect on the balance of payments by affecting its three components. !ore imports# than exports in the shortIterm may boost

the overall economic activity and exports may take some time to grow. This will result in more demand for foreign currencies in the short run. !ovement of foreign capital can dominate exchange rate movements for appreciable length of time. &f the outlook of foreign investors on an economy is positive# then foreign capital investments rise and ease the supply of foreign currency visIOIvis the domestic currency. 4M )iscal /olicy0 6y following a policy of lower tax rates# a government may fuel economic growth thereby leading to better trade performance of the economy. " high level of moneti'ation of budgetary deficit may cause inflationary pressures adversely affecting exchange rates vis currency. -M &nterest >ates0 .igh interest rates attract Phot money% $ peculative Capital( affecting exchange rates. &f there is free movement of funds# capital is attracted to high interest rate economy# increasing supply of foreign currencies. .ere it is important to note that the real interest rate Nnominal interest rate expected depreciation over the period of investment is more important than the nominal interest rate for the foreign inverter. GM Moneta45 ,ol675# The main ob:ective of monetary policy is to maintain money supply at such levels that price stability is ensured# along with higher levels of employment and economic growth. The monetary policy of a country influences interest rates inflation# employment and foreign investments# affecting the exchange rates visIOIvis domestic currencies. FM ,ol6t67al Fa7to4*# 5ith stable political conditions and thereby resulting in stable economic policy# the currency of the concerned country ac+uires stability visIOIvis foreign currencies. LM *xchange Control0 This generally controls free movement of capital flows and affects exchange rates. ometimes same countries maintain exchange rates at artificial levels by managed exchange rates. *xchange rates can also be controlled by imposing exchange controls on movement of capital into a country seeking higher rateNsM of return. a vis domestic

JM Central 6ank &ntervention0 The buying or selling of foreign currencies in the domestic market by the Central 6ank of a country is known as $intervention(. " Central 6ank may buy a dominant foreign currency# increasing demand for in and its price visIOIvis domestic currency# thereby given boost to exports. 6y selling the foreign currency# it can deflate in price visIOIvis domestic currency# boosting imports. ometimes central banks of different countries act together and intervene in the markets to stabilise one or more currencies. .owever# it has been generally found that it is generally the speculators who win the day in their fights with the central banks. The intervention and its effectiveness depend upon the depth of the pockets of the central banks and the perfect ness of the timing of central bank intervention. 7M

peculation0

/erhaps more than 78D# 7GD of the )orex market is

speculative and if a few big speculation start hammering a currency. The inability of the 6ank of *ngland to protect sterling in early 78%s due to the position taken by George oros is by now legendary. 18M Te78n67al fa7to4*# &f central bank imposes technicalities on trading by market players and say limits their open positions the banks have to buy/sell )orex to keep their positions s+uare. The integration of money market and )orex markets# the depth of )orex market etc. also have influence on exchange rates. 11M E9:e7tat6on* of Fo4e9 ;a4<et :la5e4*# "t times the market is affected by expectations# which may be wild or carefully nurtured by the Central 6ank of the country. uch expectations have been known to make the shortIterm exchange rates leading to increased volatility in the )orex market.

ORGANIZATION OF FOREX (TREASURY) OFFICE OF AN AUTHORIZED DEALER :


)oreign exchange market is a global market# a ,-Ihour market and with integration of various economics into a global economy it is also becoming increasingly complex and risk%sIprone.

<ealing in foreign exchange is a highly specialised undertaken only by wellItrained personnel.

function# to be

<ealing in )orex re+uires the

dealers interacting with market participants and actually doing the buying and selling of currencies# followed by accounting for the deals and maintenance of position book# review of the risks associated with dealing and ensuring risk management as per informal and external guidelines and settlement of domestic and foreign currency payments and reconciliation of various currency accounts etc. The most important principle to be followed by all the Treasuries of the banks is to ensure that three 4 functions are effectively segregated and remain segregated all other. The Treasury is re+uired to be set up with 4 watertight departments doing specific :obs. There departments Nthe organi'ational set upM and their functions are as follows0 I 1) )ront =ffice N<ealing >oomM : This is also known as the <ealing >oom# which physically occupies front position in a typical treasury of a bank. This office takes care of the dealers# defining dealing procedures and duties of individual dealers# ensuring that the technological support such as voiceI recorders# dealing screens etc. are always in place# dealers are rotated as per specific policy the dealers are always well informed about regulatory re+uirements and their own discretionary limits etc. times . The skill sets re+uired for these functions are different but also complimentary to each

2) M6= Off67e #

(Risk Management, MIS etc).

0 This has to ensure that

proper management approved risk management policy is effectively in place at all times. The deals are properly recorded at the correct rates at which they are executed the confirmation of contracts# revaluation of )orex profit/losses# submission of correct currency position to management# maintenance of position and fund books with continuous up gradation based on deal slips# preparation of daily reports etc. 3M Back Office (Se !e"e# $ Rec%#ci!ia i%# Acc%&# i#' e c( :

This office

ensures that exchange of currencies as per the value dates takes place# and any delays in settlement of funds are rectified as +uickly as possible. 6ack

office

also

undertakes

reconciliation

of

the

various

Nostro

"ccounts

maintained by the 6ank.

taff not dealing with operations in Nostro accounts

should do reconciliation. >esponding to outstanding entries bank charges debited to Nostro being recovered promptly and periodic/document audit of Treasury activities also forms part of 6ank =ffice duties.

RISKS IN FOREIGN EXCHANGE BUSINESS


)oreign *xchange is a product for which a market exists and it is bought and sold for profit. Aike any other product trading# buying and selling for foreign exchange is also a risky business# with different kinds of attendant risks. .owever# it is possible to manage the various risks associated with the business of foreign exchange for the purpose of classification the following are the ma:or types of risk0 1. /osition or *xchange >ate >isk# ,. Credit or Counter party >isk N/reIsettlement Q settlementM 4. !ismatch !aturities or Ai+uidity >isk -. =perational >isk G. Aegal >isk F. overeign >isk The treasury of the "uthori'ed <ealer must evolve a risk control and risk management system# which is suitable to the scale# complexity and risk content of the )orex trading activities currently undertaken or being planned by the department. 6efore we turn to the >isks themselves# we must understand that the executives manning the )orex treasury need to be selected very carefully and need to possess certain +ualities more abundantly than any other bank executive. The treasury executives# more particularly the foreign exchange dealers need to have strong presence of mind and common sense. They also need to possess very high degree of analytical skills and an ability to deal with numbers and data and to be able to spot emerging trends Nif anyM in a fast moving market. &t is not uncommon to find C"s # *ngineers# and !6"s occupying dealing room positions. &n private corporate treasuries too the situation is not different. "bove everything else# what the )orex dealers needs most is nerves of steel.

Fo4e6>n E978an>e !eal6n>*#


"ny bank dealing in foreign exchange as an "uthori'ed <ealer has to look for profits and also ensure that any losses that may arise Nas they are bound to arise at sometime or the otherM# are kept to minimum. &t is not possible that a )orex dealer would never incur losses; it is also not practical to prohibit dealers from making losses. 6ecause of the special features of foreign exchange as a product which is bought and sold in boundary less international markets# the )orex dealing Nbuying and sellingM transactions are all the more risky. 5e need to keep in mind the following special features of the )orex market.

S:e76al Feat?4e* of Fo4e9 !eal6n>*@Ma4<et*


1M )oreign exchange dealings always involve two currencies and exchange rates of the currencies are influenced by a multitude of domestic and international social economic# political# technical etc. factors# ,M The )orex market is a ,-Ihour market and works in different time 'ones in different centers. )or example# when Tokyo market is open the ; market is closed. This situation creates some specific uncertainties and risks such as exchange rate risk and counter party risk# which cannot be avoided and only controlled. 4M )orex markets and transactions are crossIborder in nature and government restrictions in foreign countries play important role in this market. The fiscal monetary and overall economic policies of various countries and their effects on currency prices need to be understood properly to deal profitably in )orex market# -M )orex market is a very fast making market and deals in this market have to be undertaken at a very fast speed generally without much time being available to the dealer for second thoughts. The speed with which decisions have to be taken in )orex markets itself opens up risks in dealing.

Fo4e6>n E978an>e R6*<*# ,o*6t6on o4 E978an>e Rate R6*<


There are two basic positions# namely /urchase position and ale position.

5hen a dealer buys a foreign currency# he does so at a specific exchange rate and knows the cost of ac+uisition of the currency. 5hen he sells the currency# he does so at a specific exchange rate and knows the amount that he will receive from the purchaser of the currency. ince the buy and sale positions are taken at particular rates on overbought or oversold position can result in losses to the bank in case of an adverse movement in )orex rates. Over bought position0 5hen a dealer buys more foreign currency than he sells# it results in an overbought position# which is also called Aong /osition. &f the specific currency in which the dealer has taken overbought/Aong /osition depreciates against local currency# then the sale of the foreign currency would fetch less local currency than what was spent to buy the foreign currency# resulting in a loss to the bank. Oversold Position0 I 5hen a dealer sells more foreign currency than he buys# it results in an =versold /osition# which is also called hort /osition. &f the foreign currency in which the bank has taken this position is appreciating# it will result in exchange loss because the bank will have to shell out more local currency that it would have been re+uired to. "n oversold or overbought position may occur due to a conscious decision of the dealer based on his perception of prices of currencies involved sometimes the position can result from the fact that# due to circumstances beyond the control of the dealer he has been unable to s+uare his bought/sold position. To make profits# an overbought or oversold position Ni.e. a speculative positionM is generally considered unavoidable and hence to control the position or *xchange >ate >isk is the practical way out and not altogether elimination of the risk. There are three types of A&!&T # which are prescribed by bank managements for their )orex dealers to follow to ensure that the position or *xchange >ate >isk is reasonably controlled.

"6;6t* Set ?: to Cont4ol ,o*6t6on R6*<

1M Day Light Limit0 I This is a limit which is fixed for the dealing room as a whole for various currencies and also for individual dealers. This limit refers to the maximum open position Noverbought/oversoldM that a dealer can take in a currency at any time during the day. "ny breach of <ay Aight Aimit by an individual dealer re+uires specific approvalsM of senior management. The <ay Aight Aimit is fixed taking into account risk appetite of the bank# the volatility of the specific currency# maturity of experience and past track record of the individual dealer. ,M Overnight Limit0 I Generally this limit is fixed for open positions in each currency. "n overall limit for all dealt currencies is also fixed and the overnight limit has to be fixed rather conservatively and is less than the <ay Aight Aimit. This is so because day time positions can be continuously monitored and corrective action can be taken immediately. .owever# in case of overnight open positions no risk mitigating action is possible therefore the overnight limit has to be ade+uate to cover pipeline transactions but smaller than <aylight Aimit. 4M Cut-Loss/ top-Loss Limit0 I &n an open position# with adverse movement of rates a loss is bound to occur. &n fact# it is accepted reality that however good a dealer may be# he is bound to incur loss on his position some time or the other. " dealer%s position can become more and more adverse if the rates keep moving against him and so a limit up to which a dealer can incur loss on account of adverse movement of exchange rates# is fixed# and this is the CutIAoss/ topIloss limit. 5ith computeri'ation of dealing room operations# these days this limit is monitored automatically and the system itself warms the dealer Q management informed automatically. 5hen due to adverse movement of rates the loss becomes e+ual to the amount of limit# the dealer has to li+uidate the position and book loss irrespective of his perception of the rate movements. Cut loss limit is generally fixed in terms of the number of points an exchange rate and also the si'e of exposure. &f the absolute loss limit is ,8 points movement on ; < one million# a 18 points movement on a position of ; < two millions would enforce the cutIloss limit.

