Chapter 1

INTRODUCTION

Foreign exchange risk (also known as FX risk, exchange rate risk or currency risk) is
a financial risk that exists when a financial transaction is denominated in a currency other
than that of the base currency of the company. The exchange risk arises when there is a risk
of appreciation of the base currency in relation to the denominated currency or depreciation
of the denominated currency in relation to the base currency. The risk is that there may be an
adverse movement in the exchange rate of the denomination currency in relation to the base
currency before the date when the transaction is completed.

Foreign exchange risk also exists when the foreign subsidiary of a firm maintains financial
statements in a currency other than the reporting currency of the consolidated entity.

Investors and businesses exporting or importing goods and services or making foreign
investments have an exchange rate risk which can have severe financial consequences, but
steps can be taken to manage (i.e. reduce) the risk.

Foreign exchange risk is the exposure of a company’s financial strength to the potential
impact of movements in foreign exchange rates. The risk is that adverse fluctuations in
exchange rates may result in a reduction in measures of financial strength. It is acknowledged
that specific foreign exchange risk practices may differ among banks depending upon factors
such as the institution’s size, and the nature and complexity of its activities. However, a
comprehensive foreign exchange risk programme should deal with, at a minimum, good
management information systems, contingency planning and other managerial and analytical
techniques.

Foreign exchange (FX) is a risk factor that is often overlooked by small and mediumsized
enterprises (SMEs) that wish to enter, grow, and succeed in the global marketplace. Although
most U.S. SME exporters prefer to sell in U.S. dollars, creditworthy foreign buyers today are
increasingly demanding to pay in their local currencies. From the viewpoint of a U.S.
exporter who chooses to sell in foreign currencies, FX risk is the exposure to potential
financial losses due to devaluation of the foreign currency against the U.S. dollar. Obviously,
this exposure can be avoided by insisting on selling only in U.S. dollars. However, such an
approach may result in losing export opportunities to competitors who are willing to
accommodate their foreign buyers by selling in their local currencies. This approach could

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also result in the non-payment by a foreign buyer who may find it impossible to meet U.S.
dollar-denominated payment obligations due to the devaluation of the local currency against
the U.S. dollar. While coverage for non-payment could be covered by export credit insurance,
such “what-if” protection is meaningless if export opportunities are lost in the first place
because of the “payment in U.S. dollars only” policy. Selling in foreign currencies, if FX risk
is successfully managed or hedged, can be a viable option for U.S. exporters who wish to
enter and remain competitive in the global marketplace.

History

Many businesses were unconcerned with and did not manage foreign exchange risk under the
Bretton Woods system of international monetary order. It wasn't until the switch to floating
exchange rates following the collapse of the Bretton Woods system that firms became
exposed to an increasing risk from exchange rate fluctuations and began trading an increasing
volume of financial derivatives in an effort to hedge their exposure. The currency crises of
the 1990s and early 2000s, such as the Mexican peso crisis, Asian currency crisis, 1998
Russian financial crisis, and the Argentine peso crisis, led to substantial losses from foreign
exchange and led firms to pay closer attention to their foreign exchange risk.

The Barter Economy

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Forex trading requires the existence of national currencies that are generally accepted as a
store of value. Forex traders trade these national currencies in pairs, speculating on the
strength or weakness of one currency against another. A currency with an artificial rate set by
a government is not appropriate for FX trading, nor is a currency that is highly volatile due to
political unrest or hyperinflation. This article traces the evolution of money from barter, to
gold, to Eurodollars held in accounts outside the U.S. Knowing the history of money helps a
Forex trader understand the factors behind a currency’s strength or weakness and price
fluctuations, enabling them to make more informed trade decisions.

People throughout time have always traded for a variety of reasons. Some reasons have been
to sell finished products for money, or obtain desired raw materials by barter, or to buy and
sell commodities or other goods only for the reason of attempting to profit from the
transaction. As an example, a baker may need wheat to make bread; a farmer may have wheat
but may need meat, and a butcher may need bread and have meat. In this example, these
individuals have a potential trade based on need. However, the barter system only provides a
means for people to obtain goods and services they need as long as they have goods or
services desired by other people.

In recent times the barter system is still used. During the cold war, when the Russian ruble
was nearly worthless, Russia was in need of wheat due to a bad harvest and the United States
had a surplus. However, the US had a shortage of oil and Russia had a surplus. A barter
exchange of oil for wheat took place between the 2 countries enabling each to take advantage
of their position to obtain the other’s surplus.

However, as you can imagine, the barter system is not perfect. It lacks convertibility (what is
a cow worth and what can it convert into), portability (how easy is it to travel with a cow),
and divisibility (if it is agreed that a cow is worth 4 sheep, what do you do if you only want 1
sheep?).

The introduction of money solved these three negative characteristics of the barter system
and has allowed for international commerce and the Forex market to develop to the point it is
at today.

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The Gold Standard and the Bretton Woods Agreement

The history of Forex trading was heavily influenced by The Gold Standard and The Bretton
Woods Agreement. The Bretton Woods Agreement was adopted in 1944 with the primary
objective of the Agreement being to provide international monetary stability by preventing
money from fleeing across nations. Its secondary objective was to restrict currency
speculation. Prior to the Bretton Woods Agreement, the Gold Standard dominated the
international economic system and paved the way for our modern foreign exchange market.

The Gold Standard existed between the years of 1815 and World War I. Under the Gold
Standard, currencies gained stability, as each country's currency was backed by gold. It
abolished the age-old practice used by kings and rulers of arbitrarily degrading the value of
their currency, triggering inflation.

The Gold Standard had its faults. As an economy strengthened, a country would import
heavily from abroad until it ran down its gold reserves. As a result, the money supply would
shrink, interest rates would rise and economic activity would slow - creating cyclical
recessions. Ultimately, when the price of goods would hit bottom, other nations would go on
buying sprees that would inject the local economy of the country with gold, increasing its
money supply, and consequently driving down interest rates and producing wealth in the
country’s economy. Such boom-bust economic patterns prevailed throughout the Gold
Standard, until the outbreak of World War I.

Under the Bretton Woods Agreement, participating countries agreed to maintain the value of
their currency within a narrow margin against the US Dollar and a corresponding rate of gold.
Countries were prohibited from devaluing their currencies to their trade advantage and were
only allowed to do so if the devaluation was less than 10%. During the 1950s, the ever-
expanding volume of international trade led to massive movements of capital generated by
post-world war construction. This economic reality destabilized foreign exchange rates,
which contradicted the Bretton Woods Agreement.

