DAMODARAM SANJIVAYYA NATIONAL LAW UNIVERSITY.

SABBAWARAM, VISAKHAPATNAM, A.P., INDIA

PROJECT TITLE
FOREIGN EXCHANGE MARKETS AND ITS RELEVANCE

SUBJECT
ECONOMICS

NAME OF FACULTY
Prof. ABHISHEK SINHA

NAME OF STUDENT: ANANYA PANICKER

ROLL NUMBER: 19LLB122

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 ACKNOWLEDGEMENT
I would like to thank Prof. Abhishek Sinha sir for giving me an opportunity for deeply
studying about Economics. This project is a result of dedicated effort. It gives me immense
pleasure to prepare this project on Foreign currency market and its relevance.
My deepest thanks to our lecturer Abhishek sir, the guide of the project
for guiding and correcting various documents with attention and care. I thank him for
consultative help and constructive suggestion in this project. I would also like to thank my
parents and colleagues who have helped us in making this project a successful one.

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CONTENTS

1. COVER PAGE
2. GRAMMERLY REPORT
3. ACKNOWLEDGEMNT
4. PROJECT SUMMARY
5. OBJECTIVE OF THE SUMMARY
6. SIGNIFICANCE AND BENEFIT OF STUDY
7. SCOPE OF THE STUDY
8. LITERATURE REVIEW
9. RESEARCH METHODOLOGY
10. HYPOTHESIS
11. BODY OF THE PROJECT
12. OUTCOMES OF THE PROJECT
13. CONCLUSIONS AND SUGGESTIONS

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CONTENTS UNDER THE BODY OF THE PROJECT

 INTRODUCTION TO THE TOPIC

- Definition
- Functions
- Characteristics
- Advantages
- Disadvantages
 NEED FOR FOREIGN EXCHANGE MARKETS
 FOREIGN EXCHANGE TRADING
 FOREIGN EXCHANGE MARKETS IN INDIA
 RISKS INVOLVED IN FOREIGN EXCHANGE

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OBJECTIVE OF THE STUDY
Herein the researcher through this project is studying the basics and working of the Foreign
Exchange Market and is presenting the research by substantiating and elaborating the
concept.

SCOPE OF THE STUDY

The researcher limits the scope of the study only up to the relevance of Foreign Exchange
Market in India. It also includes the risks involved in the market.

SIGNIFICANCE OF THE STUDY

This research helps us to know the working and concept of Foreign Exchange of Markets in
Economics. It also helps us to study the ethics, theories, and relevance (if any) of this
concept.

REVIEW OF LITERATURE
The researcher has taken information from various books, web sources, articles, journals, and
case laws.

RESEARCH METHODOLOGY
The study is based on the doctrinal method of research.

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 INTRODUCTION

The foreign exchange market is a global decentralized market for the trading of currencies.
This includes all aspects of buying, selling and exchanging currencies at current or
determined prices. In terms of volume of trading, it is by far the largest market in the world.
The main participants in this market are the larger international banks. Financial centre
around the world function as anchors of trading between a wide range of multiple types of
buyers and sellers around the clock, with the exception of weekends. The foreign exchange
market does not determine the relative values of different currencies, but sets the current
market price of the value of one currency as demanded against another. The foreign exchange
market works through financial institutions, and it operates on several levels. Behind the
scenes banks turn to a smaller number of financial firms known as “dealers”.

The foreign exchange market assists international trade and investments by enabling
currency conversion. For example, it permits a business in the United States to import goods
from European Union member states, especially Euro zone members, and pay Euros even
though its income is in United States Dollars. It also supports direct speculation and
evaluation relative to the value of currencies, and the carry trade, speculation based on the
interest rate differential between two currencies.

The modern foreign exchange market began forming during the 1970s after three
decades of government restrictions on foreign exchange transactions (the Bretton Woods
System of monetary management established the rules for commercial and financial relations
among the world's major industrial states after World War II, when countries gradually
switched to floating exchange rates from the previous exchange rate regime, which remained
fixed as per the Bretton Woods system.

The foreign exchange market has huge trading volume that represents the largest asset
class in the world leading to high liquidity, has geographical dispersion, has continuous
operation i.e. 24 hours a day except weekends, i.e., trading from 22:00 GMT on Sunday
(Sydney) until 22:00 GMT Friday (New York). There are varieties of factors that affect
exchange rates. The low margins of relative profit are compared with other markets of fixed
income. It uses leverage to enhance profit and loss margins and with respect to account size.

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As such, it has been referred to as the market closest to the ideal of perfect competition not
withstanding currency intervention by central banks.