C4e=6t o4 Co?nte4 ,a4t5 R6*<


This is also known as preIsettlement / settlement >isk and it results from the inability or unwillingness of the counter party to a )orex deal to meet its obligation. ettlement of foreign exchange contracts# whether cash# spot or forward contracts eventually takes place. The settlement of )orex contracts# conceptually speaking is +uite simple and translates into $you pay me and & pay you( .owever in real life# a single )orex settlement can not be looked upon in isolation the cause it is part of a chain of payments# involving many currencies# covering different time 'ones etc. ettlement of a )orex transaction re+uires that each counter party tells the other party where to make the payment. 6ecause a variety of payment systems exist and they are not interlinked globally# payments do not take place instantly. 5ire transfer of funds is the only practical method of settling most of the )orex deals and hence# settlement risk is generally unavoidable. &n addition# because of the delays between the initial dispatch of payment message and the final receipt of the payment by the counter party settlement risk is often borne by both parties to the transaction. " settlement risk has to be necessarily taken by the bank if it wants to be in the foreign exchange business. To control settlement >isk# Credit Aines need to be established by the 6ank for each customer and each counter party. The amount of settlement risk incurred on any given transaction is the amount of currency expected but not yet received. There are two types of counter party risk as follows 0 iM Pre-settlement !is" is the risk of loss due to counter party default during the life of a contract. &f a customer who has booked a forward contract goes bust before the contract is due# the bank will be still re+uired to do purchase sale at market rate and meet its own forward sale/forward purchase obligations on due date. &t will result in replacement cost for the bank. 6y fixing exposure limits on counter parties# this risk is managed/controlled by banks. iiM ettlement !is"0 This risk arises when the bank performs on its

obligation under a contract before the counter party does so. This risk arises

due to time 'one. This risk may arise due to operational problems# technical break down; counter party failure or legal issues. 6anks exercise control over Credit/Counter party >isk by fixing limits on the total value of outstanding for customers and other banks. 6anks also fix maximum amount to be paid to a counter party on a particular value date.

M6*;at78e= Mat?46t6e*@"6A?6=6t5 R6*<# (


5hen a bank enters a )orex contract# it is always with a counter party# which may be a bank or a customer. Ai+uidity >isk is the risk that a bank will be unable to meet its finding re+uirements or complete a transaction at a reasonable price. 5hen a bank undertakes a 5"/ is buys and sells the same amount of a foreign currency for different value dates# it does not have an open position; however# the bank runs the risk of mismatched maturity or G"/ which gives rise to risk on account of forward premium or discount moving against the bank. " mismatch or gap gives rise to uneven cash inflows and cash outflows and an unfavourable movement of forward differential may put the bank to loss in covering the gap. &f a bank buys/sells ; < 1 mio forward and sells/buys ; < 1 mio two months forward# it is faced with a one month gap between forward contracts and to cover this gap by another contract at an adverse rate would put the bank to loss. &n real life# however deep the forward market may be# exact matching of forward positions is not possible and therefore Gaps in forward positions are bound to exist. Therefore the risk arising out of mismatched maturities needs to be managed by fixing various types of limits as follows0 iM #ndividual $ap Limit0 The purchases and sales of foreign currency with value dates falling in a given month may not be e+ual i.e. on a monthly basis open Noverbought/oversoldM position is likely to exist though the overall position of the bank in that currency may be s+uare. &f in a month a bank has overbought position therefore# in another month it will have an e+ual oversold position in the particular currency and this is known as G"/. 6anks manage

the risk of open positions by putting a ceiling in the form of &ndividual Gap Aimits for each month. ii M %ggregate $ap Limits 0I This is the absolute total Nignoring R or I M of all the overbought and oversold positions a bank is having for all the months in a particular currency. iiiM &otal %ggregate $ap Limit0 I This the total of all aggregate gap limits and it ensures controlling of uneven cash flows on account of mismatches.

O:e4at6onal R6*<
&n )orex dealing transactions# operational risks can arise due to human errors/failures or systemic problems. <ealers need to be chosen for their :ob with great care and need to be trained and proper rotation between seats must be ensured banks need to remember and take proper steps to ensure that 1. <ealing and "ccounting functions are segregated# ,. )ollowIup of deal tickets and contracts confirmation are done promptly. 4. ettlement of funds is done on time# can arise failing which# due to exchange rate fluctuations losses# -. !inimise pipeline transactions G. et appropriate limits for immediate reporting of sale/purchase transactions. F. *ach and every transaction# irrespective of its +uantum is reported to <ealing >oom. L. The back up section monitors outstanding contracts# outstanding export bills# amounts to be recovered under import ACs applicant etc. J. Nostro account reconciliation is done regularly because unreconcilied entries can be source of frauds and/or losses to the bank. reconciliation. taff that does not deal with operational aspects of Nostro accts must do from the

"e>al R6*<
ince )orex markets tend to be more volatile than other markets# properly worded agreements and contracts being exchanged between two counter parties is necessary. This is likely to ensure against one of them defaulting or being able to default easily. The best way of controlling Aegal >isk is to exchange internationally accepted contracts and other back up documentation.

SoBe4e6>n R6*<
This is the risk that a government may prohibit banks from its country from settling )orex deals with counter parties. The possibility of the central bank of a country being directed by the government to ration foreign exchange outflows is another kind of problem of externali'ation. The <ealing >ooms set up country limits for dealings with counter parties from such potentially shaky countries# corporate can insist upon advance payments or standby ACs or &rrevocable ACs confirmed by a prime bank from another country in case the corporates feel high sovereign risk exists in dealing with a particular counter party. " corporate who either buys )orex from Nas in case of an importerM or sells )orex to Nas in case of an exporterM a counter party# namely bank may want to protect itself against exchange rate movements for various reasons. &t is dealing with an overseas seller or buyer and exchange rates between currencies involved play an important role in determining price per unit of product Nunder referenceM being bought or sold by the corporate. The corporate can use either )orward Contracts of derivatives such as N1M )orward >ate "greements N , M )utures N4M Currency waps or N-M Currency options to hedge itself against volatility in exchange rat overeign >isk# which is also known as the

FOR)ARD CONTRACT:
)luctuations in exchange rate of a foreign currency visIOIvis the domestic currency can hurt a corporate in more ways than one such as N 1M The local currency cost of imports may rise due to an adverse change in exchange rate# leading to losses/reduced profits# N,M the rupee value reali'ed on exports may be less than anticipated# again due to an adverse change in exchange rate# leading to losses/reduced profits. &n foreign trade# the time gap between entering into a contract# shipment of goods and reali'ation of payment can be considerable# and during this period the exchange rate between contract currency and local currency may more unfavourably for the exporter/importer. Therefore# both the buyer and the seller may want to avail of protection against exchange rate risk. " )oreign *xchange )orward Contract is a contract between a Corporate and an "uthori'ed <ealer. This is always a written contract whereby the "< agrees to buy N)orward /urchase ContractM or to sell N)orward ales ContractM a specific amount of foreign exchange at an agreed rate either at a fixed future date or during a fixed future period. There are four types of )orex deals# namely C" .# T=!# )=>5"><. 1. &n case of C" . deal exchange of currencies takes place on same value date i.e. today at rate fixed today# ,. &n case of T=! deal# exchange of currencies taken place on networking day at rate fixed today# 4. &n case of a /=T deal# settlement takes place , business days hence from date of contract# at exchange rate fixed on date of contract. This is the single most important date for foreign exchange deals and the /=T value of a currency reflects what the market has determined to be the appropriate value of the currency. -. &n case of a )=>5">< deal# settlement takes place sometime after the /=T date. /=T# and

The )orward *xchange Contract rate has two components to it# namely N1M the spot rate between the currencies and N,M interest rate differential related to the time period of forward contract.

Fo4Ca4= ,o6nt*#
"ssume that the sport rate is 1 ; < H >s. -F.JLG8 and the 4 months forward rate is 1 ; < H >s. -F.7,G8 the difference between the two rates is 8.8G >s. / ; < and it is called forward points. &n this case the ; < is at a premium to &N>. There are 4 factors which influence the si'e of the forward points spread and these factors are 0 I 1. upply E/s demand for the currency on settlement date. &f supply is more the currency will be at a discount and if supply is less# the currency would be at a premium# ,. !arket expectations about future developments in the interest rate and foreign exchange markets. 4. &nterestIrate differentials between the two countries the currencies of which are being contracted. &n case of two currencies# which are freely traded say currency "# and currency 6 let us assume that the interest rate of currency 6 is higher than interest rate on currency ". This will lead to placement of funds in currency 6 and for a given forward period there will be more demand for currency " Nfor repayment of depositsM. Therefore the )orward >ate of currency " will be at a premium# which will be e+uivalent to the interest rate difference between the two currencies. This would normally offset any advantage accruing due to borrowing lowerIinterest currency and investing in higher interest currency. To the extent that some discrepancies prevail in the )orex market# dealers would take advantage of minute exchange rate differences between different markets and book arbitrage income.

Fo4Ca4= E978an>e Cont4a7t*


1M 'i(ed Date Contra)t0 5hen a forward contract is entered for delivery

on a fixed date in futures it is known as a fixed date foreign exchange forward contract# ,M Option 'or*ard Contra)t0 5hen )orex is to be delivered in future#

during a specified period Nsay one monthM# it is known as an =ption )orward Contract. This contract provides for option as far as date of delivery of foreign exchange is concerned and the first date and the last date for delivering/taking delivery of foreign exchange under this type of contract is fixed. )urther# these above contracts can be N1M )orward /urchase Contracts or N,M )orward ales Contracts.

Fo4Ca4= ,?478a*e Cont4a7t (F,C


&n )orex business# when we talk about buying and selling# we are referring to the bank buying or bank selling foreign exchange. Therefore# a forward purchase contract is booked with an "< by a customer who expects inflow of foreign exchange either on a fixed date in future or during a given period in future. follows0 I 1. Conversion of export proceeds# ,. /urchase of )CC notes from ))!C if the currency notes were sent for reali'ation the same "< 4. /roceeds of G<># "<> etc. ome of the purposes for which )/C can be booked are as

Fo4Ca4= Sale* Cont4a7t (FSC


This is booked when an "< is to sell foreign exchange to a customer at a fixed date or during a given period in future. ) C can be booked for0 1. >epatriation of foreign currency towards import payments. ,. >epayment of loans# 4. >emittance of surplus freight or passage collections of foreign airlines/shipping cos. -. >emittance of royalties# technical knowIhow fees# repatriation of dividends etc. G. /ayment or imports financed through foreign currency loans etc.