It was clearly time for a change; the Bretton Woods Agreement was finally abandoned in
1971, and the US Dollar was no longer convertible into gold. By 1973, currencies of major
industrialized nations floated more freely. The value of a country's currency was now
controlled by the forces of supply and demand and no longer by gold reserves. Prices of
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currencies were floated daily, and ever increasing volume, speed and price volatility rapidly
developed throughout the 1970s. This gave rise to new financial instruments, market
deregulation and trade liberalization.

In the 1980s, cross-border capital movement accelerated with the advent of computers and
technology, extending foreign exchange trading throughout the Asian, European and
American time zones. Transactions in foreign exchange rocketed from about $70 billion a
day in 1980, to more than $2.4 trillion a day in 2003.

The Explosion of the Eurodollar Market

A major catalyst to the growth of Forex trading was the rapid development of the Eurodollar
market - where US Dollars are deposited in banks outside the US. In addition, Euro-markets
are those where assets are deposited outside the currency of origin. The Eurodollar market
first came into being in the 1950s when Russia's oil revenue - all in Dollars - was deposited
outside the US in fear of being frozen by US regulators. This gave rise to a vast offshore pool
of Dollars outside the control of US authorities. The US government imposed laws to restrict
Dollar lending to foreigners. Euro-markets were particularly attractive because they had far
less regulations and offered higher yields. From the late 1980’s onwards, US companies
began to borrow offshore, finding Euro-markets a highly attractive alternative for holding
excess liquidity, as well as for providing short-term loans and financing of imports and
exports.

London was (and remains) the principal Forex market place. In the 1980’s, London became
the financial center of the Eurodollar marketplace when British banks began lending Dollars
as an alternative to Pounds sterling in order to maintain their leading position in global
finance. The geographical location of London (operating during Asian and American market
hours) is also instrumental in preserving its dominance in the Euro-marketplace.

Characteristics of the Foreign Exchange Market

1. Most Liquid Market in the World:
Currency spot trading is the most popular FX instrument around the world, comprising more
than 1/3 of the total activity. It is estimated that spot FX trading generates about $1.5 trillion
a day in volume, making it the largest most liquid market in the world.

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Compare that to futures $437.4bn and equities $191bn and you will see that foreign exchange
liquidity towers over any other market. Even though there are many currencies all over the
world, 80% of all daily transactions involve trading the G-7 currencies i.e. the “majors.”

When compared to the futures market, which is fragmented between hundreds of types of
commodities, and multiple exchanges and the equities market, with 50,000 listed stocks (the
S&P 500 being the majority), it becomes clear that the futures and equities provides only
limited liquidity when compared to currencies.

Liquidity has its advantages, the primary one being no manipulation of the market. Thin stock
and futures markets can easily be pushed up or down by specialists, market makers,
commercials, and locals. Spot FX on the other hand takes real buying/selling by banks and
institutions to move the market. Any attempted manipulation of the spot FX market usually
becomes an exercise in futility.

Among the various financial centers around the world, the largest amount of foreign
exchange trading takes place in the United Kingdom, even though that nation’s currency—
the pound sterling—is less widely traded in the market than several others. The United
Kingdom accounts for about 32 percent of the global total; the United States ranks a distant
second with about 18 per cent and Japan is third with 8 percent. Thus, together, the three
largest markets—one each in the European, Western Hemisphere, and Asian time zones—
account for about 58 percent of global trading. After these three leaders comes Singapore
with 7 percent.

The large volume of trading activity in the United Kingdom reflects London’s strong position
as an international financial center where a large number of financial institutions are located.
In the 1998 foreign exchange market turnover survey, 213 foreign exchange dealer
institutions in the United Kingdom reported trading activity to the Bank of England,
compared with 93 in the United States reporting to the Federal Reserve Bank of New York.

2. Most Dynamic Market in the World:

Foreign exchange market is the most dynamic market in the world. Regardless of which
instrument you are trading – be it stocks, municipal bonds, U.S. treasuries, agricultural
futures, foreign exchange, or any of the countless others – the attributes that determine the
viability of a market as an investment opportunity remain the same.

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Namely, good investment markets all possess the following characteristics- liquidity, market
transparency, low transaction costs, and fast execution. Based upon these characteristics, the
spot FX market is the perfect market to trade.

3. It is a Twenty-Four Hour Market:

During the past quarter century, the concept of a twenty-four hour market has become a
reality. Somewhere on the planet, financial centers are open for business, and banks and other
institutions are trading the dollar and other currencies, every hour of the day and night, aside
from possible minor gaps on weekends. In financial centers around the world, business hours
overlap; as some centers close, others open and begin to trade. The foreign exchange market
follows the sun around the earth.

The International Date Line is located in the western Pacific, and each business day arrives
first in the Asia-Pacific financial centers— first Wellington, New Zealand, then Sydney,
Australia, followed by Tokyo, Hong Kong, and Singapore. A few hours later, while markets
remain active in those Asian centers, trading begins in Bahrain and elsewhere in the Middle
East.

Later still, when it is late in the business day in Tokyo, markets in Europe open for business.
Subsequently, when it is early afternoon in Europe, trading in New York and other U.S.
centers start. Finally, completing the circle, when it is mid- or late-afternoon in the United
States, the next day has arrived in the Asia-Pacific area, the first markets there have opened,
and the process begins again.

The twenty-four hour market means that exchange rates and market conditions can change at
any time in response to developments that can take place at any time. It also means that
traders and other market participants must be alert to the possibility that a sharp move in an
exchange rate can occur during an off hour, elsewhere in the world.

However, foreign exchange activity does not flow evenly. Over the course of a day, there is a
cycle characterized by periods of very heavy activity and other periods of relatively light
activity. Most of the trading takes place when the largest number of potential counterparties
is available or accessible on a global basis.

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Market liquidity is of great importance to participants. Sellers want to sell when they have
access to the maximum number of potential buyers/and buyers want to buy when they have
access to the maximum number of potential sellers.
Business is heavy when both the U.S. markets and the major European markets are open—
that is, when it is morning in New York and afternoon in London. In the New York market,
nearly two thirds of the day’s activity typically takes place in the morning hours. Activity
normally becomes very slow in New York in the mid- to late afternoon, after European
markets have closed and before the Tokyo, Hong Kong, and Singapore markets have-
opened.