According to the Bank for International Settlements, the preliminary global results
from the 2013 Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives
Markets activity shows that trading in foreign exchange markets averaged $5.3 trillion per
day in April 2013. This is up from $4.0 trillion in April 2010 and $3.3 trillion in April 2007.

 FOREIGN EXCHANGE MARKET

The foreign exchange (currency or forex or FX) market exists wherever one currency is
traded for another. It is by far the largest market in the world, in terms of cash value traded,
and includes trading between large banks, central banks, currency speculators, multinational
corporations, governments, and other financial markets and institutions.

Retail traders (small speculators) are a small part of this market. They may only participate
indirectly through brokers or banks and may be targets of forex scams.

o MARKET SIZE AND LIQUIDITY

The foreign exchange market is popular because of:

• its trading volume,

• the extreme liquidity of the market;

• the large number of, and variety of, traders in the market;

• its geographical dispersion;

• its long trading hours - 24 hours a day (except on weekends); and

• the variety of factors that affect exchange rates.

According to the BIS study Triennial Central Bank Survey 2004, the average daily
international foreign exchange trading volume was $1.9 trillion in April i.e.

o $600 billion in spot

o $1,300 billion in derivatives
o $200 billion in forwards
o $1,000 billion in forex swaps

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 o $100 billion in forex options

Exchange-traded forex futures contracts were introduced in 1972 at the Chicago

Mercantile Exchange and are actively traded relative to most other futures contracts.

Forex futures volume has grown rapidly in recent years, but only accounts for about
7% of the total foreign exchange market volume, as per “The Wall Street Journal Europe
(5/5/06, Page No. 20)”.

 FUNCTIONS OF THE FOREIGN EXCHANGE MARKET

The foreign exchange market is the mechanism by which a person of firm transfers
purchasing power from one country to another, obtains or provides credit for international
trade transactions, and minimizes exposure to foreign exchange risk.

Transfer of Purchasing Power:

Transfer of one country to another and from one national currency to another is called the
transfer of purchasing power. International transactions normally involve different people
from countries with different national currencies. Credit instruments and bank drafts are used
to transfer the purchasing power this is one of the important functions in forex. In forex the
transaction can only be done in one currency.

Provision of credit for foreign trade:

  The forex takes time to move the goods from a seller to buyer so the transaction must
be financed. Foreign exchange market provides credit to the traders. Credit facility is need by
exporters when the goods are transited. Goods some on the other need credit facility when
this kind of special credit facility is used the forex exchange department is extended to
finance the foreign trade.

Foreign Exchange Dealers:

Foreign exchange dealers, deal both with interbank and client market. The profit of
the dealers is there buying at a bid price and sells it at a high price. Worldwide competitions
among dealers narrows the spread between bid and ask and so contributes to making the
foreign exchange market efficient in the same sense as securities markets. Dealers in the
foreign exchange departments of large international banks often function as market makers.

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They stand willing to buy and sell those currencies in which they specialize by maintaining
an inventory position in those currencies.

Minimizing Foreign Exchange Risk: The foreign exchange market provides "hedging"
facilities for transferring foreign exchange risk to someone else.

 CHARACTERISTICS OF FOREIGN EXCHANGE MARKET

Changing Wealth:
The ratios between the currencies of two countries are exchange rates in forex. If one
currency losses its value in the market and at the same time the value of another currency
increases, it causes fluctuations in the exchange rate in foreign exchange market.
For Example, over 20 years ago a single US dollar bought 360 Japanese Yen, whereas at
present 1 US dollar buys 110 Japanese Yen; this explains that the Japanese Yen has risen in
value, and the US dollar has decreased in value (relative to the Yen). This is said to be a shift
in wealth, as a fixed amount of Japanese Yen can now purchase many more goods than two
decades ago.

No Centralized Market:
The foreign exchange market does not have a centralized market like a stock
exchange. Brokers in the foreign exchange market are not approved by a governing agency.
Business network and operation market of foreign exchange takes place without any
unification in transaction. Foreign exchange currency trading has been reformed into a non-
formal and global network organization it consists of advanced information system. Trader of
forex should not be a member of any organisation.

Circulation Work:
Foreign exchange market has member from all the countries, each country has
different geographical positions so forex operates all around the clock on working days i.e.
Monday to Friday every week. Because the time in Australia is different than in European
countries, this kind of 24 hours operation, free from any time is an ideal environment for
investors. For instance, a trader may buy the Japanese Yen in the morning at the New York
market, and in the night if the Japanese Yen rises in the Hong Kong market, the trader can
sell in the Hong Kong market. This signifies that more opportunities are available for the
forex traders. In FOREX market most trading takes place in only a few currencies; the U.S.