Co;:onent* of a Fo4Ca4= E978an>e Cont4a7t


)orward *xchange Contracts are legally enforceable and are drawn on stamp paper of ade+uate value. " merchant Nexporter/importer/fcy borrower etc.M is re+uired to return a copy of the contract to the "< with whom he has booked it# duly signed by an authori'ed signatory# retaining one copy for his own records. &he )ontents o+ a 'or*ard ,()hange Contra)t are0 1M Curren)y and %mount0 I )orward contracts are for specific currency and specific amount without any provision for excess or short fall. " forward purchase contract may mention more than one rate for bills of different deliveries and in that case the contract must state the amount and delivery against each rate. ,M Option o+ Delivery0 I &n a forward contract the date of delivery may be fixed or the option period of delivery may be fixed in terms of a calendar week etc# but never more than one calendar month. &f the fixed day delivery or last date of deliver option is a holiday/is declared a holiday the delivery is to be effected on the preceding working day. 5hen a contract permits option period of delivery it must state the first and the last working dates of delivery.

4M Pla)e o+ Delivery0 I "ll forward contracts have to be delivered or paid for at the bank and at the named place. -M Date o+ Delivery0 I The date of delivery in case of forward contracts is as follows0 I i. ii. iii. &n case of )/C# when export bill is negotiated# purchased or discounted# the date of payment to the exporter. &n case of )/C# when an export bill is sent for collection# date of payment of &N> to customer on reali'ation of export bill# &n case of retirement of &mport Collection or crystalli'ation of import bill under AC# the date of retirement/crystalli'ation. &n view of the fact that as per exchange control regulations in force in &ndia# exports have to be reali'ed and imports have to be paid for in F months from the date of shipment. )/Cs and ) Cs call be booked up to F th month of delivery.

Can7ellat6on of Fo4Ca4= E978an>e Cont4a7t


1. "s per )*<"& rules# when customer does not give any instructions# a forward exchange contract# which has matured# will be automatically cancelled on 1Gth day from the date of maturity. &n case 1G th day is a aturday or holiday# the contract will be cancelled on the next working day. ,. "< can cancel the unutili'ed portion of forward exchange contract irrespective of the amount involved# Cal)ulation o+ 'or*ard !ate )orward *xchange Contract >ate is based on /=T rate and also the )orward

/remium or <iscount on the foreign currency has to be taken into account. &n &ndia# like in the rest of the world# we have adopted <&>*CT >"T* +uotation between P&N> and )oreign Currencies Ne.g. 1 ; < H &N> -F.JLG8M. The bank# while +uoting )orward /urchase or )orward sale rate to its customer assumes that the customer will give/take delivery at that time when

it is most favourable to the customer and# as a result# most adverse to the bank. The customer can exercise the option of giving or taking delivery at any time during the option period. 1M #n )ase o+ 'or*ard !ate at Dis)ountaM 5hen a forward purchase contract is involved# bank +uotes maximum discount assuming that the customer will deliver )orex on the latest possible date. bM 5hen a )orward first possible date. ,M #n )ase o+ 'or*ard !ate at PremiumaM 5hen a )/C is involved# bank will +uote minimum premium assuming the customer will deliver )orex at the earliest possible date# bM 5hen a ) C is involved# bank will +uote maximum premium assuming the customer will take delivery of )orex at the latest possible date. ale Contract is involved the bank +uotes minimum discount assuming that the customer will take delivery of )orex on the

$4o<en !ate Fo4Ca4= E978an>e Cont4a7t*


&n foreign exchange market # the contracts are normally +uoted for 1#,#4#F months etc. .owever# customer can ask for forward exchange rates for periods falling between standard contract periods. These type of contracts are known as $6roken <ate )orward *xchange Contracts(. )or broken period pro rata difference between the related differentials is taken into account and added Nin case of premiumM to or subtracted from Nin case of discountM from the spot rate. ,(ample: 1 month forward differential H 1F points N?anM , month forward differential H 44 points N)ebM <ifference for N,J daysM of )eb H 1L points /er day diff H 1L S ,J H 8.F8L1

&n case broken period is 18 days Total no. =f points 8.8FL1 x 18 H F.L Nor LM , months forward differential H 44 Aess 18 days differential H 8L H ,F points pot I ,F points gives broken period forward rate.

SCa::6n> of Fo4Ca4= C?44en75


" known as transaction of buying and selling or selling and buying#

simultaneously same amount and same currency for different value dates is 5"/ when a bank buys forward currency from its customer for a fixed value date or for an option period it also undertakes or forward sale for matching period and s+uares its position. There are two types of 5"/ possible as follows0 ell pot/6uy )orward => ell )orward/6uy forward => 6uy pot/ ell )orward => 6uy )orward / ell )orward &rrespective of whether the customer fulfils his part of the forward contract or not# the bank will have to fulfill its contract. )or example in case a customer has entered )orward /urchase/ ale Contract with the bank for delivery on 41st !arch ,88G# the bank will have covered the bought/sold position by a forward sale/purchase of same currency for same amount and same value date. 6y s+uaring its forward position the bank has eliminated its exchange rate risk. &n real life# the "uthori'ed <ealer%s Ni.e. his )orex dealer%sM life is never so easy# because at the re+uest of the customer# it is optional for a bank to 0 aM "ccept or give early delivery# bM *xtend the contract# cM Cancel the contract before or after the maturity date.

1M ,arly Delivery under 'PC This will result in 4 different components# of cost to be recovered from the merchant. customer. "M )/C for ; < 1 Aac T ; < 1 H >s. -L.4G <elivery ?uly 41 st Customer delivery ; < 1 Aac on lst !ay. !ay >ates pot ; < 1 H >s. -L.,J,G S -L.4,LG )orwards pot/!ay pot/?uly 5hat is the 5"/ involved9 ". 6ank buys ; < 1 Aac on 1st !ay at )/C rate Q sells at spot rate. 6. ince customer will not deliver on 41st ?uly# but bank has under ) C on 41st ?uly ; < 1 Aac. C. 6ank buys on 1st !ay ; < 1 Aac for delivery 41st ?uly. N ell
st

ometimes the merchant may be benefited from early delivery# if

the bank# instead of paying up earns money due to early delivery done by the

H ,G88 / ,L88 H LL88 / J,88

pot/?une H G,88 / GG88

to deliver pot ; < l

lac # buy forward ; < 1 AacM )or 41 ?uly rate is spot/?uly LL88/J,88 is the &nter 6ank !arket. 6ank pays J, paise for 41 st ?uly <elivery per ; <. wap Aoss H ; < 188888 x >s. 8.J, H >s . J,888/I N To recover from customerM

6M 6ank pays >s. -L.4G x 188888 H >s. -L.4G lacs ;nder )/C >ate 6ank receives by spot sell >s. -L.,J,G x 188888 i.e . -L,J,G8/I>s. -L,J,G8. -L4G888 -L,J,G8 Cost 1 ?uly &nterest at 1,D p.a. for 4 months on >s. FLG8 H 18 Cost , Cost L8G,.G8 H ,8,.G8 >s. )lat fee >s. 188/I for early delivery. Total >ecovery >s. FLG8 R ,8,.G8 R 188 H >s. FLG8 x 1, x 4 188 x 1, H ,8,G N6ank /ay%sM I U )/C >a N6ank receivesM IU pot ?elling 6ack Cash outlay for 4 months from lst !ay to 41 st >s

FLG8 IU

NON*RESIDENT ACCOUNTS
3"CC=;NT =) N=N >* &<*NT &N<&"N # =C6s# N=N >* &<*NT 6"N@ "N<

**)C# >)C "CC=;NT 2

&ntroduction0
No person in &ndia can make a payment to or place any sum of money to the credit of any person resident outside &ndia without general permission or special exemption granted by >eserve bank of &ndia. imilarly# for making any payment or for placing any sum of money to the credit of any person residing outside &ndia# >eserve 6ank of &ndia%s permission is re+uired. =pening of accounts in the names of nonIresident &ndians in &ndia and operations in such accounts are therefore governed by the rules and regulations framed in this regard.

N=NI>* &<*NT &N<&"N 0


NonIresident &ndians fall into the following two broad categories0 C%&,$O!. %: 12 &ndian Citi'ens0 Those who have gone abroad on permanent basis / emigration. ,2 Those who have gone abroad for employment# carrying on business etc or for any other purpose indicating an indefinite stay abroad. C%&,$O!. /: 12 &ndian citi'ens employed by &nternational "gencies like ;N= / &!) ;N* C=/ 5.= / 5orld 6ank or at an &ndian *mbassy/ .igh Commission etc. ,2 &ndian citi'ens employed in Government# emi Government# organi'ations posted on deputation abroad 3other than to Nepal / 6hutan2

P,! O0

O' #0D#%0 O!#$#0:

)ollowing are considered as persons of &ndian =rigin0 "2 "n &ndian national# who held# at any time# an &ndian /assport# 62 " person whose either of the parents or any of the grand parents held an &ndian /assport# C2 " spouse of a citi'en of &ndia or of a person of &ndian origin 3not being a national of /akistan or 6angladesh2 is also deemed to be of &ndian origin even though he/ she may be of Non &ndian =rigin 3"ccount to be opened :ointly with the N>& spouse2.

N=NI>* &<*NT <*/= &T "CC=;NT 0


)ollowing persons are eligible to open Non >esident accounts with banks in &ndia. 12 Non resident &ndians# ,2 /ersons of &ndian =rigin# 42 =verseas Corporate 6odies with Non resident interest of F8D or more. 3 =btain certificate from the overseas chartered accountant / auditor / certified public accountant of =C6 in form ="C / ="C1 at the time of opening the account and annually thereafter.2 -2 Crewmembers of &ndian nationality or origin employed by )oreign / &ndian hipping Companies and "irlines and posted abroad. G2 "ccounts in the name of &ndian branches / offices of foreign companies and resident foreign nationals are treated as resident accounts.

TC/* =) N=N >* &<*NT 6"N@ "CC=;NT 0


11 0on !esident Ordinary %))ounts: 2 /3 C%3 and &erm Deposits1 These are meant for credit of bonafide local funds and legal payments of Non >esident &ndians. These accounts can be maintained in the nature of current# savings or term deposit accounts These resident &ndian. accounts can be opened :ointly between nonI resident &ndians or Non >esident &ndian can open N>= account :ointly with a

=n receipt of intimation that the status of the account holder has changed from >esident to Non >esident# redesignate all the resident accounts of the customer as N>= accounts.