4. Market Transparency:
Price transparency is very high in the FX market and the evolution of online foreign
exchange trading continues to improve this, to the benefit of traders. One of the biggest
advantages of trading foreign exchange online is the ability to trade directly with the market
maker. A reputable forex broker will provide traders with streaming, executable prices. It is
important to make a distinction between indicative prices and executable prices.

Indicative quotes are those that offer an indication of the prices in the market, and the rate at
which they are changing. Executable prices are actual prices where the market maker is
willing to buy/sell. Although online trading has reached equities and futures, prices represent
the LAST buy/sell and therefore represent indicative prices rather than executable prices.

Furthermore, trading online directly with the market maker means traders receive a fair price
on all transactions. When trading equities or futures through a broker, traders must request a
price before dealing, allowing for brokers to check a trader’s existing position and ‘shade’ the
price (in their favor) a few pips depending on the trader’s position.

Online trading capabilities in FX also create more efficiency and market transparency by
providing real time portfolio and account tracking capability. Traders have access to real time
profit/loss on open positions and can generate reports on demand, which provide detailed
information regarding every open position, open order, margin position and generated
profit/loss per trade.

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5. International Network of Dealers:
The market is made up of an international network of dealers. The market consists of a
limited number of major dealer institutions that are particularly active in foreign exchange,
trading with customers and (more often) with each other. Most, but not all, are commercial
banks and investment banks. These dealer institutions are geographically dispersed, located
in numerous financial centers around the world. Wherever located, these institutions are
linked to, and in close communication with, each other through telephones, computers, and
other electronic means.

There are around 2,000 dealer institutions whose foreign exchange activities are covered by
the Bank for International Settlements’ central bank survey, and who, essentially, make up
the global foreign exchange market. A much smaller sub-set of those institutions accounts for
the bulk of trading and market-making activity. It is estimated that there are 100- 200 market-
making banks worldwide; major players are fewer than that.

At a time when there is much talk about an integrated world economy and “the global
village,” the foreign exchange market comes closest to functioning in a truly global fashion,
linking the various foreign exchange trading centers from around the world into a single,
unified, cohesive, worldwide market.

Foreign exchange trading takes place among dealers and other market professionals in a large
number of individual financial centers— New York, Chicago, Los Angeles, London, Tokyo,
Singapore, Frankfurt, Paris, Zurich, Milan, and many, many others. But no matter in which
financial center a trade occurs, the same currencies, or rather, bank deposits denominated in
the same currencies, are being bought and sold.

A foreign exchange dealer buying dollars in one of those markets actually is buying a dollar-
denominated deposit in a bank located in the United States, or a claim of a bank abroad on a
dollar deposit in a bank located in the United States. This holds true regardless of the location
of the financial center at which the dollar deposit is purchased. Similarly, a dealer buying
Deutsche marks, no matter where the purchase is made, actually is buying a mark deposit in a
bank in Germany or a claim on a mark deposit in a bank in Germany. And so on for other
currencies.

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Each nation’s market has its own infrastructure. For foreign exchange market operations as
well as for other matters, each country enforces its own laws, banking regulations, accounting
rules, and tax code, and, as noted above, it operates its own payment and settlement systems.

Thus, even in a global foreign exchange market with currencies traded on essentially the
same terms simultaneously in many financial centers, there are different national financial
systems and infrastructures through which transactions are executed, and within which
currencies are held.

With access to all of the foreign exchange markets generally open to participants from all
countries, and with vast amounts of market information transmitted simultaneously and
almost instantly to dealers throughout the world, there is an enormous amount of cross border
foreign exchange trading among dealers as well as between dealers and their customers.

At any moment, the exchange rates of major currencies tend to be virtually identical in all of
the financial centers where there is active trading. Rarely are there such substantial price
differences among major centers as to provide major opportunities for arbitrage. In pricing,
the various financial centers that are open for business and active at any one time are
effectively integrated into a single market.

Accordingly, a bank in the United States is likely to trade foreign exchange at least as
frequently with banks in London, Frankfurt, and other open foreign centers as with other
banks in the United States. Surveys indicate that when major dealing institutions in the
United States trade with other dealers, 58 percent of the transactions are with dealers located
outside the United States. Dealer institutions in other major countries also report that more
than half of their trades are with dealers that are across borders; dealers also use brokers
located both domestically and abroad.

6. Most Widely Traded Currency is the Dollar:

The dollar is by far the most widely traded currency. According to the 1998 survey, the dollar
was one of the two currencies involved in an estimated 87 percent of global foreign exchange
transactions, equal to about $1.3 trillion a day. In part, the widespread use of the dollar
reflects its substantial international role as – “investment” currency in many capital markets,
“reserve” currency held by many central banks, “transaction” currency in many international
commodity markets, “invoice” currency in many contracts, and “intervention” currency

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employed by monetary authorities in market operations to influence their own exchange
rates.

In addition, the widespread trading of the dollar reflects its use as a “vehicle” currency in
foreign exchange transactions, a use that reinforces, and is reinforced by, its international role
in trade and finance. For most pairs of currencies, the market practice is to trade each of the
two currencies against a common third currency as a vehicle, rather than to trade the two
currencies directly against each other. The vehicle currency used most often is the dollar,
although by the mid-1990s the Deutsche mark also had become an important vehicle, with its
use, especially in Europe, having increased sharply during the 1980s and ’90s.

Thus, a trader wanting to shift funds from one currency to another, say, from Swedish krona
to Philippine pesos, will probably sell krona for U.S. dollars and then sell the U.S. dollars for
pesos. Although this approach results in two transactions rather than one, it may be the
preferred way, since the dollar/Swedish krona market, and the dollar/Philippine peso market
are much more active and liquid and have much better information than a bilateral market for
the two currencies directly against each other.

By using the dollar or some other currency as a vehicle, banks and other foreign exchange
market participants can limit more of their working balances to the vehicle currency, rather
than holding and managing many currencies, and can concentrate their research and
information sources on the vehicle.

Use of a vehicle currency greatly reduces the number of exchange rates that must be dealt
with in a multilateral system. In a system of 10 currencies, if one currency is selected as
vehicle currency and used for all transactions, there would be a total of nine currency pairs or
exchange rates to be dealt with (i.e., one exchange rate for the vehicle currency against each
of the others), whereas if no vehicle currency were used, there would be 45 exchange rates to
be dealt with.