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Dollar ($), European Euro (€), Japanese Yen (¥), British Pound Sterling (£), Swiss Franc (Sf),
Canadian Dollar (Can$), and to a lesser extent, the Australian and New Zealand Dollars.

 ADVANTAGES OF FOREIGN EXCHANGE MARKET

Flexibility:
FOREX Exchange markets provide traders with a lot of flexibility. This is because
there is no restriction on the amount of money that can be used for trading. Also, there is
amongst no regulation in the market. This combines with the fact that the market operates on
a 24X7 basis creating a very flexible scenario for traders. People with regular jobs can also
indulge in Forex trading on the weekends or in the nights. However, they cannot do the same
if they are trading in the stock or bond markets or their own countries. It is for this reason that
Forex trading is the trading of choice for the part time traders since it provides a flexible
schedule with least interference in their full-time jobs.

Transparency:
The Forex market is huge in size and operates across several time zones. Despite this,
information regarding Forex markets is easily available. Also, no country or central bank has
the ability to single handily corner the market or rig prices for an extended period of time.
Short term advantages may occur to some entities because of the time lag in passing
information. However, this advantage cannot be sustained over time. The size of the market
also makes it fair and efficient.

Trading Options:
Forex markets provide traders with a wide variety of trading options. Traders can
trade in hundreds of currency pairs. They also have the choice of entering into spot trade or
they could enter into a future agreement. Futures agreements are also available in different
sizes and with different maturities to meet the needs of the Forex traders. Therefore, Forex
market provides an option for every budget and every investor with a different appetite for
risk taking.

Transaction Costs:
Forex market provides an environment with low transaction costs as compared to
other markets. When compared on a percentage point basis, the transaction costs of trading in

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Forex are extremely low as compared to trading in other markets. This is primarily because
forex market is largely operated by dealers who provide a two-way quote after reserving a
spread for themselves to cover the risks. Pure play brokerage is very low in Forex markets.

Leverage:
Forex markets provide the most leverage amongst all financial asset markets. The
arrangements in the Forex markets provide investors to lever their original investment by as
many as 20 to 30 times and trade in the market. This magnifies both profits and gains.
Therefore, even though the movements in the Forex market are usually small, traders end up
gaining or losing a significant amount of money.

 DISADVANTAGES OF FOREIGN EXCHANGE MARKET

Counterparty Risks:
Forex market is an international market. Therefore, regulation of the Forex market is a
difficult issue because it pertains to the sovereignty of the currencies of many countries. This
creates a scenario wherein the Forex market is largely unregulated. Therefore, there is no
centralized exchange which guarantees the risk-free execution of trades. Therefore, when
investors or traders enter into trades, they also have to cognizant of the default risk that they
are facing i.e. the risk that the counterparty may not have the intention or the ability to honour
the contracts. Forex trading therefore involves careful assessment of counterparty risks as
well as creation of plans to mitigate them.

Leverage Risks:
Forex markets provide the maximum leverage. The word leverage automatically
implies risk and a gearing ratio of 20 to 30 times implies a lot a risk. Given the fact that there
are no limits to the amount of movement that could happen in the forex market in a given
day, it is possible that a person may lose all their investment in a matter of minutes if they
placed highly leveraged bets. Certain investors are more prone to making such mistakes
because they do not understand the amount of risk that leverage brings along.

Operational Risks:

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 Forex trading operations are difficult to manage operationally. This is because the
Forex market works all the time whereas humans do not! Therefore, traders have to resort to
algorithms to protect the value of their investments when they are away. Alternatively,
multinational firms have trading desks spread all across the world. However, that can only be
done if trading is conducted on a very large scale.
Therefore, if a person does not have the capital or doesn’t know how to manage their
positions when they are away, forex market could cause a significant loss of value in the
nights or on weekends. The forex market caters to different types of investors with different
risk appetites.

1. NEED FOR FOREIGN EXCHANGE MARKET

In today’s world no country is self-sufficient, consequently there is a need for
exchange of goods & services amongst different countries. Every sovereign country in the
world has a currency which is a legal tender in its territory & this currency does not act as
money outside its boundaries. Therefore, whenever a country buys or sells goods and services
from one country to another, the residents of two countries have to exchange currencies.
Hence, Forex markets acts as a facilitating mechanism through which one country’s’
currency can be exchanged i.e. bought or sold for the currency of another company. The need
can be briefly explained in following points:

Liquidity:
The market operates the enormous money supply and gives absolute freedom in opening or
closing a position in the current market quotation. High liquidity is a powerful magnet for any
investor, because it gives him or her freedom to open or to close a position of any size
whatever.