OP,!%&#O0%L $4#D,L#0, :
"dvances against <eposits0 "llow loans / overdrafts against term deposits held & N>= accounts as per norms applicable to resident deposits sub:ect to the condition that the advance is not utili'ed for agricultural / plantation activities or for investments in real estate business. >epayment of loans / overdrafts may be out of fresh remittances from abroad or from out of maturity proceeds of N>* / )CN>/ N>= accounts or local funds. Credits: "llow the following credit transactions in N>= accounts0 12 Credit balances in existing resident accounts at the time of redesignation of the resident account as N>= account# ,2 >emittances received from abroad through normal banking channels and in permitted currencies# 42 Transfer from rupee accounts of nonIresident companies# -2 Aegitimate dues in >upees to the account holder in &ndia# G2 Transfer from existing N>=/ N>*/ )CN> / N>N> accounts. F2 ale proceeds of immovable property held by the nonIresident for a period of not less than 18 years sub:ect to payment of applicable taxes. L2 !aturity proceeds of N> > account deposits. Debits: "ll local payments in >upees# >epatriation of balances as follows0 ;pto ;pto ; < 48888 per academic year to meet expenses in connection with ; < 188888 to meet the medical expenses abroad of the account education of the account holder%s children# holder or his family members#

;pto

; < 18888per annum representing sale proceeds of immovable

property# held by the account holder for a period of not less than 18 years sub:ect to payment of applicable taxes. 21 0on !esident ,(ternal Deposit %))ounts: 2 /3 C%3 and &erm Deposits1 The funds held in these accounts are freely repatriable and are meant mainly for domestic payments in &ndian >upees including investment in shares# securities# properties etc. These accounts can be opened in the nature of savings# current and term deposit accounts. These can be opened for Non >esident &ndians or =C6s with at least F8D N>& share. ?oint accounts in the names of two or more Non >esident individuals can be opened. 5hen one of the :oint account holders becomes resident# delete his name and allow the account to continue as N>* account or redesignate the account as >esident/ >)C account at the option of the account holders. /ermit repatriation of balances along with interest at any time without approval of >eserve 6ank of &ndia. >ate of interest on N>* 6 and T< accounts is payable as per >6& guidelines in force from time to time. Credits: /roceeds of remittances received from abroad in an approved manner and in freely convertible foreign currency# TCs and <rafts in the name of the account holder# and foreign currency notes deposited by the account holder in person during his temporary visit to &ndia# &nterest accrued on N>* deposit accounts# Transfer from another N>* account of the account holder or N>* account of his close relative# >efund of shares / debentures subscription in case the amount was paid from N>* / )CN> accounts or from out of foreign inward remittance. Current income like rent# dividend# pension# interest etc# if the "< is satisfied that the credit represents current income of the non resident account holder and income tax thereon has been deducted / paid/ provided for# as the case may be. =ther transactions generally or specially permitted by >eserve 6ank of &ndia.

Debits: Aocal disbursements / payments# >emittances abroad# Transfer to other N>*/ )CN> accounts# =ther transactions generally or specially permitted by >eserve 6ank of &ndia. Premature Closure o+ Deposits: N= interest is payable if the N>* term deposit is closed before 1, months from date of opening. Premature ,(tension: No interest is payable if N>* term deposit is withdrawn within six months )or premature extension pay interest at rate applicable as on date of deposit for the period for which deposit has run provided renewal is at least for the period of original contract. !ene*al o+ Overdue Deposit: /ermit renewal from original maturity date if overdue period does not exceed 1- days# in which case pay interest at the rate applicable for the original maturity date or rate prevalent on the date of renewal# whichever is lower. &f the overdue period exceeds 1- days# renew the deposit from the date of the receipt of renewal application and pay interest on overdue period at the rate advised by Corporate =ffice from time to time. %dvan)es %gainst Deposits: 12 Aoans / =verdrafts in &ndia to the account holders0 Grant these for purposes other than investments# fully secured by term deposit receipt and sub:ect to observing the usual norms regarding margin re+uirements etc. >epayment of advance is done through ad:ustment of deposits or by remittance from abroad. >epayment out of balances in N>= accounts or from local funds is permitted with commercial rate of interest being applied. ,2 /ermit overseas correspondents to grant advances / facilities to nonI resident depositors or third parties on the re+uest of the depositors for bonafide purposes against security of N>& deposits. >emit proceeds of the deposit for the purpose of li+uidation of the outstanding loan.

42 "dvances to resident individuals# firms# companies in &ndia against collateral securities of term deposits held in N>* accounts is sub:ect to the following guidelines0 a 2 There should be no direct or indirect foreign exchange consideration to N>* depositor for pledging the deposit# b2 ;ndertaking to be given by N>& not to withdraw the deposit during the life of the loan# c2 "dvance is to be granted for personal purpose or for business other than agriculture or plantation activities. &rans+er o+ 'unds bet*een 0!, a))ounts: "llow transfer of funds between N>* accounts of different persons with us or with other "< s. &n case the transfer of funds is between different "<s # the "< transferring the funds has to issue a certificate confirming the nonI resident status of the transferor. &rans+er o+ 'unds bet*een 0!, and 'C0! a))ounts: /ermit free transfer of funds from N>* accounts to )CN> 362 accounts and vice versa. !emittan)e / &rans+er o+ 'unds to 0on !esident 0ominee: This is possible with prior approval of >eserve 6ank of &ndia. permitted

Change o+

tatus +rom 0on-resident to !esident:

=n intimation of change of status of the account holder from non resident to resident# convert the account to resident account but continue with the contracted rate of interest till the maturity of the deposit. &a( /ene+its: &nterest is exempted from income tax in case of N>& individuals but not in case of =C6s. Gifts made out of deposits are also exempt from Gift Tax.

/roviding .ousing Aoan in &N> to N>&s/ /&=s


"n "< or a .ousing )inance Company approved by the National .ousing 6ank can provide a housing loan to a Non >esident &ndian or /erson of &ndian =rigin resident outside &ndia for following purposes0 12 "c+uiring residential accommodation in &ndia# ,2 )or repairs/ renovation/ improvement of residential accommodation owned by the N>& / /&= in &ndia. !epatriation o+ sale Pro)eeds o+ immovable property in #ndia a)5uired by 0!#s/ P#Os&t will be in order for branches of "<s to allow repatriation of sale proceeds of residential accommodation purchased by N>&s / /&=s out of funds raised by them by way of loans from "<s / housing finance institutions# to the extent of such loans repaid by them out of foreign inward remittances received through banking channels or by debit to their N>*/ )CN> account.

)=>*&GN C;>>*NCC N=N >* &<*NT "CC=;NT 36"N@ 2


The main advantage of )CN> 362 <eposits is that these deposits are denominated in foreign currency# are freely repatriable# and several tax exemptions are available. "ll no residents of &ndian nationality or origin# =C6s with at least F8D N>& share are eligible to open these accounts. )CN> 362 accounts can be opened in :oint names of two or more nonIresidents and when one of them becomes resident# after deleting the name of the person the deposit can be continued till the maturity. )CN> 3 6 2 accounts can not be opened by non residents :ointly with residents. )CN> 362 accounts can be only fixed deposits for minimum one and maximum three years and in one of the following currencies only0 ; <ollars# /ound terling# ?apanese Cen# *uro. The rate of interest on these deposits varies from currency to currency and is advised by the Corporate =ffice from time to time. 6ode o+ !emittan)e +or Opening o+ %))ount: 12 6y way of foreign inward remittance by means of che+ues / drafts/ !T188 etc drawn in foreign currency 3not necessarily currency of )CN> 362 deposit.2 ,2 )unds to be received for credit of Nostro account of the bank issuing the deposit 42 &n case of drafts drawn payable in &ndia in foreign currency at the counters of another bank# obtain a counter draft from the drawee appropriate Nostro account. bank in foreign currency# send it for collection and get the proceeds credited to our

-2 )oreign currency notes may be sent to Thomas Cook and a counter draft in the currency may be obtained for opening the )CN> 362 account. G2 N>* deposits may be converted at TT selling rate into the currency of )CN> 36V <eposit. #nterest payment: &nterest is provided half yearly taking into account 1 year H 4F8 days. &nterest may be paid in currency of deposit / in another currency or in &N> as per the choice of the depositor. Period o+ Deposit: )CN> 362 deposits are accepted for minimum one year and maximum three years as per >eserve 6ank of &ndia guidelines. Premature Payment: N= interest is payable on premature payment before completion of one year. !epayment at maturity: )CN> 362 <eposits are repayable in currency of deposit or another convertible currency of the choice of the depositor. These deposits may also be credited to N>* / N>= account of the depositor as per his instructions# by converting the )cy depositor. The " < is re+uired to book forward purchase contract maturing with date of maturity of )CN> deposit to facilitate repayment of the deposit. !ene*al at 6aturity: >enewal of )CN> 362 deposits after maturity within 1- days can be done wef date of maturity of the deposit. "fter 1- days it can be done only after paying overdue interest rate advised by corporate office from time to time and by applying the rate of interest applicable on the date of renewal. amount of the deposit into &N> at TT buying rate. &n case of conversion into another currency# any exchange loss is for account of the

"dvances against CN> 362 deposits0


&n case of loans / overdrafts against )CN> 362 deposits# calculate the margin re+uirements on the >upee e+uivalent of the deposit amount at prevailing exchange rate. The other guidelines are the same as in case of loans against N>* deposits. 'oreign Curren)y Loans in #ndia to holders o+ 'C0! 2/1 Deposits: 2%P 2D#! eries1 Cir)ular no 27 o+ 28th eptember 29921

The >eserve 6ank of &ndia# has permitted "< s vide the above circular# to grant foreign currency loans in &ndia against the security of funds held in )CN> 362 deposit accounts to the account holders only. Guidelines for granting of foreign currency loans in &ndia to holders of )CN> 362 deposits0 12 Aoans should be granted against own )CN> 362 deposits and not against the deposits of third parties. ,2 Aoans should be granted only to deposit holders and not to any third party 3ties2. The deposit holders should execute the documents and not the /ower of "ttorney holders. 42 The maturity of the loan shall not exceed the maturity of the deposit under any circumstances. -2 Aoans should be sanctioned to the account holder for purposes other than investments in &ndia. G2 "dvances shall be fully secured by the deposit and regulations# if any# relating to margin shall be complied with. F2 >epayment of loan to be effected by fresh remittances in foreign exchange or by ad:ustment of the deposit. L2 The banks to put in place an ade+uate monitoring system. J2 *xtension of this facility should have approval of the board of the bank.

Conversion o+ 'C0! 2/1 deposits into #0! )onse5uent upon the )hange o+ status o+ the depositor 2'rom 0on resident to !esident1: The )CN> 362 deposits of returning &ndians may be allowed to continue till maturity at the contracted rate of interest. *xcept the provisions relating to rate of interest and reserve re+uirements as applicable to )CN> 362 deposits# for all other purposes such deposits would be treated as resident deposits from the date of return of the account holder to &ndia. "<s should convert the )CN> 362 deposits on maturity into resident rupee deposits or >)C accounts 3if eligible2# at the option of the account holder.

