Currency Market

An introduction Debasish Mitra Sr. Manager Finance, PSL LTD

It is a 24 hrs Market Moves from one centre to another

It moves as sun moves round the world It starts from Tokyo to Hong Kong  to Singapore to Kuwait  to London to New York  to San Francisco to Sydney  and again moves to Tokyo.


In short exchange rate is the ratio used to convert one currency into another

Exchange rates are quoted under two methods

1. Direct method  2. Indirect method



DIRECT QUOTATIONS


If the unit of foreign currency is kept constant and its value is expressed in terms of variable home currency the method of quoting exchange rate is known as Direct Quotation. Quotation. i.e USD 1 = Rs. 46.1500 Rs. 46.

 

Effective from August, 6,1993 we have changed our system of quoting exchange rates to direct quotations. quotations.

INDIRECT QUOTATIONS


When the unit of home currency is kept constant and the unit of home currency is expressed in terms of variable units foreign currency, then this method of quoting exchange rate is called Indirect Quotation. Quotation. Prior to August 1993 we were following this system for quoting exchange rates. rates. E.g., Rs.100/- = USD 2.2400 Rs.100/

   

Example:
 if, USD 1 = Rs.47.9725/50 Rs.47.9725/ ICICI Bank is prepared to buy USD at Rs.47.9725 (Bid) Rs.47. and sell at 47.9750 (Offer/Ask) 47. This method of quoting both buying and selling rates is known as "TWO WAY QUOTATION". QUOTATION".

BUY LOW - SELL HIGH

For all practical purposes if we treat Foreign Exchange as a commodity,  a trader always wants to buy a commodity at a lower price  and sell at a higher price. price.


TT Selling Rate. Rate.

SELLING RATE

Transaction involving outward remittance in foreign currency (TT, MT,DD) Bill Selling Rate. Rate. Transaction involving remittance of proceeds of import bill

BUYING RATES
TT Buying Rate: Rate:  Transaction involving inward remittance (TT, MT, and DD) Bill Buying Rate: Rate:  Purchase/ negotiation/ discounting of export bills and other instruments

CALCULATION OF EXCHANGE RATES

STEP 1  The rate at which ADs will cover the transaction (either sale or buy transaction) in the market immediately the customer delivers the instrument. instrument.

STEP 2 Load the prescribed profit margin

EXCHANGE MARGIN:
 

FEDAI has left the discretion of loading profit margin to the individual banks. banks. It is now purely at the discretion of the individual bankers to load the appropriate exchange margin and improve the exchange rate depending upon the volume and nature of the transaction. transaction.

STEP 3. 3.

Rounding off the transaction to the nearest 4 decimals i.e. .0025/50/75/00.

EXAMPLE
Exporter has submitted a bill for USD 100,000.  Inter bank exchange rate 45.95/96  Profit margin 1.5 paise


STEP 1


In this case Bank may dispose off USD 100000 at Rs 45.95 in the Inter bank 45. market at the market-buying rate. marketrate.

STEP 2.


Load the prescribed profit margin (Spread) Base rate.... Rs.45.95 Deduct the profit margin: Rs.45.9500 - 0.0150 = Rs.45.9350 Since bank will pay Indian Rupees to exporter (customer), Bank will deduct their profit margin from the rupee proceeds. proceeds.

 

STEP 3.
Round off to the nearest 4 decimals.  In the above transaction Bank will quote the rate as 45.9350 to the customer.


Cross Rate
Example:  An Importer wants to honour his import liability in EURO.  In India direct quotation on USD = INR is available.


CROSS RATES


First leg of the transaction is, Importer will go to Authorised Dealer to procures USD against Indian Rupees. Rupees.