Promptness:
With a 24-hour work schedule, participants in the FOREX market need not wait to respond to
any given event, as is the case in many markets.

Availability:
A possibility to trade round-the-clock; a market participant need not wait to respond to any
given event.

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Flexible regulation of the trade arrangement system:
A position may be opened for a predetermined period of time in the FOREX market, at the
investor’s discretion, which enables to plan the timing of one’s future activity in advance.

Value:
The Forex market has traditionally incurred no service charges, except for the natural bid/ask
market spread between the supply and the demand price.
One-valued quotations:
With high market liquidity, most sales may be carried out at the uniform market price, thus
enabling to avoid the instability problem existing with futures and other forex investments
where limited quantities of currency only can be sold concurrently and at a specified price.

Market trend:
Currency moves in a quite specific direction that can be tracked for rather a long period of
time. Each particular currency demonstrates its own typical temporary changes, which
presents investment managers with the opportunities to manipulate in the FOREX market.

Margin:
The credit leverage (margin) in the FOREX market is only determined by an agreement
between a customer and the bank or the brokerage house that pushes it to the market and is
normally equal to 1:100. That means that, upon making a $1,000 pledge, a customer can enter
into transactions for an amount equivalent to $100,000. It is such extensive credit leverages,
in conjunction with highly variable currency quotations, which makes this market highly
profitable but also highly risky.

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 2. FOREIGN EXCHANGE TRADING
Foreign Exchange, forex or just FX are all terms used to describe the trading of the
world’s many currencies. The forex market is the largest market in the world, with trades
amounting to more than $1.9 trillion every day. This is more than one hundred times the daily
trading on the NYSE (New York Stock Exchange). Most forex trading is speculative, with
only a few percent of market activity representing governments’ and companies’ fundamental
currency conversion needs.

The foreign exchange market is the most sophisticated market in the world for
currency exchange. Forex trading takes place not on a centralized exchange as in the case of
options, stock or futures, but through a wide variety of forex brokers. Nonetheless, money
transfer comparison websites offer the most comprehensive and useful information. They do
the legwork for you: they research the trends in the market; they compare exchange rates and
brokers and list the best results based on your instructions.

Foreign exchange transactions are more present in our daily lives than we may realize. Quite
often we find ourselves in the position having to make these kind of transactions: when we
travel abroad and need other countries’ currencies, when we buy properties, make an
investment, conduct international trade or start a business overseas, even when buying a
wedding gift and having to send it to another country, we naturally make a foreign exchange
transaction.

Learning about forex before actually making any trade is right part to ensure you
understand what is happening with your money, while you receive a rate or another, how and
what you are charged it does not have to be a daunting process. Just bear in mind that there
are several key factors to look out for, besides the obvious exchange rates and commissions
that may apply. These factors include: the country where you want to make the transfer, how
long will it take for the funds to clear, how much you wish to spend and how often. Finding

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the provider which best meets the above conditions is neither hard nor difficult. It’s just a
matter of knowing what to look for and doing some basic research.

Another important thing to know about the foreign currency transfers is that the
conditions can vary considerably depending on the size of the transfer. Small transfers,
usually less than $1000 or equivalent to the domestic currency, regardless of the selected
operator, entail quite high commissions and regular exchange rates. Though the amount to
transfer is not so big, one cannot choose the rate and depending on the urgency of the
transfer, one has to pay high fees.

On the contrary, large transfers (more than $1000 dollar or equivalent) recommended to
be made through FX brokers, are more open to negotiation. Whether one needs to make
regular payments abroad to pay for a mortgage, to send to your salary to family, to pay for
school tuition or contribute to an investment abroad, he/she is in the position to ask for better
rates and lower fees.

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 3. FOREIGN EXCHANGE MARKET IN INDIA

The Foreign Exchange Market in India works under the central government in
India and executes wide powers to control transactions in foreign exchange. The Foreign
Exchange Management Act, 1999 or FEMA regulates the whole foreign exchange market
in India. Before this act was introduced, the foreign exchange market in India was
regulated by the reserve bank of India through the Exchange Control Department, by the
FERA or Foreign Exchange Regulation Act, 1947. After independence, FERA was
introduced as a temporary measure to regulate the inflow of the foreign capital. But with
the economic and industrial development, the need for conservation of foreign currency
was urgently felt and on the recommendation of the Public Accounts Committee, the
Indian government passed the Foreign Exchange Regulation Act, 1973 and gradually, this
act became famous as FEMA.