N=N >* &<*NT 6"N@ "CC=;NT 0


General0 Credit to the account of a nonIresident bank is a permitted method of payment to nonIresident and is# therefore# sub:ect to the regulations applicable to transfer of foreign currency. <ebit to the account of a nonIresident bank is an inward remittance in foreign currency. &n the case of individual payments of ; < 1888 or more# the purpose of remittance as given by the recipient should be reported in the > >eturn. "uthorised dealers may issue encashment certificates for <<# !T# TT paid by them to the debit of nonIresident bank account held with them. !4P,, %CCO40& O' 0O0-!, #D,0& /%0: :

6anks may open / close rupee accounts 3nonIinterest bearing2 in the names of their overseas branches or correspondents without prior approval of >eserve 6ank of &ndia. =pening of accounts in the names of branches of /akistani banks operating outside /akistan re+uires specific approval of >eserve bank of &ndia. The .ead / /rincipal =ffice of each bank should furnish an up to date list of all its offices / branches# which are maintaining rupee accounts of non resident banks# as at the end of <ecember every year giving the code numbers allotted by the >eserve 6ank of &ndia.

'O!6 %3: "ll debits / credits to the accounts of nonIresident banks should be reported in form "4.

'unding o+ %))ounts o+ 0on !esident ban"s: 6anks may freely purchase foreign currency from their overseas correspondents / branches at ongoing market rates to lay down funds in their accounts for meeting their bonafide needs in &ndia. Transactions in these accounts should be closely monitored to ensure that overseas banks do not take a speculative view on the &N>. "ny such instances should be notified to >eserve bank of &ndia. )orward purchase or sale of foreign currencies against rupees for funding is prohibited. =ffer of twoIway +uotes for a nonIresident bank is also prohibited. &rans+er +rom other a))ounts: Transfer of funds between the accounts of the same bank or different banks is freely permitted. Conversion o+ !upees into 'oreign Curren)ies: 6alances held in >upee accounts of nonIresident banks may be freely converted into foreign currency. "ll such transactions should be reported in )orm ", and the corresponding debit to the account should be in form "4 under the relevant > >eturn. !esponsibilities o+ Paying and !e)eiving /an"s: &n the case of credits to account the paying banker should ensure that all Control re+uirements are met and are correctly furnished in form "1/ ", as the case may be. The receiving banker after ensuring that the funds are eligible for credit should submit form "1 / ", under cover of the > >eturn.

!e+und o+ !upee !emittan)es: >e+uests for cancellation or refund of &nward >upee remittances may be complied with without reference to the >eserve bank of &ndia after the "< satisfies himself that the refunds are not being made in cover of transactions of compensatory nature. Overdra+ts / Loans to Overseas /ran)hes / Correspondents: 6anks may permit their overseas branches/ correspondents temporary overdrawals not exceeding >s G88 Aac in the aggregate# for meeting normal business re+uirements. This limit applies to the amount outstanding against all branches and correspondents in the books of all branches of the bank in &ndia. This facility should not be used for postponing funding of accounts. &f overdrafts in excess of the above limit are not ad:usted within five days a report should be submitted to the Central =ffice of >eserve bank of &ndia 3)orex !arkets <ivision2 within 1G days from the close of the month# stating the reasons thereof. value dating. 6anks wishing to extend any other credit facility in excess of the above to overseas banks should seek prior approval from the Chief General manager # >eserve 6ank of &ndia# *xchange Control <epartment 3)orex !arkets <ivision2# Central =ffice# !umbai. !upee %))ounts o+ ,()hange ;ouses: =pening of >upee accounts of exchange houses for facilitating private remittances into &ndia re+uires approval of >eserve bank of &ndia. >emittances through *xchange .ouses for financing trade transactions are permitted up to >s , Aac per trade transaction. uch a report is not necessary if arrangement exist for

>* &<*NT )=>*&GN C;>>*NCC "CC=;NT 3)=> >*T;>N&NG &N<&"N 2


$eneral #ntrodu)tion: The >)C scheme enables eligible returning &ndians 3i.e. N>& s returning to &ndia with change of status for Non >esident to >esident2 to open and maintain foreign currency accounts with authorised dealers in &ndia. These accounts can be opened in any foreign currency. ,ligibility: Citi'ens of &ndia or persons of &ndian origin who after being resident outside &ndia for a continuous period of not less than one year have returned to &ndia 3have become permanent residents of &ndia2 on or after 1J/8-/7,. &ypes o+ %))ounts: =pen Current# avings or Term <eposit accounts. )or premature closure of >)C Term <eposit accounts terms and conditions of )CN> 36V deposits apply except that the >)C <eposits can be for one month. &nterest >ate0 =n >)C avings bank accounts and fixed deposit accounts pay interest at rates stipulated by Corporate =ffice of our bank. Credits to !'C %))ounts: 12 /roceeds of investments made outside &ndia when the account holder was nonIresident and eligible for such investments. ,2 &ncome on eligible assets of the account holder# 42 ale proceeds of eligible assets# -2 /ensions or other monetary benefits received from outside &ndia through normal banking channels arising out of employment outside &ndia before returning to &ndia. G2 &nterest earned on other >)C accounts of the account holder# F2 )oreign Currency Notes / TCs brought into the country by the account holder. L2 6alances in N>* / )CN> accounts of the account holder# J2 "ny other amounts permitted by the >eserve 6ank of &ndia#

<o not transfer balances held in non convertible rupee accounts of persons resident in 6ilateral countries and balances in non convertible N>& deposit schemes like N>N> to >)C accounts. Operations: "llow funds to be freely utilised by account holder for all bonafide remittances outside &ndia as per relevant *xchange Control guidelines. "llow nominations as per existing guidelines applicable to nominations in bank accounts. *xisting N>* 3T< and 62 balances can be converted into >)C 3)cy2 accounts applying TT elling rate on the date of conversion. >)C balances can be converted into &N> by applying TT buying rate on the date of conversion. 5hen a returning &ndian becomes nonIresident once again the >)C accounts can be redesignated as Non >esident accounts.

*KC."NG* *">N*> % )=>*&GN C;>>*NCC "CC=;NT 0


$eneral #ntrodu)tion: *xporters of goods and services and other beneficiaries of inward remittances in convertible currencies are permitted to open **)C accounts in foreign currency. **)C accounts can not be opened for those exporters who are permitted to maintain foreign currency accounts with banks abroad# **)C accounts cannot be opened for recipients of inward remittances under repatriation guarantee. !e)eipt o+ ,(port Pro)eeds / 'oreign #n*ard !emittan)es: 5hen the beneficiary of the above proceeds wishes to retain / credit a part of it in **)C account# obtain specific written instructions from him to that effect. &f export bills are tendered for purchase/ discount / negotiation# finance the exporter only to the extent of foreign currency amount net of amount to be transferred to **)C account. &n case of bills tendered for collection also obtain specific instructions for transfer to **)C account.

&n either case# the amount is to be transferred to **)C account only after the realisation of the export bill. &rans+er to Other %))ounts: "llow funds held in **)C accounts to be freely converted into &N>. *xternal Commercial 6orrowings can also be paid from the balances held in **)C accounts. Credits to ,,'C %))ounts: 6anks stipulate minimum amounts that can be credited to **)C accounts per transaction however there is generally no such stipulation with respect to debits to **)C accounts. There is no stipulation for minimum Dwhen it comes to credit to **)C account from export proceeds. Corporate and others can credit up to L8D and G8D of their foreign exchange earnings to their **)C accounts respectively. >eserve 6ank of &ndia may allow on a caseIbyIcase basis the corporate to credit higher Dto **)C accounts for the purpose of allowing the corporate **)C account holder to prepay *xternal Commercial 6orrowings. !ate o+ #nterest: >ate of interest on **)C savings and term deposit accounts are determined and advised by the Corporate =ffice of the bank from time to time. &nterest is payable on **)C accounts from the date of credit of foreign currency to the bank%s Nostro account.

4tili<ation o+ 'unds: The most important purposes for which **)C balances can be used are as follows0 12 "dvance payment towards imports into &ndia# ,2 /ayment of freight for imports into &ndia# 42 Cost of goods purchased by 188D* = ; s from other similar units for export production# -2 *xpenses for setting up branches / offices abroad# G2 "ll bonafide expenses of the account holder towards travel / medical treatment abroad for self and family members# F2 /ayment towards consultancy fees to foreign consultancy organisations for services provided to &ndian entities sub:ect to *xchange Control re+uirements. L2 >epayment of foreign currency loans availed of under )CN> 36V deposits# J2 &nvestment by &ndian companies in ?E 3?oint Eentures2 / 5= =wned ubsidiaries2 abroad under **)C )ast Track 5indow. 35holly

EXCHANGE CONTROL REGULATIONS IN INDIA

&ntroduction
&n the following note we shall study the *xchange Control >egulations applicable in &ndia0 12 General Note ,2 receipt of )oreign *xchange# 42 >epatriation of )oreign *xchange# -2 Current "ccount Transactions# G2 )oreign Currency "ccounts of >esidents in &ndia# F2 /ossession and >etention of )oreign *xchange by >esidents of &ndia# L2 >eali'ation# >epatriation# and urrender of )oreign *xchange# J2 >emittance of )oreign *xchange from &ndia.

General Note0
The exchange control regulations in force in &ndia result from the provisions of the )oreign *xchange !anagement "ct which replaced the )oreign *xchange >egulations "ct & the year ,888. The exchange control regulations apply to various transactions undertaken by individuals and "uthori'ed /ersons and the ma:or heads under which transactions governed by *xchange Control fall# are as follows0 >eceipt of foreign exchange in &ndia by a resident of &ndia#

>epatriation of foreign exchange from &ndia by a resident of &ndia# !ethods of receiving and making payment in foreign exchange# Current "ccount transactions# Capital "ccount transactions# &nvestments in ?oint Eentures in &ndia# &nvestments in ?oint Eentures abroad# *xports from &ndia# &mports into &ndia# &ssues of &ndia# 6orrowing or Aending in foreign currency# 6orrowing or lending in &ndian >upees# <eposits of N>&s with banks in &ndia# )oreign Currency accounts of residents of &ndia # /ossession of foreign exchange by residents of &ndia# *xchange control regulations for &nsurance ector# &ssuance of foreign currency guarantees# )oreign currency derivative contracts# =ffshore 6anking ;nits. &n this note we propose to study select aspects of *xchange Control regulations as follows0 ecurities in &ndia by a branch / office of a person resident outside

>eceipt of )oreign *xchange in &ndia


There are two ways of receipt of foreign exchange in &ndia by an "uthori'ed <ealer. uch payment may be received against exports from &ndia or against any other approved purpose. The foreign currency payment may be received in free foreign currency or in "C; <ollars or to the debit of E= T>= account of a foreign bank with a bank in &ndia. &n case of receipt of payment in the "sian Clearing ;nion# the payment for all permitted current account transactions may be received to the debit of "C;

<ollar account in &ndia of a bank of the member country in which the other party to the transaction resides. The payment may be also received by credit to the "C; <ollar account of the "< maintained with the Correspondent 6ank in the member country.

>epatriation of )oreign *xchange by a >esident of &ndia0


" payment in foreign currency by an "<# against payment for imports into &ndia or against any other purpose may be done as follows0 /ayment to a receiver in an "C; Country may be made by credit to "C; <ollar account in &ndia of a bank in the member country in which the other party to the transaction is resident. /ayment to such a receiver may be made by debit to the "C; <ollar account of the "< with the Correspondent bank in the member country and payment may be made in any other currency in all other cases. )or payment to all nonI"C; countries# the same may be made in &N> to the account of a resident of any country or Nepal or 6hutan or payment may be made in a permitted currency.