In a system of 100 currencies with no vehicle currencies, potentially there would be 4,950
currency pairs or exchange rates [the formula is- n(n-1)/2].Thus, using a vehicle currency can
yield the advantages of fewer, larger, and more liquid markets with fewer currency balances,
reduced informational needs, and simpler operations.

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7. “Over-The-Counter” Market with an “Exchange-Traded” Segment:
Until the 1970s, all foreign exchange trading in the United States (and elsewhere) was
handled “over-the-counter,” (OTC) by banks in different locations making deals via
telephone and telex. In the United States, the OTC market was then, and is now, largely
unregulated as a market.

Buying and selling foreign currencies is considered the exercise of an express banking power.
Thus, a commercial bank or Securities & brokerage firms in the United States do not need
any special authorization to trade or deal in foreign exchange.

There are no official rules or restrictions in the United States governing the hours or
conditions of trading. The trading conventions have been developed mostly by market
participants. There is no official code prescribing what constitutes good market practice.

However, the Foreign Exchange Committee, an independent body sponsored by the Federal
Reserve Bank of New York and composed of representatives from institutions participating
in the market, produces and regularly updates its report on Guidelines for Foreign Exchange
Trading. These Guidelines seek to clarify common market practices and offer “best practice
recommendations” with respect to trading activities, relationships, and other matters.

Although the OTC market is not regulated as a market in the way that the organized
exchanges are regulated, regulatory authorities examine the foreign exchange market
activities of banks and certain other institutions participating in the OTC market.

As with other business activities in which these institutions are engaged, examiners look at
trading systems, activities, and exposure, focusing on the safety and soundness of the
institution and its activities. Examinations deal with such matters as capital adequacy, control
systems, disclosure, sound banking practice, legal compliance, and other factors relating to
the safety and soundness of the institution.

The OTC market accounts for well over 90 percent of total U.S. foreign exchange market
activity, covering both the traditional (pre-1970) products (spot, outright forwards, and FX
swaps) as well as the more recently introduced (post-1970) OTC products (currency options
and currency swaps). On the “organized exchanges,” foreign exchange products traded are
currency futures and certain currency options.

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Foreign Exchange and its Functions.

Transfer of Purchasing Power

The Primary function of a foreign exchange market is the transfer of purchasing power from
one country to another and from one currency to another.
The international clearing function performed by foreign exchange markets plays a very
important role in facilitating international trade and capital movement.

Provision of credit
the credit function performed by foreign exchange markets also plays a very important role in
the growth of foreign trade, for international trade depends largely on credit facilities.
Exporters may get pre shipment and post shipment credit. Credit facilities are available also
for importers. The Euro dollar market has emerged as a major international credit market.

Provision of Heding Facilities

The other important of the foreign exchange market is to provide hedging facilities. Hedging
refers to covering of foreign trade risks, and it provides a mechanism to exporters and
importers to guard themselves against losses arising from fluctuations in exchange rates.

Methods of Affecting International Payments

There are important methods to effect international payments.

Transfers
Money may be transferred from a bank in one country to a bank in another part of the world
be electronic or other means

Cheques and Bank Drafts

International payments may be made by means of cheques and bank drafts. The latter is
widely used. A bank draft is a cheque drawn on a bank instead of a customer’s personal
account. It is an acceptable means of payment when the person tendering is not known, since
its value is dependent on the standing of a bank, which is widely known, and not on the credit
worthiness of a firm or individual known only to a limited number of people.

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 Foreign Bill of Exchange

A bill of exchange is an unconditional order in writing, addressed by one person to another,

requiring the person to whom it is addressed to pay a certain sum or demand or on a specified
future date. There are two important differences between inland and foreign bills. The date on
which an inland bill is due for payment is calculated from the date on which it was drawn, but
the period of a foreign bill runs fro m the date on which the bill was accepted. The reason for
this is that the interval between a foreign bill being drawn and its acceptance may be
considerable, since it may depend on the time taken for the bill to pass from the drawers
country to that of the acceptor. The second important difference between the two types of bill
is that the foreign bill is generally drawn in sets of three, although only one of them bears a
stamp and of course one of them is paid.

Now days it is mostly the documentary bill that is employed in international trade. This is
nothing more than a bill of exchange with the various shipping documents the bill of lading,
the insurance certificate and the consular invoice attached to it. By using this the exporter can
make the release of the documents conditional upon either

 payment of the bill if it has been drawn at sight or

 Its acceptance by the importer if it has been drawn for a period.
Transactions in the foreign Exchange Market

A very brief account of certain important types of transactions conducted in the foreign
exchange market is given below Spot and Forward Exchanges

Spot Market

The term spot exchange refers to the class of foreign exchange transaction which requires the
immediate delivery or exchange of currencies on the spot. In practice the settlement takes
place within two days in most markets. The rate of exchange effective for the spot transaction
is known as the spot rate and the market for such transactions is known as the spot market.

Forward Market

The forward transactions is an agreement between two parties, requiring the delivery at some
specified future date of a specified amount of foreign currency by one of the parties, against
payment in domestic currency be the other party, at the price agreed upon in the contract. The

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rate of exchange applicable to the forward contract is called the forward exchange rate and
the market for forward transactions is known as the forward market.

The foreign exchange regulations of various countries generally regulate the forward
exchange transactions with a view to curbing speculation in the foreign exchanges market. In
India, for example, commercial banks are permitted to offer forward cover only with respect
to genuine export and import transactions.

Futures

While a focus contract is similar to a forward contract, there are several differences between
them. While a forward contract is tailor made for the client be his international bank, a future
contract has standardized features the contract size and maturity dates are standardized.
Futures cab traded only on an organized exchange and they are traded competitively. Margins
are not required in respect of a forward contract but margins are required of all participants in
the futures market an initial margin must be deposited into a collateral account to establish a
futures position.

Options

While the forward or futures contract protects the purchaser of the contract from the adverse
exchange rate movements, it eliminates the possibility of gaining a windfall profit from
favorable exchange rate movement.

An option is a contract or financial instrument that gives holder the right, but not the
obligation, to sell or buy a given quantity of an asset as a specified price at a specified future
date. An option to buy the underlying asset is known as a call option and an option to sell the
underlying asset is known as a put option. Buying or selling the underlying asset via the
option is known as exercising the option. The stated price paid (or received) is known as the
exercise or striking price. The buyer of an option is known as the long and the seller of an
option is known as the writer of the option, or the short. The price for the option is known as
premium.