If inter bank $ =Rs exchange rate is 45.95/96

to procure US$ 1, AD will quote Rs.45.96 With this USD, AD of the importer will go to London market and procure EUR paying 1 EUR = USD 1.2590

Example

Then 1 EUR will be equivalent to 1.2590*45.96 = INR 57.8636 Rounding off to 4 decimals = Rs.57.8650

There are four rates are available

Cash transaction. transaction. Tom Price for the date of

Price for the next day of the transaction. transaction. Spot Price for the 2nd working day of transaction.after the day transaction. of transaction Forward Price for any day after the spot date upto 365 days

Premium of currency
When a currency is costlier in future (forward) as compared to spot. spot. Premium is always added to both buying and selling rate. rate.


Discount of currency


When a currency is cheaper in future (forward) as compared to spot Discount is always deducted from both buying and selling rate. rate.

Factors affecting forward

Supply and Demand for the currency for a particular settlement date Market Expectation Interest rate differential

Interest rate differential

     

Example :USD 1 = INR 46.0000 46. Interest rate in US @ 5% p.a Interest rate in India@ 10% p.a 10% Condition: Condition: Exchange rates remain the same for a period of one year

What will happen ?

Mr X will borrow USD 100 for one year @ 5% p.a from US market, and convert the same into Indian Rupee and place the same as deposit for one year @10% 10% in Indian market. market.

What will be the situation?



Step 1: Mr X will borrow USD 100 at 5% and sell against Rupees @ 46 per USD. USD.

Step 2:
Mr x will place the Rupee deposit of Rs 4600 @10% for one year and will enjoy interest

After one year.



Step 3:
Mr X will get Rs 4600+Rs 460 = Rs 5060 (including 4600+Rs interest) At the same time he will pay interest against USD borrowing.Total outflow in USD will be USD (-) 105 (-

Where is the arbitrage possibility?




Step 4:
Mr X will convert the total inflow in Indian Rupee, into USD @ 46.00 and will receive USD 46. i.e Rs 5060/46 =USD 110 5060/ Net gain to Mr X is USD 110 USD 105 = USD 5

Person having Rs would not like to give this opportunity



The forward exchange rate of USD/INR will be adjusted by market forces to eliminate the arbitrage opportunity. So USD/INR rate would opportunity. be USD 105 = INR 5060 1 USD = INR 5060/105 = INR 48.1904 0r 5060/ 48. 48. 48.1900

 

Factors affecting exchange rate Last couple of months

Change Of Interest Rate  Inflow Of Foreign Fund  Price Of Oil  Comments Of Leader  Release Of Economic Data  RBI Intervention  Natural Calamity


Exchange Rate Fluctuation

46.5000 46.0000 45.5000 45.0000 USD = INR 44.5000 44.0000 43.5000 43.0000 42.5000 42.0000 41.5000 Exchange Rate Fluctuation

'0 5 SE PT '05 O C T'0 5

'05

FE B' 06 M AR '0 6 AP R '0 6

LY '0 5

V' 05

JU

M AY '06

DE C

NO

AU

JA N

'06

VOSTRO ACCOUNT
  

Account maintained by a foreign bank with a bank in India Account is maintained in Rupee. Rupee.

NOSTRO ACCOUNT


When an Indian Bank maintains Foreign Currency A/C abroad An Indian Bank can maintain many accounts in different currencies.

Exchange Earner's Foreign Currency (EEFC) Account



An account expressed in foreign currency Maintained with an Authorized Dealer, To credit prescribed percentage of earnings in convertible foreign currency. currency. NonNon-interest bearing current account. account. Cheque facility available

EEFC A/C - Permissible Debits

Travel, medical, studies abroad, permissible imports, commission, customs duty, etc. etc. Payments towards permissible capital account transactions. transactions.


Payment in India to 100% Export Oriented 100% Units/Units in Export Processing Zones/ Software Technology Parks/Electronic Hardware Technology Parks towards cost of goods and services provided by them. them.

EEFC A/C Permissible CREDIT



Status Holder

100 % 100% 100%

100% 100% Export Oriented Units/ Units in Export Processing Zones /Software Technology Parks /Electronic Hardware Technology Parks Others

50% of earnings 50%

At last.


Continuous update of information and knowledge will give us a through understanding of the currency market, which will ultimately help any corporate to take a correct position, to safeguard its interest