Current "ccount Transactions


There are three schedules which govern Current "ccount Transactions as follows0 C.*<;A* 10 /rohibited transactions such as remittances of lottery winnings# remittance of income form racing / riding etc# remittance for purchase of lottery tickets# banned maga'ines# football pools# sweepstakes etc. payment of commission for certain types of exports from &ndia as well as payment for $ call back( telephone services are also prohibited under this schedule. C.*<;A* ,0 /rior approval of Government of &ndia is re+uired for cultural tours# remittance of freight on vessel chartered by a / ;# payment for

imports on C&) basis by Government <epartments/ / ;s# >emittance under technical collaboration agreement# >emittance f pri'e money/ sponsorship of sports activity# etc are covered under this schedule. C.*<;A* 4 0 ;nder this schedule# prior approval of >eserve 6ank of &ndia is re+uired for remittances beyond monetary limits prescribed by the >eserve 6ank of &ndia for following activities 0 Gift remittances# >elease of foreign exchange in a calendar year for one or more foreign visits# foreign exchange for going abroad for employment# remittances for maintenance of close relatives# release of foreign exchange for business travel# release of foreign exchange for studies abroad# release of foreign exchange for medical treatment abroad# remittances for consultancy service procured from outside &ndia etc. "ll other transactions not covered under any one of the above schedules can be freely carried out by persons resident in &ndia.

)oreign Currency "ccounts of >esidents in &ndia


" person resident in &ndia may open# hold and maintain with an "< in &ndia# a foreign currency account to be known as **)C account. .e may open such account out of foreign exchange received as payment# or reali'ed on conversion of overseas assets# received as gift or ac+uired in inheritance. The resident of &ndia may also hold >)C accounts. " foreign currency account held or maintained before commencement of the *xchange Control regulations with special or general permission of the reserve 6ank of &ndia shall be deemed to be held or maintained under these regulations.

/ossession and retention of )oreign *xchange by >esidents of &ndia


" person resident in &ndia may posses without limit foreign currency coins. " person resident in &ndia may retain foreign currency notes# ban notes# and foreign currency TCs not exceeding ; < two thousand or its e+uivalent in another currency# if ac+uired by him on a visit to any place outside &ndia by way of payment for services. " person resident in &ndia may ac+uire foreign currency from a person not resident in &ndia and on a visit to &ndia as honorarium/ gift /for services provided or in settlement of any lawful obligation and retain up to ; < two thousand or its e+uivalent in another currency. " person resident in &ndia but not permanently resident# may possess without limit foreign currency# if such foreign currency was ac+uired# held or owned by him when he was resident outside &ndia# and has been brought into &ndia in accordance with exchange control regulations. " person not permanently resident in &ndia# means a person resident in &ndia for employment of a specific duration or for a specific :ob or assignment not exceeding three years.

>etention# >epatriation# and urrender of )oreign *xchange


" person resident in &ndia to whom any amount of foreign exchange is due or has accrued# shall take al necessary steps to reali'e and repatriate to &ndia such foreign exchange. uch person shall not do anything or shall refrain from taking any action which may delay receipt of foreign exchange or the foreign exchange shall cease to be receivable by him in whole or in part. The foreign exchange once reali'ed shall e dealt with by the person resident in &ndia as follows0 "2 ale to an "< for reali'ation in &N>#

=r 62 >etention in an account with a "< in &ndia# => C2 ;se to pay off a foreign currency liability to the extent specified by >6&# urrender o+ 'oreign ,()hange to an %D/ %uthori<ed Person in #ndia: 2'ore( re)eived in #ndia1 " person shall sell reali'ed foreign exchange to an "uthori'ed /erson as follows0 )oreign exchange due or accrued as remuneration for services rendered # whether in or outside &ndia# or in settlement of any lawful obligation# or an income on assets held outside &ndia# or as inheritance# settlement etc 5&T.&N L <"C =) >*C*&/T =) )=>*&GN *KC."NG*. &n all other cases# within 78 <"C =) >*C*&/T. 2'ore( originally a)5uired +rom an %D1 "ny person who has ac+uired foreign exchange for a purpose mentioned in the declaration made by him to the "< # but does not use it for that or any other permissible purpose# either in full or partially# shall surrender it to an authori'ed person 5&T.& F8 <"C the foreign exchange. " person who has ac+uired foreign exchange for travel abroad shall surrender unspent exchange to a authori'ed person in &ndia as follows0 5&T.&N 78 <"C notes and coins# 5&T.&N 1J8 <"C from the date of return to &ndia# when it is & the form of TCs. .G from the date of return to &ndia when it is in the form of from the date of ac+uisition or purchase of

>emittance of )oreign *xchange from &ndia0

>emittance of foreign exchange re+uires the applicant to pay in &N> and he may ac+uire it for his own use or may re+uest an "< to remit the foreign exchange to a beneficiary abroad. The remittance of foreign exchange from &ndia falls under various categories as follows0 >emittance "gainst &mports into &ndia0 >emittance through "C;# or

>emittance in free foreign currency or >emittance by was of Credit to N>* 6ank account in &ndia0 "AA "G"&N T appropriate )=>! "1. >emittance for various approved purposes0 >emittance favouring individuals# remittance for subscription to maga'ines# remittance for various other purposes0 "AA "G"& T )=>! ",. >emittance by way of >upee Credit to Non >esident bank account of a foreign bank with a bank in &ndia0 "G"&N T )=>! "4.

)ll the aEo.e remittances ha.e to Ee re'orte* to -eser.e =ank o$ >n*ia at regular inter.als through the remittance transaction took 'lace.

FOREIGN EXCHANGE: HEDGING OF RISKS (FRA+ $ S)A,S$ FUTURES$ O,TIONS)


&NT>=<;CT&=N !ost organi'ations as well as individuals face financial risk changes in interest rates# exchange rate fluctuations# and changes in stock market prices are perhaps# some of the most common examples of happenings all of which are risky in some way or the other for an investor# for a currency trader for an organi'ation such as a commercial bank. Earious financial instruments have been developed for the management of various financial risks. )inancial <erivatives are financial instruments whose prices are derived from the prices of other financial instruments. <erivatives provide commitment to prices or interest or exchange rates for future dates or derivatives provide protection against adverse movements and thus they can be used to reduce financial risk. ome prominent financial derivatives are )orward >ate "greements# )utures; =ptions Q waps are the instruments to which they relate are stocks# bonds# interest rates and currencies. 5ith the collapse of fixed exchange rates system Nthe 6retton ystemM# new financial environment came into existence. 5oods This new

environment is characteri'ed by constantly changing exchange rates in response to the market forces of demand and supply. !ovements in currency prices# interest rate fluctuations etc. giving rise to new forms of business risks characteri'ed this new system. The new environment created need for reducing the new business risks and at the same time it also gave rise to opportunities for speculation. speculation. The financial markets came to be characteri'ed not only by volatility of currency markets# but also fluctuations/ charges in short term interest rates had implications for long term interest rates and in turn# for bond prices which are largely determined by long term interest rates. )inancial <erivatives have been developed over the last 48 add years to address the needs of risk control and scientific

FOREIGN EXCHANGE DERI-ATI-ES


Aong term interest rates are influenced by average of current and expected future shortIterm interest rates and increased volatility of short term interest rates is accompanied by an increase in volatility of long term interest rates which lead to increased instability of bond prices. AongIterm interest rates influence not only bond prices but also prices of other longIterm assets such as stocks. The volatility of share prices is reflected in the volatility of share market indices# which provide measure of average share price movements. AongIterm interest rates affect all share prices and therefore are a source of systematic risk Na risk which is common to all# or most of the sharesM. 5ith the increased instability of financial markets# financial derivatives have emerged as means of managing the risks associated with that instability# and also of taking advantage of the instability. 6asically# )orward >ate "greements# )utures and waps involve commitment to exchange of cash flows in the future at prices or rates decided at the time of entering into the commitment. "n option provides the right# but not the obligation# to a future exchange at a price or rate determined in the present. <erivatives are used as instruments to hedge an existing risk of a price Nor rateM movement. ince forwards# futures and swaps involve commitments# these exclude the possibility of benefiting from otherwise favourable price or rate movements. =ptions provide protection against adverse movements and presence the right to benefit from any favourable price or rate movements. " speculator who uses an option can ignore it and also avoid potentially large losses at the same time but he cannot do so with other derivatives. .owever# options attract payment of option premium to the option writer by the purchased Ninvestor/speculatorM of the option. No such payment is re+uired when using forwards# futures or swaps.

Forward Rate Agreements:


De+inition: This is a <erivative contract where in future interest rate on a currency Nto be borrowedM forms the basis of the contract. This is a contract between two parties and fixes a rate of interest on a notional amount of principal for a future loan or a deposit commencing from an agreed future date for a period fixed today. )>"s interest rate movements. are used for managing interest rate risk to take a view on by banks# borrowers# lenders# investors etc. to hedge against future adverse peculators can use )>"s unpredictable interest rate movements and profiting from these movements. *xample0 " corporate wants to borrow ; < 188 mio 4 months from today on a floating rate Nsay A&6=>M for a period of F months. Though he has to borrow at floating rate he is more comfortable at a fixed rate of say FD p.a. for the loan period of F months. The corporate approaches a bank# which is the market maker in )>"s wants to 6;C an )>" from the bank. The )>" will read as0 $FD p.a. on ; < 188 millions for 4 months against 7 months( and the )>" will work as follows0 1M FD is the $>eference >ate $ or $Contract >ate( and is the price of )>" fixed with the market maker. The borrower corporate and the bank agree to compare this rate with a $6enchmark >ate( two days before the notional loan period begins Nwhich is 4 months from date of )>"M. The $6enchmark >ate( is also known as the $ ettlement >ate(. ,M The amount of ; < 188 million represents the $Notional "mount( used to calculate $Compensatory payment(. The )>" relates only to interest rate and does not imply any obligation by counter parties to make a loan or deposit. This Notional "mount is used only to calculate the settlement amount. and

4M The term $4 months against F months ( refers to the $start date( and the $maturity date( of the notional loan.

Compensatory Payment
&f the benchmark NA&6=>M in this case is at F.GD two days before the notional loan period begins the marketImaking bank Nthe seller of the )>"M shall pay compensatory amount to the borrower at NF.GDI F.88DM 8.GD p.a. for F months on ; < 188 millions. &f the bench mark rate is at G.LGD on the fixing date Ni.e. , days before loan period beginsM# the buyer of )>" i.e. the corporate pays the seller bank at 8.,GD p.a. for F months on ; < 188 millions.