Types of options: With reference to their exercise characteristics, there are two types of
options, American and European. A European option cab is exercised only at the maturity or
expiration date of the contract, whereas an American option can be exercised at any time
during the contract.

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 Swap operation

Commercial banks who conduct forward exchange business may resort to a swap operation to
adjust their fund position. The term swap means simultaneous sale of spot currency for the
forward purchase of the same currency or the purchase of spot for the forward sale of the
same currency. The spot is swapped against forward. Operations consisting of a simultaneous
sale or purchase of spot currency accompanies by a purchase or sale, respectively of the same
currency for forward delivery are technically known as swaps or double deals as the spot
currency is swapped against forward.

Arbitrage
Arbitrage is the simultaneous buying and selling of foreign currencies with intention of
making profits from the difference between the exchange rate prevailing at the same time in
different markets

Forward Contract
Forward contracts are typical OTC derivatives. As the name itself suggests, forward are
transactions involving delivery of an asset or a financial instrument at a future date. One of
the first modern to arrive contracts as forward contracts ere known was agreed at Chicago
Boar of Trade in March 1851 for maize corn to be delivered in June of that year.

Characteristics of forward contracts

The main characteristics of forward contracts are given below;

 They are OTC contracts

 Both the buyer and seller are committed to the contract. In other words, they have to take
deliver and deliver respectively, the underlying asset on which the forward contract was
entered into. As such, they do not have the discretion as regards completion of the
contract.
 Forwards are price fixing in nature. Both the buyer and seller of a forward contract are
fixed to the price decided upfront.
 Due to the above two reasons, the pay off profiles of the borrower and seller, in a forward
contract, are linear to the price of the underlying.

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 The presence of credit risk in forward contracts makes parties wary of each other.
Consequently forward contracts are entered into between parties who have good credit
standing. Hence forward contracts are not available to the common man.

Determining Forward Prices

In principle, the forward price for an asset would be equal to the spot or the case price at the
time of the transaction and the cost of carry. The cost of carry includes all the costs to be
incurred for carrying the asset forward in time.
Depending upon the type of asset or commodity, the cost of carry takes into account the
payments and receipts for storage, transport costs, interest payments, dividend receipts,
capital appreciation etc. Thus
Forward price = Spot or the Cash Price + Cost of Carry

Merchant Rate

The foreign exchange dealing of a bank with its customer is known as ‘merchant business’
and the exchange rate at which the transaction takes place is the merchant rate. The merchant
business in which the contract with the customer to buy or sell foreign exchange is agreed to
and executed on the same day is known as ready transaction or cash transaction. As in the
case of interbank transactions a value next day contract is deliverable on the next business
day and a ‘spot contract’ is deliverable on the second succeeding business day following the
date of the contract. Most of the transactions with customers are on ready basis. In practice,
the term ‘ready’ and ‘spot’ are used synonymously to refer to transactions concluded and
executed on the same day.

Foreign Exchange Transactions

Foreign exchange dealing is a business in which foreign currency is the commodity. It was
seen earlier that foreign currency is not a legal tender. The US dollar cannot be used for
settlement of debts in India; nevertheless, it has value. The value of US dollar is like the
value of any other commodity. Therefore, the foreign currency can be considered as the
commodity in foreign exchange dealings.

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 Purchase and Sale transactions

Any trading has two aspects Purchase and sale. A trader has to purchase goods from his
suppliers which he sells to his customers. Likewise the bank (which is authorized to deal in
foreign exchange) purchases as well as sells its commodity the foreign currency.
Two points need be constantly kept in mind while talking of a foreign exchange transaction:

1. The transaction is always talked of from the banks point of view

2. The item referred to is the foreign currency.
Therefore when we say a purchase we implied that

 the bank has purchased

 it has purchased foreign currency
Similarly, when we sale a sale, we imply that

 the bank has sold

 it has sold foreign currency.
In a purchase transaction the bank acquired foreign currency and parts with home currency.
In a sale transaction the bank parts with foreign currency and acquires home currency.

Exchange Quotations

We have seen that exchange rates can be quoted in either of the two ways;

 direct quotation
 indirect quotation.
The quotation in which exchange rate is expressed as the price per unit of foreign currency in
terms of the home currency is k known as ‘Home currency quotation’ or ‘Direct quotation’. It
may be noted that under direct quotation the number of units of foreign currency is kept
constant and any change in the exchange rate will be made by changing the value in term of
rupees. For instance, US dollar quoted at Rs.48 may be quoted at Rs 46 or Rs.49 as may be
warranted.
The quotation in which the unit of home currency is kept constant and the exchange rate is
expressed as so many unit of foreign currency is known as ‘Foreign Currency quotation’ or
Indirect quotation’ or simply ‘Currency Quotation’. Under indirect quotation, any change in
exchange rate will be effected by changing the number of units of foreign currency.

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FOREIGN EXCHANGE EXPOSURE

Exposure:

Exposure is defined as the possibility of a change in the assets or liabilities or both of a

company as a result in the exchange rate. Foreign exchange exposure thus refers to the
possibility of loss or gain to a company that arises due to exchange rate fluctuations.

The value of a firm’s assets, liabilities and operating income vary continually in response to
changes in a myriad economic and financial variable such as exchange rates, interest rates,
inflation rates, relative price and so forth. We can these uncertainties as macroeconomic
environment risks. These risks affect all firms in the economy. However, the extent and
nature of impact of even macroeconomic risks crucially depend upon the nature of firm’s
business. For instance, fluctuations of exchange rate will affect net importers and exporters
quite differently. The impact of interest rate fluctuations will be very different from that on a
manufacturing firm.

The nature of macroeconomic uncertainty can be illustrated by a number of commonly

encountered situations. An appreciation of value of a foreign currency(or equivalently, a
depreciation of the domestic currency), increase the domestic currency value of a firm’s
assets and liabilities denominated in the foreign currency-foreign currency receivables and
payables, banks deposits and loans, etc. It ill also change domestic currency cash flows from
exports and imports. An increase in interest rates reduces the market value of a portfolio of
fixed-rate in the rate of inflation may increase value of unsold stocks, the revenue from future
sales as well as the future costs of production. Thus the firms exposed to uncertain changes in
a numbers of variable in its environment. These variables are sometimes called Risk Factors.