Until 1992, all foreign investments in India and the repatriation of foreign capital
required previous approval of the government. The Foreign Exchange Regulation Act rarely
allowed foreign majority holdings for forex in India. However, a new foreign investment
policy announced in July 1991, declared automatic approval for foreign exchange in India for
34 industries. These industries were designated with high priority, up to an equivalent limit of
51 percent. The foreign exchange market in India is regulated by the Reserve Bank of India
through the Exchange Control Department.

Initially the government required that a company`s routine approval must rely on
identical exports and dividend repatriation, but in May 1992 this requirement of foreign
exchange in India was lifted, with an exception to low-priority sectors. In 1994 foreign and
non-resident Indian investors were permitted to repatriate not only their profits but also their
capital for foreign exchange in India. Indian exporters are enjoying the freedom to use their
export earnings as they find it suitable. However, transfer of capital abroad by Indian
nationals is only allowed in particular circumstances, such as emigration. Indian authorities

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are able to manage the exchange rate easily, only because foreign exchange transactions in
India are so securely controlled. From 1975 to 1992 the rupee was coupled to a trade-
weighted basket of currencies.

In Feb 1992, the Indian government started to make the rupee convertible, and in
March 1993 a single floating exchange rate in foreign exchange market was implemented. In
July 1995, Rs 31.81 was worth US$1, as compared to Rs 7.86 in 1980, Rs 12.37 in 1985, and
Rs17.50 in 1990.

Since the onset of liberalization, foreign exchange markets in India have witnessed
explosive growth in trading capacity. The importance of the exchange rate of foreign
exchange in India for the Indian economy has also been far greater than ever before. While
the Indian government has clearly adopted a flexible exchange rate regime, in practice the
rupee is one of most resourceful trackers of the US dollar.

Predictions of capital flow-driven currency crisis have held India back from capital
account convertibility, as stated by experts. The rupee`s deviations from Covered Interest
Parity (as compared to the dollar) display relatively long-lived swings. An inevitable side
effect of the foreign exchange rate policy in India has been the ballooning of foreign
exchange reserves to over a hundred billion dollars. In an unparalleled move, the government
is considering to use part of these reserves to sponsor infrastructure investments in the
country.

The foreign exchange market India is growing very rapidly, since the annual turnover
of the market is more than $400 billion. This foreign exchange transaction in India does not
include the inter-bank transactions. According to the record of foreign exchange in India, RBI
released these transactions. The average monthly turnover in the merchant segment was $40.5
billion in 2003-04 and the inter-bank transaction was $134.2 for the same period. The average
total monthly turnover in the sector of foreign exchange in India was about $174.7 billion for
the same period. The transactions are made on spot and also on forward basis, which include
currency swaps and interest rate swaps.

The Indian foreign exchange market is made up of the buyers, sellers, market
mediators and the monetary authority of India. The main centre of foreign exchange in India
is Mumbai, the commercial capital of the country. There are several other centres for foreign
exchange transactions in India including the major cities of Kolkata, New Delhi, Chennai,

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Bangalore, Pondicherry and Cochin. With the development of technologies, all the foreign
exchange markets of India work collectively and in much easier process.

Foreign Exchange Dealers Association is a voluntary association that also provides

some help in regulating the market. The Authorized Dealers and the attributed brokers are
qualified to participate in the foreign Exchange markets of India. When the foreign exchange
trade is going on between Authorized Dealers and RBI or between the Authorized Dealers
and the overseas banks, the brokers usually do not have any role to play. Besides the
Authorized Dealers and brokers, there are some others who are provided with the limited
rights to accept the foreign currency or travellers’ cheque; they are the authorized
moneychangers, travel agents, certain hotels and government shops. The IDBI and EXIM
bank are also permitted at specific times to hold foreign currency. The Foreign Exchange
Market in India is a flourishing ground of profit and higher initiatives are taken by the central
government in order to strengthen the foundation.

 FOREIGN EXCHANGE RATE

In finance, an exchange rate (also known as a foreign exchange rate, forex rate, ER oFX rate)
between two currencies is the rate at which one currency will be exchanged for another. It is
also regarded as the value of one country’s currency in relation to another country. For
example, an interbank exchange rate of 119 Japanese Yen (JPY, ¥) to the United States
Dollar (US$) means that ¥199 will be exchanged for each US$1 and vice versa. In this case,
it is said that the price of a dollar in relation to yen is ¥119, or equivalently that the price of a
yen in relation to dollars is $1/199.

Exchange rates are determined in the foreign exchange market, which is open to a
wide range of different types of buyers and sellers, and where currency trading is continuous:
24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT
Friday. The spot exchange rate refers to the current exchange rate. The forward exchange rate
refers to an exchange rate that is quoted and traded today but for delivery and payment on a
specific future date.

