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Definition of foreign
exchange
Deposits, credits and balances payable in
foreign currency
Drafts, travellers cheques, letter of credit or
bill of exchange expressed or drawn in
Indian currency but payable in foreign
currency
Drafts, travellers cheques, L/Cs, etc. drawn
by banks, institutions or persons outside
India but payable in Indian currency
The above definition is as per FEMA (1999)
Fundamental reasons
Balance of payments->surplus>appreciation
Growth rate of the economy-> higher
growth->depreciation of currency
Fiscal policy-> financing of fiscal deficit
influences exchange rate
Monetary policy->loose monetary
policy-> depreciation of exchange rate
Technical reasons
Freedom or restrictions on capital
movements can affect exchange
rates to a large extent
Among other factors there are:
Huge trade surpluses of oil exporting
countries
Capital moving from low-yielding
currencies to high yielding currencies
(interest differential)
Speculation
Self-fulfilling prophecies
Anticipation of depreciation of a
currency can cause dealers to sell that
currency
Forward rate
If the forward value of a currency is higher
than the spot value the currency is said to
be at a premium
If the above is reversed the currency is said
to be at a discount
The forward premium/discount is based on
interest rate differentials of the two
currencies involved
Direct and indirect quotes of exchange ratedirect quote, local currency is variable
Exchange Arithmetic
All foreign exchange calculations have to be
worked with care and accuracy and several
rules have to be kept in mind
Chain rule- is used to attain comparison or
ratio between two quantities which are
linked together through another or other
quantities. Equation in the form of a chain is
derived.
Per cent and per mille- Per 100 units/per
1000 units
London Market
US $ 1 = FRF 6.0500/6.0550
Foreign exchange
transactions (1)
Arbitrage: Is an operation by which
one can make risk free profit by
undertaking offsetting transactions.
Can be in interest rates: borrow in one
centre and lend in another
Can be in exchange rates: Buy a currency
in one market and sell in another
Foreign Exchange
Transactions (2)
Merchant rates: Quotes offered to
merchants (importers, exporters) by banks.
Inter-bank rates: The rates quoted by banks
for dealing in the inter-bank market.
Merchant quotations: In India all merchant
quotations for foreign currencies shall be in
so many rupees for one unit of foreign
currency except for Japanese Yen, Italian
Lira and Belgian Franc (Rs/100 units of the
currency)
All quotes are in four decimal places with
the last two digits in the multiple of 25
PART I. INTRODUCTION
I. INTRODUCTION
A. The Currency Market:
where money denominated in
one currency is bought and
sold with money denominated
in another
currency.
INTRODUCTION
B. International Trade and
Capital Transactions:
- facilitated with the ability
to transfer purchasing power
between countries
INTRODUCTION
C. Location
1. OTC-type: no specific location
2. Most trades by phone,
telex, or SWIFT
SWIFT: Society for Worldwide
Interbank Financial
Telecommunications
PART II.
ORGANIZATION OF THE FOREIGN
EXCHANGE MARKET
Forward Market:
- transactions take place at a
specified future date
2.
Threatens traders
oligopoly of information
3.
Provides liquidity
PART III.
THE SPOT MARKET
I. SPOT QUOTATIONS
A. Sources
1. All major newspapers
2. Major currencies have four
different quotes:
a.
b.
c.
d.
spot price
30-day
90-day
180-day
b.
European terms
example: dm1.713/$
EXAMPLE:
dm0.25/FF
Ask Bid
PS
x100
Ask
3.
PART II.
MECHANICS OF SPOT
TRANSACTIONS
SPOT TRANSACTIONS: An
Example
Step 1. Currency transaction:
verbal agreement, U.S.
importer specifies:
a. Account to debit (his acct)
b. Account to credit (exporter)
MECHANICS OF SPOT
TRANSACTIONS
Step 2. Bank sends importer
contract note including:
- amount of foreign
currency
- agreed exchange rate
- confirmation of Step 1.
MECHANICS OF SPOT
TRANSACTIONS
Step 3. Settlement
Correspondent bank in Hong
Kong transfers HK$ from
nostro account to exporters.
Value Date.
U.S. bank debits importers
account.
PART III.
THE FORWARD MARKET
I. INTRODUCTION
A. Definition of a Forward
Contract
an agreement between a bank and
a customer to deliver a specified
amount of currency against another
currency at a specified future date
and at a fixed exchange
rate.
discount or
2.
a. 30-day
b. 90-day
c. 180-day
d. 360-day
Longer-term Contracts
PART IV.
INTEREST RATE PARITY THEORY
I. INTRODUCTION
A. The Theory states:
the forward rate (F) differs
from
the spot rate (S) at
equilibrium
by an amount
equal to the
interest
differential (rh - rf)
between two countries.
In equilibrium, returns on
currencies will be the same
i. e. No profit will be realized
and interest parity exists
which can be written
(1 + rh) = F
(1 + rf)
S
interest rates.
c. Parity eventually
reached.
forward