Forward Rate Agreement (FRA) &t is important to remember that aM " corporate who wants to borrow the notional amount 6uys )>" Ni.e. fixes borrowing rateM bM " corporate that wants to place a notional deposit# fixes deposit# *AA )>" Ni.e. fixes deposit rateM % ban"3 *hi)h a)ts as mar"et ma"er in '!%s 5uotes0 /#D !ate0 for buying an )>" i.e. the 6ank is prepared to pay fixed rate Q receive floating rate. O'',! !ate0 for selling an )>" i.e. the bank is prepared to receive fixed rate and pay floating rate. The spread between the 6id and =ffer >ate is the profit of the market maker in )>". 4 , O' '!%s *AA )>". Ni.e.

1. To speculate on future interest rates# ,. To hedge interest rate risk Nas a borrower or as a depositorM 4. " borrower can convert a variable rate loan to a fixed rate loan# -. " depositor can convert a variable rate deposit to a fixed rate deposit#

G. " bank can manage interest rate risk in funding a relatively longIterm fixed rate loan with variable rate deposits.

SWAPS
The term means# $exchange( and in the domain of financial derivatives# it simply means exchange of liabilities between two NcounterM parties. waps help the borrowers to borrow/fund themselves in more ways than one or change the interest rate or currency exposure from the terms of initial contract. The borrower can use The basic types of bM 6asis waps cM Currency waps 1M a M &nterest >ate waps N/lainIEanillaM &n advanced financial centers/developed economics interest rates are sub:ect to various factors such as demand for and supply of funds# borrower profile Q credit rating of the borrower# period of borrowal and risk factor etc. The &nterest >ate 5"/ uses differences in perception of a borrower%s 5"/ to change his asset/liability profile as per changing re+uirements/market scenario. 5"/ are as follows0 I aM &nterest >ate waps#

creditworthiness with regard to fixed rate visIOIvis floating rate borrowings. The main types of &nterest >ate waps are as follows0 I )loating >ate Aoan exposes the borrower to the risk of increasing interest rate during the tenure of the loan# and to avoid this risk the borrower the borrower may not have ade+uate credit standing to borrow at fixed rate or he may be able to borrow at a particularly high fixed rate of interest. &n this situation the borrower may attempt to a fixed rate liability. The &nterest >ate 5"/ his floating rate liability for 5"/ may be done between two

borrowers directly or may involve a bank as an intermediary; when a bank is involved as an intermediary it may become counter party to both the borrowers and bear the risk of default by either of the borrowers. This situation has two advantages# namely N1M The two borrowers remain anonymous to each other because they deal with the market maker# i.e. the

bank# and each other.

N,M The two borrowers need not investigate creditworthiness of

,(ample: 6orrower a borrows at floating rate from Aender "# 6orrower 6 borrows at fixed rate from Aender 6. 6ank KCB is the intermediary bank# which agrees with " to provide funds for payment of floating rate of interest and to accept interest payment at a fixed rate. The bank also finds a fixed rate borrower wanting a floating rate loan and the 6orrower 6 agrees to pay floating rate while receiving fixed rate. &n this case Aender " deals with borrower " and receives floating rate of interest and Aender 6 continues to deal with 6orrower 6 and receives fixed rate of interest. &n the situation where bank acts as a counter party to borrowers " and 6# it runs the risk of default by either of them# and bank is left exposed to interest rate risk. *xample0 5hen rate risk is being hedged with 5"/# it is important to note that gains/losses offset losses/gains on the positions being hedged. &n case a provider of funds borrowers at fixed rate and lends at floating he may take out a 5"/ of floating interest rate for fixed. " bank may agree to pay him fixed interest rate and receive floating interest rate. 5ith a rise in floating interest rate# the borrower would end up paying more to the bank and also earn more on the floating interest rate lending done by him. The gain from higher receipts against lending is offset by higher payment to the bank. 6asis waps0 The term basis refers to the $>eference &nterest >ate( on which a 5"/ is

based. )or example# in a floating interest rate scenario# A&6=> may be the basis and A&6=> R D may be the basis for interest calculation. The A&6=> taken into account may be a 4Imonth A&6=> or F months A&6=> etc. &n a 6asis 5"/ two borrowers may swap the basis on which their payment of interest to the lender is structured. Thus a borrower " who has borrowed at 4 months A&6=> may 5"/ his borrowing with another borrower 6 for 4 months

TI6ills or 4 months TI6ills R ,8 bps Nfor exampleM There are a variety of 6asis 5"/ some of which are as follows0 I 1M <ifferent tenor with same reference rate 4 months A&6=> against F months A&6=> ,M <ifferent tenor or same tenors of different reference rates S 4 months A&6=> against F month T 6ill rate R bps or 4 months A&6=> against 4 months T 6ill rate R bps ;sing 5"/ to reduce interest costs NT= "<<M

CURRENCY SWAPS
There are 4 different meanings of the term $swap( in international finance and these are as follows0 1M The spot purchase/sale and simultaneous forward sale/purchase of a currency. ,M )orward /urchase and )orward amount and period. 4M *xchange of debt servicing liabilities or exchange of beneficial ownership of assets. *xample of Currency wap " 6ritish company may have easier access to the 6ritish capital market than the ; capital market and an "merican company may have easier capital market than the 6ritish capital market. &n practice Company and the ; Company can access to the ; ale of a given currency for same

this results in a scenario where the 6ritish company can raise sterling resources on better terms than the ; raise ; <ollar resources on better terms than the 6ritish company. Now visuali'e a situation where the 6ritish Co. has to invest in ; <ollar assets in ; and the "merican Co. has to invest in sterling assets in ;.@. The 6ritish Co. is vulnerable to strengthening of sterling against ; < and would be interested in swapping its sterling liability into ; <ollars.

The 6ritish Company and the "merican Company enter into a Currency wap by a direct approach or more likely through an intermediary bank. The 6ritish Company agrees to meet the "merican Co%s <ollar interest and principal repayments through the bank and the "merican Co. agrees to meet the 6ritish Co%s tg. &nterest and principal repayments through the bank. The intermediary bank acts as the counter party to both the companies and the two companies need not know each other and their leaders in the respective markets need not know about the currency swap. &f dollar becomes stronger the bank will gain in its transaction with 6ritish company but lose with the ; Company. .owever# in normal circumstances the gains and losses being e+ual and opposite# would cancel each other out. 6ut if the 6ritish Company were to default# the bank will have on its hands only the loss making commitment with the ; Company. Currency waps allow the borrowers to take of the relatively

advantageous terms# which they might en:oy in particular markets. &t is mutually advantageous for each to borrow in the more favourable market and exchange the currencies borrowed Nor buy the re+uired currency in spot market with some resultsM and also the liabilities created resulting in assets and liabilities in same currencies. " swap need not give rise to exchange of spot currencies and a swap may merely be an agreement to service each other%s debt. *xample of 5"/0 ; Co. German Co. &f ; &nterest >ates ; < G F <.!. F G

Co borrows <! at FD p.a. and German Co. borrows ; < T FD Co. borrows ; < and German Co. borrows <!# the total Co. pays German Co. GD N<!M

the total interest cost H 1,D p.a. .owever if ; interest cost H 18D p.a. To share the interest advantage the ; and German Co. pays ; costs. Co. GD N; <M both saving 1D each on interest

The different rates on the two currencies have the same effect as forward premium/discount would have. The exchange of principal upon maturity would be done at the same rate as the original exchange of principal and the different interest rates on the currencies make the swap e+uivalent to the use of forward currency exchange contracts. waps result in one or more of the following advantages for the counter parties0 1M >aising finance at cheaper cost# ,M .edging against interest rate exposure 4M .edging against exchange rate exposure# -M >aising resources abroad# which may not be otherwise allowed by foreign authorities# GM "rbitraging in different markets# FM peculation.

INTEREST RATE CA,S+ F"OORS+ CO""ARS


Corporates can use these to hedge their risks on floating interest rates 0 C%P &nterest >ate Cap is an agreement between a 6ank and its borrower who has borrowed at floating rate# whereby any extra cost over and above a predetermined NceilingM interest rate is borne by the bank. )or this the bank charges the corporate borrower a premium. 5hen a corporate wishes to invest in a pro:ect# it works out a maximum interest rate beyond which it is not worthwhile to undertake the pro:ect from the viewpoint of profitability. The corporate would therefore like to $Cap the interest rate( at this predetermined level. The borrower may buy the cap from the lender who will change a higher premium because of the dual risk of amount lent and cap sold. To lower the premium# the borrower can borrow from one source and buy the cap from another source Q thereby divide the risk# reducing the premium payable.

'LOO! " depositor who has substantial amount to deposit or lend and floating rate of interest is available would like t ensure that the rate of interest that he earns does not fall below a certain D Ni.e. to set a $floor for the interest rate(M. .e pays a lump sum premium and buys an &nterest >ate )loor. COLL%!: &t is +uite possible that a corporate takes view that interest rates will remain $>ange 6ound( i.e. they will not fall below a certain D NfloorM and may not rise above a certain D NCapM. The corporate borrower may buy a Collar whereby he does not pay below the floor rate and above the Cap rate below the floor rate and above the cap rate. Though he loses if interest rate falls below the floor# he also pays less premium . "uthori'ed <ealers in &ndia have been permitted by >eserve 6ank of &ndia to offer &nterest >ate caps/floors/collars )>"s waps# Currency waps# /urchase of &nterest rate to their corporates for hedging their various

exposures. The "< can book the transaction overseas or on back to back basis# without prior approval of the Government or the >eserve 6ank of &ndia. )or this# following conditions have to be complied with by the corporate. 1M The necessary approvals for concluding the loan transaction must be in place# ,M The notional principal amount of the hedge must not exceed the outstanding amount of fcy loan# 4M The maturity of the hedge must not exceed the remaining life to maturity of the underlying loan# -M The 6oard of <irectors of the Co. has approved the financial limits and the authori'ed designated official to conclude the hedge transaction.

FOREIGN EXCHANGE$ HEDGING OF RISK .O,TIONS / FUTURES0


OP !ON D,'#0#&#O0 "n option is the right to buy or sell a specified amount of a financial instrument at a preIarranged price on# or before# a particular date. " right to buy is known as a C"AA =/T&=N and the right to sell is a /;T =/T&=N. The difference between a )orward *xchange /urchase or means of an example. ale contract and a Call or /ut option will put the option in the correct perspective by

Forward P"r#$ase Contra#t %&s Ca'' Opt(on


Customer " enters into a )/C with bank KCB Atd. )or ; < 1 million at -F.JLG8# <elivery 1st )eb.I,Jth )eb. ,88G or <elivery 1Gth )eb ,88G. &n the former case it is an option period of one month and in the later case it is a fixed dated option. &n this case if the customer " delivers the currency earlier/later than the option period/fixed date or does not deliver the currency at all for whatever reasonNsM# he ends up paying 5"/ cost to the bank NCounter party to the )/CM C%LL OP&#O0 Customer " enters a call option with counter party bank to buy ; < 1 million at -F.JLG8 either during 1 st )eb. S ,Jth )eb# N"merican optionM or on 1Gth )eb. ,88G N*uropean =ptionM. &f the customer does not deliver the foreign currency at contracted rate because ongoing market rate is more favourable he will not have to pay any penalty as in case of a )orward /urchase Contract. The counter party bank suffers the loss between the higher on going market price and the price fixed for the call option.