In retail currency exchange market, different buying and selling rates will be quoted by
money dealers. Most trades are to or from the local currency. The buying rate is the rate at
which money dealers will buy foreign currency, and the selling rate is the rate at which they
will sell that currency. The quoted rates will incorporate an allowance for a dealer’s margin
(or profit) in trading, or else the margin may be recovered in the form of a commission or in

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some other way. Different rates may also be quoted for cash (usually notes only), a
documentary form (such as traveller’s cheques) or electronically (such as a credit card
purchase). The higher rate on documentary transactions has been justified as compensating
for the additional time and cost of clearing the document. On the other hand, cash is available
for resale immediately, but brings security, storage and transportation costs and the cost of
tying up capital in stock of banknotes (bills).

The Retail Exchange Market:

Currency for international travel and cross-border payments is predominantly
purchased from banks, foreign exchange brokerages and various forms of bureau de change.
These retail outlets source currency from the inter-bank markets, which are valued by the
Bank of International Settlements (BIS) at 5.3 trillion US dollars per day. The purchase is
made at the spot contract rate. Retail customers will be charged, in the form of commission or
otherwise, to cover the provider’s cost and generate a profit. One form of charge is the use of
an exchange rate that is less favourable than the wholesale spot rate.

Fluctuations in Exchange Rates:

A market-based exchange rate will change whenever the values of either of the two
component currencies change. A currency will tend to become more valuable whenever
demand for it is greater than the available supply and vice versa.

Increased demand for a currency can be due to either an increased transaction demand for
money or an increased speculative for money. The transaction demand is highly correlated to
a country’s level of business activity, gross domestic product (GDP) and employment levels.
The more people that are unemployed, the less the public as a whole will spend on goods and
services. Central banks typically have little difficulty adjusting the available money supply to
accommodate changes in the demand for money due to business transactions.

Speculative demand is much harder for central banks to accommodate, which they
influence by adjusting interest rates. A speculator may buy a currency if the return i.e. the
interest rate is high enough. In general, the higher a country’s interest rates, the greater will
be the demand for that currency. It has been argued that such speculation can undermine real
economic growth, in particular since large currency speculators may deliberately create
downward pressure on a currency by shorting in order to force that central bank to buy their

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own currency to keep it stable. For carrier companies, shipping goods from one nation to
another, exchange rates can often impact them severely. Therefore, most carriers have a CAF
charge to account for these fluctuations.

Manipulation of Exchange Rates:

A country may gain an advantage in international trade if it controls the market for its
currency to keep its value low, typically by the national central bank engaging in open market
operations. In the early twenty-first century, it was widely asserted that the People’s Republic
of China had been doing this over a long period of time.

Other nations, including Iceland, Japan, Brazil, and so on also devalue their currencies
in the hope of reducing the cost of exports and thus bolstering their economies. A lower
exchange rate lowers the price of a country’s goods for customers in other countries, but
raises the price of imported goods and services for customers in the low value currency
country. In general, exporters of goods and services will prefer a lower a value for their
currencies, while importers will prefer a higher a higher value.

 FOREIGN TRADE POLICY OF INDIA

Increment of exports is of utmost importance, India will have to facilitate imports which are
required for the growth Indian economy. Rationality and consistency among trade and other
economic policies is important for maximizing the contribution of such policies to
development. Thus, while incorporating the new policy, the past policies should also be
integrated to allow developmental scope of India’s foreign trade.

Objectives:
Trade propels economic growth and national development. The primary purpose is
not the mere earning of foreign exchange, but the stimulation of greater economic activity.
 To double the percentage share of global merchandise trade within the next five
years.
 To act as an effective instrument of economic growth generating employment level.
Strategy:
Removing government controls and creating an atmosphere of trust and transparency to
promote entrepreneurship, industrialization and trades.

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  Simplification of commercial and legal procedures and bringing down transaction
costs as well as simplification of levies and duties on inputs used in export products.

 Facilitating development of India as a global hub for manufacturing, trading and

services.

 Generating additional employment opportunities, particularly in semi-urban and rural

areas, and developing a series of ‘Initiatives’ for each of these sectors.

 Facilitating technological and infrastructural upgradation of all the sectors of the

Indian economy, especially through imports and thereby increasing value addition and
productivity, while attaining global standards of quality.

 Free Trade Agreements / Regional Trade Agreements that India enters into to enhance
exports.

 Revitalizing the Board of Trade by redefining its role, giving it due recognition and
inducting foreign trade experts while drafting Trade Policy.