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The nature of Exposure and Risk

Exposure are a measure of the sensitivity of the value of a financial items (assets, liabilities or
cash flow) to changes in the relevant risk factor while risk is a measurable of the variability
of the item attributable to the risk factor.

Corporate treasurers have become increasingly concerned about exchange rate and interest
rate exposure and risk during the last ten to fifteen years or so. In the case of exchange rate
risk, The increased awareness is firstly due to tremendous increase in the volume of cross
border financial transactions (which create exposure) and secondly due to the significant
increase in the degree of volatility in exchange rates(which, given the exposure, creates risk)

Classification of foreign exchange exposure and risk

Since the advent of floating exchange rates in 1973, firms around the world have become
acutely aware of the fact that fluctuations in exchange rates expose their revenues, costs,
operating cash flows and thence their market value to substantial fluctuations. Firms which
have cross-border transactions-exports and imports of goods and services, foreign borrowings
and lending, foreign portfolio and direst investment etc, are directly exposed: but even purely
domestic firms which have absolutely no cross border transactions are also exposed because
their customers, suppliers and competition are exposed. Considerably effort has since been
devoted to identifying and categorizing currency exposure and developing more and more
sophisticated methods to quantify it.

Foreign exchange exposure can be classified into three broad categories:

 Transaction exposure
 Translation exposure
 Operating exposure

Of these, the first and third together are sometimes called “Cash Flow Exposure” while the
second is referred to as “Accounting Exposure” or Balance sheet Exposure”.

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Transaction exposure

When a firm has a payable or receivable denominated in a foreign currency, a change in the
exchange rate will alter the amount of local currency receivable or paid. Such a risk or
exposure is referred to as transaction exposure.

For example , if an Indian exporter has a receivable of $100,100 due three months hence and
if in the meanwhile the dollar depreciates relative to the rupee a cash loss occurs. Conversely,
if the dollar appreciates relative to the rupee, a cash gain occurs. In the case of payable, the
outcome is of an opposite kind: a depreciation of the dollar relative to the rupee results in a
gain, where as an appreciation of the dollar relative to the rupee result in a loss.

Translation exposure

Many multinational companies require that their accounts of foreign subsidiaries and
branches get consolidated with those of it. For such consolidation, assets and liabilities
expressed in foreign currencies have to be translated into domestic currencies at the exchange
rate prevailing on the consolidation dates. If the values of foreign currencies change between
a two or successive consolidation dates, translation exposure will arise.

Operating exposure

Operating exposure, like translation exposure involve an actual or potential gain or loss.
While the former is specific to the transaction, the latter relates to entire investment. The
essence of this operating exposure is that exchange rate changes significantly and alter the
cost of firm’s inputs along with price of it output and thereby influence its competitive
position substantially.

Eg: Volkwagon had ahighly successful export market for its ‘beetle’ model in the US before
1970. With the breakdown of Bretten-woods of fixes exchanged rates, the deuschemark
appreciated significantly against the dollar. This created problem for Volkswagan as its
expenses were mainly in deuschemark but its revenue in dollars. However, in a highly price-
sensitive US market, such an action caused a sharp decreased in sales volume-from 600,000
vehicles in 1968 to 200,000 in 1976.(Incidentally, Volkswagen’s 1973 losses were the
highest, as of that year, suffered by any company anywhere in the world.)

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Types of foreign exchange risk

Transaction risk

A firm has transaction risk whenever it has contractual cash flows (receivables and payables)
whose values are subject to unanticipated changes in exchange rates due to a contract being
denominated in a foreign currency. To realize the domestic value of its foreign-denominated
cash flows, the firm must exchange foreign currency for domestic currency. As firms
negotiate contracts with set prices and delivery dates in the face of a volatile foreign
exchange market with exchange rates constantly fluctuating, the firms face a risk of changes
in the exchange rate between the foreign and domestic currency. It refers to the risk
associated with the change in the exchange rate between the time an enterprise initiates a
transaction and settles it.

Many times, companies will participate in a transaction regarding more than one currency. In
order to meet the standards of processing these transactions, the companies that are involved
have to send any foreign currencies involved back to the countries they came from. As it is
implied, businesses have a goal of making all monetary transactions ones that end in high
profits. This goal may be delayed because foreign currency transactions as well as the
currency market are always moving in different directions, and they must be carefully
observed. This process may cause fluctuation to a certain extent, because it is occurring at a
market exchange rate, over a very short period of time. Unfortunately, many losses may
occur to the companies, because there is a time lag between the execution and the settlement.
This time delay or lag occurs right after the companies have agreed on a purchase, and the
foreign exchange transaction has been executed, which completes the deal. The lag that is
caused by these transactions then creates a risk that the relevant exchange rate will fluctuate
immensely. With the sudden movement that the transaction risk brings to the exchange rate, a
company that wants to purchase will have to spend a lot more money on capital than they
may have wanted to, just to complete a payment in a transaction, which is going to be in the
supplier’s currency. This process can cut profits, and lead to defaults on payments as
well. Fortunately, there are ways that companies can minimize their potential losses,
disregarding the time lag. If a company decides to go with purchasing an option, the company
is able to set a rate that is “at-worst” for the transaction. The positive part about this choice is
that it is very popular with companies, and cheap as well. If the option expires and it’s out-of-
the-money, the company is able to execute the transaction in the open market, and they are

22
able execute it at a favorable rate to them. Using natural hedging (or netting foreign exchange
exposures) will be a very helpful way to reduce a company’s exposure to transaction risk.
The reason netting Foreign Exchange exposures is such an efficient form of hedging is
because it will help reduce the margin that is taken by banks when businesses exchange
currencies. Natural hedging is also a very simple form of hedging to understand. To enforce
the netting, there will be a systematic approach requirement, as well as a real time look at
their exposure and a platform for initiating the process. Unfortunately, this along with the
foreign cash flow uncertainty can make the procedure seem more difficult. Having a back-up
plan such as foreign currency accounts will be extremely helpful in this process. The
companies that deal with inflows and outflows that are the same currency will experience
efficiency and a reduction in risk by calculating the net of the inflows and outflows, and
using foreign currency account balances that will pay in part for some or all of the exposure.

Economic risk

A firm has economic risk (also known as forecast risk) to the degree that its market value is
influenced by unexpected exchange rate fluctuations. Such exchange rate adjustments can
severely affect the firm's market share position with regards to its competitors, the firm's
future cash flows, and ultimately the firm's value. Economic risk can affect the present value
of future cash flows. Any transaction that exposes the firm to foreign exchange risk also
exposes the firm economically, but economic risks can be caused by other business activities
and investments which may not be mere international transactions, such as future cash flows
from fixed assets. A shift in exchange rates that influences the demand for a good in some
country would also be an economic risk for a firm that sells that good.

