FOREIGN EXCHANGE MARKET

Group Members
Devendra Bhagyawant Atit Dhaygude Ankita Gagwani Shekhar Gite Pratik Patil Roy Thomas 61 66 73 77 105 111

MMS (Finance)

Contents
1. 2. 3. 4. Introduction of Forex Market Factors Determining Exchange Rates Mechanism of Foreign Exchange Rate Meaning and Calculation of Spot & Forward Rates 5. Risk Associated With Foreign Exchange Operations 6. Role of RBI & FEDAI

Foreign Exchange Market

Foreign Exchange (Forex) The mechanism by which the currency of one country gets converted into the currency of another country. The World Trade, Export & Import of commodities & services, Cross-border movement of Manpower & Capital, Travel & Tourism necessitate need for exchange of currency of one country to the currency of another country

Foreign Exchange Market

USA (Exporter) export Machine to India (Importer) USA would like to get payment in USD Payment in INR will not serve their purpose Indian Rupee cant be used as currency in the USA Therefore need arises for the conversion of importers country to that of exporters country i.e. INR to USD

Foreign Exchange Market

Foreign Exchange Market

A market in which currencies are bought and sold.

Forex Rate
The rate at which one currency can be exchanged for another. e.g. 1 USD = 50 INR

Features of Forex Market

1. 24 Hours Market

2. Huge Volume of Transactions

3. Highly Liquid Market 4. Most difficult Market to trade in 5. Over The Counter Market 6. Currencies Traded

Participants
Corporations Commercial Bank Central Banks Others

Factors Determining Exchange Rates

Fundamental Reasons
1. 2. 3. 4. 5. 6. BOP Economic Growth Rate Fiscal Policy Monetary Policy Interest Rates Political Issues

Technical Reasons Speculation

Electronic Modes of Transmission

SWIFT

CHIPS
Fedwire

CHAPS
TARGET

RTGS-Plus & EBA

RTGS / NEFT in India

Exchange Rate Mechanism

Direct & Indirect Quotes Direct Quotes The Local Currency is variable say in India, 1 USD = Rs. 48.10 Indirect Quotes The Local Currency remains fixed say in India, Rs. 100 = 2.05 USD

Exchange Rate Mechanism

Fixed v/s Floating Rates Fixed Rate Set by the Monetary Authorities Floating Rate Decided by Demand & Supply factors for a particular currency.

Exchange Rate Mechanism

Bid & Offered Rates Bid Rate (Buying Rate) The price at which the market would buy the currency pair

Offer Rate (Selling or Ask Rate) The price at which the market would sell the currency pair
e.g. In a USD/INR quote, 1 USD = Rs. 48.10/11 Rs.48.10 (Bid Rate) & Rs. 48.11 (Offer Rate)

Exchange Rate Mechanism

Bid-Offer Spread The amount by which the ask price exceeds the bid e.g. In a USD/INR quote, 1 USD = Rs. 48.10/11 Rs.48.10 (Bid Rate) & Rs. 48.11 (Offer Rate) Bid-Offer Spread = Rs. 48.11 Rs. 48.10 = Rs. 00.01

Exchange Rate Mechanism

The Delivery of FX Deals can be settled in one or more of the following ways: Ready or Cash Tom Spot Forward

Exchange Rate Mechanism

Ready or Cash Settlement of transaction on the same day. e.g. Date of Cash Deal is 5th Oct, 2012 (Monday) Settlement Date will also be 5th Oct, 2012

Exchange Rate Mechanism

TOM Settlement of transaction on the next working day e.g. Date of TOM Deal is 5th Oct, 2012 (Monday) Settlement Date would be 6th Oct, 2012 (Tuesday) If Tuesday is a holiday, in any of the 2 countries, the settlement date will be next working day in both the countries.