Partnership:
Foreign Trade Policy of India foresees merchant exporters and manufacturer
exporters, business and industry as partners of Government in the achievement of its stated
objectives and goals.
Future:
This Foreign Trade Policy of India is a stepping stone for the development of India’s
foreign trade. It contains the basic principles and points the direction in which it proposes to
go. A trade policy cannot be fully comprehensive in all its details it would naturally require
modification from time to time with changing dynamics of international trade.

 DEVELOPMENT OF FOREX MARKET IN INDIA

Every nation has its own currency. For international financial transactions most of the
country involve in an exchange of one’s currency to another. The rate (conversion of one
currency to another) of one currency in terms of another is known as exchange rate. In India
the rates are quoted in USD/INR terms, where USD is termed as base currency and INR is
known as variable currency.

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 In practice the rates are quoted by direct method. In India USD is used as intervention
currency for quoting the rates. For getting the rates of other currency we use the cross-
currency method to determine their price. The majority of all foreign exchange trades involve
the US dollar against another currency due to the fact that the US economy is the largest in
the world and being global leader, it is used for benchmarking.
Average daily trading volume of Indian Forex market is nearly $34 billion as per Bank for
International settlement survey. The origin of the forex market development in India could be
traced back to 1978 when banks were permitted to undertake intra-day trades. However, the
market witnessed major activities only after 1990s with the floating of the currency in March
1993, following the recommendations of Raghuram Rajan committee.

 FACTORS AFFECTING FOREX RATES

Price determination:
The law of supply and demand essentially governs the Forex market like any other market.
The law of supply states, as prices rises for a given commodity or currency, the quantity of
the item that is supplied will increase; conversely, as the price falls, the quantity provided
will fall. It is the interaction of these basic forces that results in the movement of currency
prices in the Forex market.
FUNDAMENTAL FACTORS

Exchange rate policy and regime: Fixing an exchange rate is policy matter but in India it is
largely dismantled as market force determines the exchange rates with certain exchange
control regulations.
Monetary policy & fiscal policy: If a government runs into deficit, it has to
Borrow money (by selling bonds). If it can't borrow from its own citizens, it must borrow
from foreign investors. That means selling more of its currency, increasing the supply and
thus driving the prices down.
Domestic Financial Market: Strong domestic financial markets will also lead to the
strengthening of domestic currency, as investors will be less worried about their investments
and foreign investor will also be attracted.
Central bank intervention in Forex market: By open market operation or by increasing /
decreasing key rates or by purchasing and selling the forex, central bank directly or indirectly
affects the forex market operation.

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Capital account liberalization: Till now convertibility of capital account is not fully
permitted by government. Convertibility of capital account means freedom to convert local
financial assets to foreign financial assets and vice versa.
Interest rate differentials: If there are higher interest rates in home country then it will
attract investments from abroad in the form of FII, FDI and increased borrowings leading to
increased supply of foreign currency. On the other hand, if the interest rates are higher in the
other country, investments will flow out leading to decreased supply of foreign currency.

TECHNICAL FACTORS

Market (price) action discounts everything: This means that the actual price is a reflection
of everything that is known to the market that could affect it.
Prices move in trends: It is used to identify patterns of market behaviour.
History repeats itself: Forex chart patterns have been recognized and categorized for over
100 years, and the manner in which many patterns are repeated leads to the conclusion that
human psychology changes little over time. Since patterns have worked well in the past, it is
assumed that they will continue to work well into the future.

 FUTURE OF FOREX MARKETS IN INDIA

It provides a comprehensive study of the key issues affecting the market including the
dramatic developments taking place in trading technology, the impact of the EMU and the
opportunities and threats posed by emerging markets.
The Future of the Foreign Exchange Markets discusses the new forex clearing bank:
CLSS and considers its implications for the future structure of the global forex market,
specifically the reduction of settlement risk. It reviews the emergence of Contracts for
Differences (CFDs) which avoid the need for any settlement. The expected effects of EMU
on the size and structure of the market are analysed, with issues such as the likely size and
distribution of activity in the euro being specifically addressed.
Structure & Scope:
 Developments in the foreign exchange markets including the spot market, the
forwards market and foreign exchange options and derivatives market.

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  Trading Technology - in particular the development of electronic matching systems
and their new dominance of trading in the market.
 Netting and Settlement systems, with particular reference to the new foreign exchange
clearing bank, CLSS. The rise of CFDs will also be considered.
 EMU - a discussion on the size and structure of the market, both during the first year
of its implementation and once stage three of monetary union is completed.
 Emerging Markets - considering the growing proportion of forex trading devoted to
emerging market currencies and whether this growth and development will continue
in the face of the turmoil in Asia and Russia.