In every organization, economic risk, or also known as forecast risk, refers to the possibility
that macroeconomic conditions will influence an investment, especially in a foreign
country (Investing Answers, n.d.). Some examples of the macroeconomic conditions are
exchange rates, government regulations, or political stability. When financing an investment
or a project, a company’s operating costs, debt obligations, and other economically
unsustainable circumstances should be thoroughly calculated in order to produce adequate
revenues in covering those investment costs (Ready Ratios, n.d.). For instance, when an
American company invests money in a manufacturing plant in Spain, there are certain
economic risks that influence the outcomes and values of the investment. Hypothetically, the
political government in Spain might shift instantly that negatively impact the American

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company’s ability in operating the plant, such as changing laws or even seizing the plant. In
this situation, the economic risks can be hyperinflation and exchange rate fluctuations, which
lead to immensely expensive rates to pay workers’ salaries. Thus, the risks might unable the
American company to move its profits out of Spain. As a result, all possible risks that
outweigh an investment’s profits and outcomes need to be closely scrutinized and
strategically planned before initiating the investment. Some examples of potential economic
risks can be steep market downturns, unexpected cost overruns, and low demand for goods.

International investments are associated with significantly higher economic risk levels as
compared to domestic investments. In international firms, economic risk heavily affects not
only investors but also bondholders and shareholders, especially when dealing with sale and
purchase foreign government bonds. Despite of the risky outcomes, economic risk can
tremendously elevate the opportunities and profits for investors globally. When investing in
foreign bonds, investors can gain high profits due to the fluctuation of the foreign exchange
markets and interest rates in different countries (Ready Ratios, n.d.). Although, investors
should always be analytical in calculating the possible changes made by the foreign
regulatory authorities. Changing laws and regulations on sizes, types, timing, credit quality,
and disclosures of bonds will immediately and directly affect the investments in foreign
countries. For example, if a central bank in a foreign country raises interest rates or the
legislature increases taxes, the investment will be significantly influenced. As a result,
economic risk can be reduced by utilizing various analytical and predictive tools that consider
the diversification of time, exchange rates, and economic development in multiple countries,
which offer different currencies, instruments, and industries.

To develop a comprehensive analysis of an economic forecast, several risk factors should be

noted. One of the most effective strategies is to develop a set of positive and negative risks
that associate with the standard economic metrics of an investment. (Dye, 2017). In a
macroeconomic model, a few main risks are GDP levers, exchange rate fluctuations, and
commodity prices and stock market fluctuations. On the other hand, it is equally critical to
identify the stability and volatility of the market economic system. Before initiating an
investment, consider the stability of the investing sector that influence the exchange rate
reactions. For instance, a service sector is less likely to have inventory swings and exchange
rate reaction as compared to a large consumer sector.

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Translation risk

A firm's translation risk is the extent to which its financial reporting is affected by exchange
rate movements. As all firms generally must prepare consolidated financial statements for
reporting purposes, the consolidation process for multinationals entails translating foreign
assets and liabilities or the financial statements of foreign subsidiaries from foreign to
domestic currency. While translation risk may not affect a firm's cash flows, it could have a
significant impact on a firm's reported earnings and therefore its stock price.

Translation risk deals with the risk of a company’s equities, assets, liabilities, or income. Any
of these can change in value because of fluctuating foreign exchange rates. Translation risk
occurs when a firm denominates a portion of its equities, assets, liabilities or income in a
foreign currency. A company doing business in a foreign country will eventually have to
exchange its host country's currency back into their domestic currency. Foreign exchange
rates are constantly fluctuating, and if exchange rates appreciate or depreciate, significant
changes in the value of the foreign currency can occur. These significant changes in value
create translation risk because it creates difficulties in evaluating how much the currencies
are going to fluctuate relative to other foreign currencies. Translation risk is the company's
financial statements of foreign subsidiaries. The subsidiary then restates financial statement
in the company's home currency. Then the firm can now prepare their consolidated financial
statements. For example, U.S. companies must restate local Euro, Pound, Yen, etc. statements
into U.S. dollars. These foreign currencies are added to the parent's U.S. dollar-denominated
balance sheet and income statement. This accounting process is called translation. The
income statement and the balance sheet are the two financial statements that must be
translated. A subsidiary doing business in the host country usually follows the country’s’
translation method to be used.

Contingent risk

A firm has contingent risk when bidding for foreign projects or negotiating other contracts or
foreign direct investments. Such a risk arises from the potential of a firm to suddenly face a
transnational or economic foreign exchange risk, contingent on the outcome of some contract
or negotiation. For example, a firm could be waiting for a project bid to be accepted by a
foreign business or government that if accepted would result in an immediate receivable.
While waiting, the firm faces a contingent risk from the uncertainty as to whether or not that
receivable will happen.

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Management

Firms with exposure to foreign exchange risk may use a number of foreign exchange hedging
strategies to reduce the exchange rate risk. Transaction exposure can be reduced either with
the use of the money markets, foreign exchange derivatives such as forward contracts, futures
contracts, options, and swaps, or with operational techniques such as currency invoicing,
leading and lagging of receipts and payments, and exposure netting.

Each hedging strategy comes with its own benefits that may make it more suitable than
another, based on the nature of the business and risks it may impose. Forward and futures
contracts serve similar purposes - they both allow transactions take place in the future for a
specified price at a specified rate in order to offset any exchange fluctuations against you.
Forward contracts are to an extent more flexible, because they can be customized to specific
transactions whereas futures come in standard amounts and are written based on certain
commodities or assets, such as cattle or other currencies. Because futures are only available
for certain currencies and time periods, they cannot entirely mitigate risk because there is
always the chance that exchange rates do move in your favor. However, the standardized
feature of futures can be part of what makes them attractive to some and is well-regulated
because they are traded only on exchanges.

Currency invoicing refers to the practice of invoicing transactions in the currency that
benefits the firm. It is important to note that this does not necessarily eliminate the foreign
exchange risk, but rather moves it to from one party to another. A firm can invoice its imports
from another country in its home currency, which would move the risk to the exporter and
away from itself. This technique may not be as simple as it sounds; if the exporter’s currency
is more volatile than that of the importer, the firm would want to avoid invoicing in that
currency. If both the importer and exporter want to avoid using their own currencies, it is also
fairly common to conduct the exchange using a third currency that is perhaps more stable.
This may be done if they cannot use any existing instrument between their currencies.

