Determinants of Foreign Exchange

DEFINITIONS
Foreign Exchange The system of converting one national currency into another, and of transferring money from one country to another.

 Foreign Exchange Market Forex market is a place in which foreign exchange transactions take place. A market in which National currencies are bought and sold against one another The foreign exchange market is one of the largest markets in the world. By some estimates, about 3.2 trillion USD worth of currency changes hands every day.

Foreign exchange reserves

Source: State Bank Of India, Chennai *TT - Telegraphic Transfer

Exchange Rates Indicative on Friday April 16, 2010

IMPORT Forward 6 months 45.26 61.23 69.92 48.84 42.8 8.22 Spot Currency 3 months 1 month TT * 44.85 60.69 69.32 48.36 42.38 8.15 Bill TT* Bill Spot

EXPORT Forward 1 month 3 months 6 months 44.5 60.21 68.81 47.95 42.01 8.09 44.78 60.59 69.23 48.26 42.28 8.14 45.19 61.14 69.84 48.72 42.7 8.21

44.58 44.42 44.46 US Dollar 60.32 60.11 60.15 Euro 68.93 68.69 68.74 Pound Sterling 48.05 47.87 47.90 Japanese Yen* 42.1 41.94 41.97 Swiss Franc 8.11 5.75 8.08 5.72 8.09 Danish Kroner 5.73 Hong Kong Dollar

44.34 44.32 60.00 59.99 68.57 68.56 47.75 47.74 41.83 41.82 8.06 5.71 8.06 5.71

32.96
5.84 41.27 31.9 7.65 6.33 45.07

32.67
5.78 41.35 31.84 7.61 6.24 44.73

32.47 32.36 32.38 Singapore Dollar

41.53 41.38 41.40 Australian Dollar 31.79 31.74 31.76 New Zealand Dollar 7.59 6.24 7.57 6.21 7.58 Norwegian Kroner 6.22 Swedish Kroner

32.29 32.28
41.32 41.31 31.68 31.68 7.55 6.20 7.55 6.20

32.42
5.73 41.45 31.79 7.59 6.22 44.39

32.61
5.77 41.57 31.92 7.62 6.26 44.66

32.91
5.83 41.65 32.08 7.67 6.32 45.06

44.47 44.31 44.34 Canadian Dollar

44.21 44.20

Features of Foreign Exchange Market

The foreign exchange market is unique because of trading volume results in market liquidity geographical dispersion continuous operation: 24 hours a day except weekends the variety of factors that affect exchange rates the use of leverage to enhance profit margins with respect to account size

Participants
Individuals: tourists, migrants Firms: importers and exporters

Banks: commercial & central banks

Governments / monetary authorities

International agencies

Example
As India import rises the demand for foreign currency increases which in result changes the exchange rate as the value of foreign currency increases with compared to domestic currency.

Functions of Forex Market

Transfer of Purchasing power Provision of credit Provision of hedging facilities

Determinants of Foreign Exchange Market

Long term Factors

Short-term Factors

Long-term Factors
Balance of Payments

 Strength of economy

The relative strength of an economy has effect on demand and supply of foreign currencies.
If an economy is growing at a faster rate, in the long-run, it is generally expected to have a better performance on Balance of Trade .

 Interest rate
The capital is attracted towards currencies yielding higher interest rates, provided there is full currency convertibility in capital account.

 Inflation
A higher rate of inflation will make a countrys currency less attractive because of the loss of real value with inflation. Hence, that currency would depreciate against major currencies.

 Money Supply

An increase in money supply will affect the exchange rate through causing inflation in the country. It can also affect the exchange rate directly in the short run.

 National Income
An increase in the national income will lead to an increase in investment or in consumption and accordingly, its effect on the exchange rate will change.

Short term factors

Central bank intervention
Buying and selling of foreign currency in the market by the Central Bank with a view to increasing the supply or demand, there by affecting the exchange rate, is known as intervention.

 Export receipts and import payments

The difference between the total receipts from export bill realizations and import payments on a given day in a country determines the exchange rate to some extent.

 Foreign investment flows

Both foreign direct and portfolio investment inflows and outflows affect the exchange rates.

 Political factors
Factors like war. Announcement of election results, oil price increase etc will cause exchange rate fluctuations.

 Speculation
If a few big speculators start buying a currency in an aggressive manner, others may follow suit. Thus, the demand of the currency may increase.

 Capital Movements
Movement will be caused by external borrowings and assistance. Large-scale external borrowing will have favorable effect on the exchange rate of the countrys currency.

FEMA
The Foreign Exchange Management Act or in short FEMA has been introduced as a replacement for earlier Foreign Exchange Regulation Act (FERA). FEMA came into act on the 1st day of June, 2000. The main objective behind the Foreign Exchange Management Act (1999) is to consolidate and amend the law relating to foreign exchange with objective of facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India. FEMA is applicable to the all parts of India. The act is also applicable to all branches, offices and agencies outside India owned or controlled by a person who is resident of India. FEMA head-office also known as Enforcement Directorate is situated in New Delhi and is headed by a Director. The Directorate is further divided into 5 zonal offices at Delhi, Bombay, Calcutta, Madras and Jalandhar and each office is headed by a Deputy Directors. Each zone is further divided into 7 sub-zonal offices headed by the Assistant Directors and 5 field units headed by the Chief Enforcement Officers

Conclusion
Liquid Investment- foreign exchange market has the advantage of being
extremely liquid. What this means is that investors would be able to withdraw from their investments at any point in time relatively easily. This is due to the fact that the foreign exchange market has a global market, which means searching for a buyer to purchase a particular currency which you are interested to sell is usually not a big problem.

Organized as an over-the-counter market, foreign exchange traders from all over the world are brought into contact each day via the internet. This means that traders would be able to trade with one another 24 hours a day, five days a week.

Convenience-foreign currency exchange trading is extremely convenient.

FACILITATES TRADE AND DEVELOPMENT