.owever while writing the call option for buyer " the KCB 6ank limited charges certain premium to customer " who has to pay it up front. &n case the ongoing market rate for ; < turns out to be less than the option rate# customer " will exercise his option and protect himself against loss. &n case the ongoing market rate is e+ual to the option rate# customer " will allow the option to lapse. 5hat can be seen from the above basis is as follows0 1. "n option gives its purchaser the right to buy/sell and not the obligation. ,. "n option buyer has to pay premium to the option writer N6ank KCBM 4. The loss of option buyer is limited to the amount of premium paid by him# -. There is no limit Nin theoryM to the amount of profit that the option buyer can derive# G. The option can be exercised either on a fixed date Nas in case of an *uropean tyle =ptionM or during a fixed period Nas in case of an "merican tyle =ptionM. F. )or every buyer of an option there must be a seller. ome further points to be noted before we turn to understand option terminology are0 L. =ptions are brought into existence by being traded# J. There is no limit to the number of options contracts that can exist at any time# 7. The process of closing out option positions leads to reduction in the total number of options contracts# 18.The traders of options are involved in a 'eroIsum game the profits/losses of buyers of options precisely e+ual the losses/profits of option writers. P4& OP&#O0 : o far as put options are concerned they can be compared with forward sales contracts for foreign exchange. The buyer " of a put option purchaser the

right but not obligation to sell a specific amount of a specific currency at a specific rate during a specific period N"merican tyle =ptionM or on a fixed 5"/ charges to KCB wap date N*uropean tyle =ptionM. &n case of nonIdelivery# early or late delivery of forward sales contract the customer " ends up paying 6ank Atd. 5ith whom he entered the ) C. &n case of the put option# customer " has paid premium to KCB 6ank Atd. S the writer of the option. The costs cannot be known in advance in case of )/C or ) C but customer " knows premium in advance. The profit that he can make by entering )/C or ) C or a Call//ut option is not know at the time of entering the )orward Contract or buying the option. "part from options being categori'ed as Call//ut# *uropean tyle/"merican tyle# they may be =TC N=ver The CounterM or *xchange traded. =TC options result from private deal between two parties generally a bank and a client. These options many relate to "NC amount of "NC financial instrument at an agreed price and "NC expiry date# which means =TC options can be tailorI made to suit specific re+uirements of the purchaser of the option. =n the other hand# exchangeItraded options are bought and sold on organi'ed exchanges. These options are standardi'ed as to the amount and price of the underlying instrument# the nature of the underlying and the available expiry dates. uch options contracts provide a limited range of tyle =ption and an "merican tyle prices and expiry dates and most of these are "merican tyle =ptions. 5e must remember that an *uropean traded through out the world. Now let us turn to an understanding of the currency options terminology0 I =ption are not limited by geographical boundaries and both option types are

CURRENCY O,TIONS TERMINO"OGY


Call Option0 I This is the right to buy specific amount of one currency against another currency at a specified exchange rate on a given date or during a given option period. Put Option0 I This is the right to sell specific amount of one currency against another currency at a specified exchange rate on a given date or during a given option period.

/uyer o+ Option0 I The person who buys a call or put option is known as the 6uyer. eller =>riter) o+ option0 I The counter party Nmay be a bank or its subsidiary or an individualM Premium0 I The amount paid by the buyer of a call/put option to the seller NwriterM of the option. tri"e Pri)e0 I This is the predetermined price at which an option can be exercised. ,(er)ise Date0 I The date of which the option can be exercised of giving or taking delivery of the currency is known as the exercise date. ,(piration Date0 I The last date up to which the option can be exercised. %meri)an tyle Option0 I "n option that the buyer can exercise at any time

between the date of the option and the expiration date of it. ,uropean expiry date . #ntrinsi) ?alue0 I The gross profit that can be obtained by immediately exercising the option Ndisregarding the premiumM and is e+ual to the difference between the exercise price and the market price of the currency when the option is &n The !oney N&T!M. #&6 Option0 I This is an option whose exercise price is less than the market price of the currency and which therefore offers an immediate gross profit to the buyer. %&6 Option0 I This is an "t The !oney =ption whose price is e+ual to the market price. tyle Option0 I "n option that the buyer on exercise only on its

O&6 Option0 I This is an out of The !oney =ption whose exercise price is greater than the market price of the underlying currency. &ime ?alue o+ Option0 I "t the time of expiry of a Traded =ption# its premium will be e+ual to its intrinsic value. is known as Time Ealue of =ption. ?olatility0 I &n the context of options# Eolatility measures the extent by which exchange rates more over a period of time. &t can be defined as the annuali'ed standard deviation of the current market price. ;sing this definition# GD volatility means that there is a 8.FF probability that the future spot rate None year from nowM will be within GD N1 either side of the current oneIyear forward price. probability tandard <eviationM on imilarly there is 8.7G 6efore expiry of the option# normally the premium would exceed the intrinsic value# and this excess price

that the future spot rate will be within 18D Nor , standard

deviationM on either side of the current forward rate. These confidence limits assume Normal <istribution. #mplied ?olatility0 I 5hen a volatility factor has been determined# the premium for a given option can be determined. imilarly# when the premium for an option is known# the volatility that would be re+uired to generate the premium can be determined. This volatility that is calculated from the premium is known as &mplied Eolatility and represents the market%s assessment of possible market movements in the relevant future. Delta0 I )or foreign exchange option# this term represents the change in premium for a small change in the underlying exchange rate# everything else being e+ual. &f the premium changes rate# everything else being e+ual. &f the premium changes by a full point for a point change in the underlying exchange rate# the delta is 1. <elta ranges from 8.8 for fare out of the money option to 1.8 for deep in the money options. <elta is affected by the relationship of the strike price to the current market price; it can also be affected by the volatility of the option market and the time to expiry.

$amma0 The measure of change in the delta due to a given change in the underlying spot market is known as gamma. &t is essentially the delta of the delta.

!ETERMINANTS OF ,REMIUM# (
Two factors need to be taken into account for determining premium on an option0I 1. %s)ertaining #ntrinsi) value0 I This is e+ual to the currency price minus the exercise price of the option# with 'ero being the minimum intrinsic value. &n principle# the option premium cannot fall below the intrinsic value because if this were to happen# there would be guaranteed profit from buying the option and immediately exercising it. ,. Determining &ime ?alue0 I This is much more complex and ma:or influencing factors on time value are 0I *xpected volatility of currency# The length of period remaining to expiry# The extent to which the option is in or out of the money. The higher the expected volatility# the greater will be the premium. The probability of an option ac+uiring intrinsic value prior to expiry arises with the length of time remaining to the expiry of the option.

Uses o) Opt(ons:
1. =n account of volatile exchange rates# a customer would prefer a call or put option to a forward contract with the bank# ,. 5hen a customer is bidding for a large value contract and therefore# not sure of the outcome of the contract# and the exposure risk# option proves an effective tool for hedging. &f contract is not awarded# option will not be exercised# and if contract is awarded# option may be exercised.

4. =ptions

are

best

answer

to

hedging

balanceIsheet

translation

exposure.

-. =ptions are useful in hedging exposures on account of foreign currency loans where amounts are large.

G. 5hen fcy amount involved is uncertain an option is more useful than a forward contract# F. 5hen timing of inflow/outflow of fcy is uncertain# again an option is more useful than a forward contract.

IN!IAN SCENARIO#
1. "uthori'ed <ealers and not Corporate Customers can write options Nboth Call and /utM# ,. "ds should sell options to resident customers only to cover their genuine exposures. Cross currency options can be sold to customers who are allowed to take cross currency forward exchange covers# 4. CrossIcurrency options should be written on fully covered basis# and option position should not be left open. -. N"< should buy from overseas branch/bank an identical option for the same amount strike price# and maturity date as the option sold to their customerM. G. =ptions written and purchased should be marked to market at suitable periods# so as to coincide with dates on which the evaluation of foreign exchange position is done# F. "ppropriate accounting entries should be passed for options purchased and sold# as well as premium paid and received. =ption exposures should appear in the books of accounts as contingent liability.

L. Aimits should be set for customer exposures and counterparty limits for options purchased should be laid down. J. "<s can buy options in overseas markets and sell them to other "ds in &ndia.

7. "ds who wish to write options have to obtain >6& permission given full details regarding arrangements made with overseas branches/banks to buy options# internal control systems# documentation etc.

The customer can sell back the option to the "< from whom he purchased it.

FUTURES CONTRACT
De+inition0 I " futures contract is a firm obligation to give delivery or take delivery of a commodity of a specific +uantity and +uality at a specific date at an agreed price. There are two types of futures in the market and these are N1M Commodity )utures and N,M )inancial futures under )inancial futures the most common ones are 0 1. &nterest >ate )utures# ,. Currency *xchange >ates )utures# 4. hare /rice &ndices )utures. hort( and the 6uyer is called The seller of a futures contract is called $ The futures markets(. " Currency )utures Contract is an agreement to buy or set at $futures exchange( a standard +uantity of a foreign currency at a future date at a price agreed between the parties to the contract. The futures contracts are traded on a $futures exchange( and its constituents are as follows0 I 1. The counter parties to the contract# namely the 6uyer and the eller# ,. )utures Commission !erchants are only allowed to trade on the exchange. The merchant collects margin balances# records and reports all trading activities of the customers.

$The Aong( and all futures contracts are bought and sold on $designated

4. *xchange0 I The buy or sell order of a customer is executed by )uture Commission !erchant on an exchange which provides physical market place Nthe floorM supervises and enforces ethical and financial standards# and promotes business interests of the members.

-. Clearing house receives daily reports of all trades# matches short against long Q reconciles the positions and computer and collects/pays daily margin calls to the members.

C"rren#y F"t"res: Sett'ement:


=n entering a futures contract# the seller has to give delivery to the buyer. !ost of the contracts are settled by offsetting futures transactions or one cash settled by offsetting futures transactions or one cash settled. .owever# in case of commodity contracts# physical delivery for contract settlement may be done and it has to be done for agreed +uantity and +uality at exchange specified location such as a warehouse etc. &n cash delivery the price of the contract is setIe+ual to the cash price of the underlying commodity at that time. "ny money owing to the seller or the buyer is transferred via clearinghouse and the contract is closed. &n most cases# the futures contracts are settled by offsetting futures contract transactions. The buyer li+uidates his position by selling and the seller by buying. &t is desirable that the markets in currency future are li+uid to ensure easy trading conditions. )inancial futures contracts are highly standardi'ed so as to enhance the +uantities of the contract and generate market li+uidity. The contracts traded on financial futures exchanges have a limited number of maturity dates each year# and the contract si'es are also standard which limits the number of different contracts available and correspondingly increases the volume traded in each case. " hedger who buys a futures contract in a currency# must also have a seller i.e. his ac+uisition of the right and obligation to buy currency on a specified date in the future at a price agreed upon in the present is matured by another user%s right and obligation to sell the currency at that date and price. *N<