If a firm looks to leading and lagging as a hedge, they must exercise extreme caution. These
acts refer to the movement of cash inflows or outflows either forward or backward in time in
a way that may benefit the achievement of other goals. For example, if a firm must pay a

26
large sum in three months but is also set to receive a similar amount from another order, they
might move the date of receipt to meet their other payment deadline. If this date is moved
sooner, this would be leading the payment; if it were moved later and delayed, it would be
lagging.

Firms may adopt alternative strategies to financial hedging for managing their economic or
operating exposure, by carefully selecting production sites with a mind for lowering costs,
using a policy of flexible sourcing in its supply chain management, diversifying its export
market across a greater number of countries, or by implementing strong research and
development activities and differentiating its products in pursuit of greater inelasticity and
less foreign exchange risk exposure.

By paying attention to currency fluctuations around the world and how they relate to the
home currency, firms can relocate their production to another country. For this strategy to be
effective, the new site must have lower production costs. This can help meet any excess
production needs that would incur larger expense elsewhere and would allow the firm to take
advantage of that extra capital. If the firm has flexibility in its sourcing, they can look to other
countries with greater supply of a certain input and relocate there, to reduce the cost of
importing it. There are many factors a firm must consider before relocating, such as a
nation’s political risk and overall state of the economy. By putting more effort into
researching alternative methods for production and development, it is possible that a firm
may discover more ways to produce their outputs locally rather than relying on export
sources that may expose them to the foreign exchange risk they are trying to avoid.

Translation exposure is largely dependent on the accounting standards of the home country
and the translation methods required by those standards. For example, the United
States Federal Accounting Standards Board specifies when and where to use certain methods
such as the temporal method and current rate method. Firms can manage translation exposure
by performing a balance sheet hedge. Since translation exposure arises from discrepancies
between net assets and net liabilities on a balance sheet solely from exchange rate
differences.

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Measurement

If foreign exchanges market are efficient such that purchasing power parity, interest rate
parity, and the international Fisher effect hold true, a firm or investor needn't protect
against foreign exchange risk due to an indifference toward international investment
decisions. A deviation from one or more of the three international parity conditions
generally needs to occur for an exposure to foreign exchange risk.

Financial risk is most commonly measured in terms of the variance or standard deviation of
a variable such as percentage returns or rates of change. In foreign exchange, a relevant
factor would be the rate of change of the spot exchange rate between currencies. Variance
represents exchange rate risk by the spread of exchange rates, whereas standard deviation
represents exchange rate risk by the amount exchange rates deviate, on average, from the
mean exchange rate in a probability distribution. A higher standard deviation would signal a
greater currency risk. Economists have criticized the accuracy of standard deviation as a risk
indicator for its uniform treatment of deviations, be they positive or negative, and for
automatically squaring deviation values. Alternatives such as average absolute
deviation and semi variance have been advanced for measuring financial risk.

Value at risk
Practitioners have advanced and regulators have accepted a financial risk management
technique called value at risk (VaR), which examines the tail end of a distribution of returns
for changes in exchange rates to highlight the outcomes with the worst returns. Banks in
Europe have been authorized by the Bank for International Settlements to employ VaR
models of their own design in establishing capital requirements for given levels of market
risk. Using the VaR model helps risk managers determine the amount that could be lost on an
investment portfolio over a certain period of time with a given probability of changes in
exchange rate.

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Benefits of foreign exchange

1. 24 Hours Market
This business runs for 24 hours. It allows you to join the market on more flexible times.
Several traders even use special automatic software to run their trade so when they are
working somewhere else, they are actually earning money from trading as well.

2. Bigger Possibilities
Foreign exchange trading allows you to invest in a huge size without influencing the other
parts of trading. It gives you chance to earn more from the foreign exchange trading.

3. Influenced by Many Factors

Foreign exchange trading is insecure in a way that it is highly influenced by like national debt
level, political condition, and so many changing factors. You need to be aware of the factors
all the time.

4. Can Be Your Side Earning

Foreign exchange can be done personally on brokers and this can be your side earning source.
You do not have to leave your current job but you can earn some more money for kids
education.

5. Guide to Learn
Foreign exchange trading can be learnt. You will be able to find guides and e-book about it.
If you join a broker, you will get tutorial as well. It is helpful and you can learn to be real
trader.

6. Forex Broker Help

Many people join the brokers to find more helps. They will help you manage your account
and your trading so it becomes more comfortable. They ask for commission tough and
security fees. Be careful in how you choose brokers. You need to consider several aspects.

7. Liquidity
This can be both the benefits and risks. In a matter of minutes or seconds, we can earn a huge
pile of profit. On the other side, if we are not very careful, we can lose the entire money on
the same duration.

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Importance of Foreign
Exchange:
(i) Foreign exchange situation of a country indicates the strength of the economy. If it
possesses large reserves of foreign exchange, it is an indication of developed economy
whereas tight foreign exchange position. indicates an underdeveloped economy. Thus,
foreign exchange position is indicative of the stage of development.

(ii) Shortage of foreign exchange refers to the position of adverse balance of payments
and Its surplus a position of favorable balance of payments. In case of adverse balance of
payments situation, the central bank or the government must try to balance the situation
by increasing its exports and restricting the outflow of foreign currency. (iii) Foreign
exchange simplifies the complexities arising out of the vast participation of nations in the
international trade. Payments are easily made on the mutually accepted and
predetermined rates. Thus, it makes the international trade easy.

(iv) The foreign exchange ‘ratio shows a direct relationship between the prices of the
commodities in the national and international markets.

(v) Foreign exchange position shows a comparative soundness of two nations. A hard-
currency nation is certainly a sound nation for the other country for which the currency
of that nation is not easily available. For example, for India, American Dollar and British
Pound-sterling are hard currencies. It means, the economies of America and Britain are
certainly richer.

(vi) The stability in exchange rates, is of high importance without which various other
problems may crop up. Instability in exchange rate may lead a country to devaluation or
revaluation.

Thus, problem of foreign exchange is very important in foreign trade especially for
developing nations because they have paucity of foreign exchange to meet their foreign
exchange liability. They are required to restrict the outflow of foreign exchange very
carefully.

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