4. FOREIGN EXCHANGE RISK

Foreign exchange risk (also known as exchange rate risk or currency risk) is a
financial risk posed by an exposure to unanticipated changes in the exchange rate between
two currencies. Investors and multinational businesses exporting or importing goods and
services or making foreign investments throughout the global economy are faced with an
exchange rate risk which can have severe financial consequences if not managed
appropriately. 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 onset
of floating exchange rates following the collapse of the Bretton Woods system that firms
perceived an increasing risk from exchange rate fluctuations and began trading an increasing
volume of financial derivatives in an effort to hedge their exposure. The outbreak of currency
crises in the 1990s and early 2000s, such as the Mexican peso crisis, Asian currency crisis,
1998 Russian financial crisis, and the Argentine peso crisis, substantial losses from foreign
exchange have led firms to pay closer attention to foreign exchange risk.

Management:

Managers of multinational firms employ a number of foreign exchange hedging

strategies in order to protect against exchange rate risk. Transaction exposure is often
managed 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.

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 Firms may exercise 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.

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. Following this logic, a firm could acquire an appropriate amount of exposed
assets or liabilities to balance any outstanding discrepancy. Foreign exchange derivatives may
also be used to hedge against translation exposure.
Measurement:
If foreign exchange markets 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 forex 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.

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Value at Risk:
Practitioners with advanced 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 risk. This
helps risk managers determine the amount that could be lost on an investment portfolio over
time with a given probability of changes in exchange rates.

 RISK MANAGEMENT
Risk Management is the process of measuring or assessing risk and then developing
strategies to manage the risk. In general, the strategies employed include transferring the risk
to another party, avoiding the risk, reducing the negative effect of risk, and accepting some or
all of the consequences of a particular risk. Traditional risk management focuses on risk
stemming from physical or legal causes (e.g. natural disasters or fires, accidents, deaths and
lawsuits). Financial risk management, on the other hand, focuses on risk that can be managed
using traded financial instruments. Intangible risk management focuses on the risks
associated with human capital, such as knowledge risk, relationship risk and engagement
process risk. Regardless of the type of risk management, all large corporations have risk
management teams and small groups and corporations’ practice informal, if not formal, risk
management.
In ideal risk management, a prioritization process is followed whereby the risks with
the greatest loss and the greatest probability of occurring are handled first, the risk with low
probability of occurrence but lower loss is handled later. In practice, the process can be very
difficult, and balancing between risks with a high probability of occurrence but lower loss vs.
a risk with high loss but lower probability of occurrence can often be mishandled.
Intangible risk management identifies a new type of risk – a risk that has a 100% probability
of occurring but is ignored by the organization due to a lack of identification ability. For
example, knowledge risk occurs when deficient knowledge is applied. Relationship risk
occurs when collaboration ineffectiveness occurs. Process-engagement risk occurs when
operational ineffectiveness occurs. These risks directly reduce the productivity of knowledge

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workers, decrease cost effectiveness, profitability, service, quality, reputation, brand value,
and earnings quality.
Intangible risk management allows risk management to create immediate value from
the identification and reduction of risks that reduce productivity.
Risk management also faces a difficulty in allocating resources properly. This is the
idea of opportunity cost. Resources spent on risk management could be instead spent on more
profitable activities. Again, ideal risk management spends the least amount of resources in
the process while reducing the negative effects of risks as much as possible.
However, leverage is a double-edged sword. Just because one lot ($10000) of
currency only requires $100 as a minimum margin deposit, it does not mean that a trader
$1000 in his account should be easily available to trade 10 lots. One lot is $10000 and should
be traded as a $1000000 investment and not the $1000 dollar put up as margin. Most traders
analyse the charts correctly and place sensible trades, yet they tend to over-leverage
themselves (getting into a position that is too big for their portfolio), and as a consequence,
often end up forced to exit a position at the wrong time.

 CONCLUSION
The submitted project is an attempt to simplify the concept of Foreign Exchange Markets in
the perspective of Economics. It comes with its own advantages and disadvantages, but we
cannot the fact that it is extremely important for a country to have Foreign Exchange reserves
for it to be able to pay its import bills and for its financial soundness/stability. India too has
its own reserves of Foreign Exchange and RBI has a big role to play in it. It is the RBI which
issues the Indian currency and gives the information of the Indian currency which is printed
in India so that the foreign market can put up the value of Dollar or any other foreign
currency equivalent to Indian Rupee.

 BIBLIOGRAPHY
 www.google.com
 www.moneycontrol.com
 www.forex.com

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 www.wikipedia.com
 www.investopedia.com
 www.scribd.com
 www.infibeam.com
 www.yahoo.com
 www.economictimes.indiatimes.com
 www.exchange-rates.org

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