Exchange Rate Mechanism

Spot Settlement of transaction to be done on the 2nd working day In the forex market all rates that are quoted are generally spot rates

e.g. if the date of Spot deal is 5th Oct, 2012 (Monday)

Settlement date will be 7th Oct, 2012 (Wednesday) Presuming all markets are working on 5, 6 & 7 Oct, 2012. If not it will be next working day in both the countries.

Exchange Rate Mechanism

Forward Settlement of transaction takes place on any day after Spot date e.g. if the date of Forward deal is 5th Oct, 2012 (Monday), for value settlement date 30th Oct, 2012 or 30th Nov, 2012.

Forward Rates
Forward Margins : Premiums and Discounts
Forward Rate = Spot Rate + Premium (or -Discounts)
Premium If the Forward value of currency is higher than the spot value (If currency is appreciating = Premium currency) Discount If the Forward value of currency is cheaper than the spot value (If currency is Depreciating = Discount currency) e.g. Spot USD/INR = Rs. 48.10/11 1 Month Forward Margin = 68/69 1 Month Forward = Rs. 48.78/80 USD is at a premium & INR is at a discount

Basis for Merchant Rates

Base Rate The Interbank Rate on the basis of which the bank quotes its merchant rate Exchange Margin To cover administrative cost, exchange fluctuation & provide some profit on transaction to the bank Bid Rate (- Ex. Margin) & Offer Rate (+ Ex. Margin) Fineness of Quotation Normally, exchange rate quoted upto 4 decimals in multiples of 0.0025, except some currencies such as JPY. e.g. USD 1 = Rs. 49.2350 EUR 1 = Rs. 48.5000

Principle Types of Exchange Rates

Exchange Rate Telegraphic Transfer TT Buying TT Selling

Bills Buying Bill Buying Bill Selling

TT Buying Rate
On 15th Sept you receive a mail transfer from your New York correspondent for USD 5,000 payable to your customer and same has been credited into your Nostro A/c. Assuming: Spot USD 1 = Rs. 49.2500/2700 Spot/Oct 2200/2300 Ex. Margin = 0.080% Calculate the exchange rate and the Rupee amount payable to the customer.

TT Buying Rate
The Rate applicable is TT Buying Rate
Dollar/Rupee Market Spot Buying Rate = Rs. 49.2500 Less: Exchange Margin @ 0.08% on Rs. 49.2500= Rs. (0.0394) = Rs. 49.2106

Rounded off to the nearest multiple of 0.0025 Exchange Rate quoted to customer = Rs. 49.2100 Amount payable for USD 5,000 @ Rs. 49.2100 per Dollar = Rs. 2,46,050

Bill Buying Rate

On 8th Sept, an exporter tenders a demand bill for USD 1,00,000 drawn on New York. Assuming: Spot USD 1 Spot/Sept Spot/Oct = Rs. 49.3000/3500 = Rs. 6000/7000 = Rs. 8000/9000

Transit Period = 25 Days. Ex Margin = 0.10% Interest on Export Finance = 10% p.a. Out of pocket Exps = Rs. 500 Customer opts to retain 15% of the proceeds in USD. Find out Rupee Amount Payable to the Customer

Bill Buying Rate

The Rate applicable is Bill Buying Rate
Since the currency is at premium, the transit period will be rounded off to lower month (i.e. nil) Dollar/Rupee Market Spot Buying Rate = Rs. 49.3000 Less: Exchange Margin @ 0.10% on Rs. 49.3000 = Rs. (0.0493) = Rs. 49.2507 Rounded off to the nearest multiple of 0.0025 Exchange Rate quoted to customer = Rs. 49.2500 Rupee amount payable on the bill for USD 85,000 (100000 15% of 100000) @ 49.2500 per dollar = Rs. 41,86,250 Less : Interest @ 10% for 25 Days = Rs. (28,673) Out of pocket Exps = Rs. (500) Net Amount Credit to Customer Account = Rs. 41,57,077

TT Selling Rate
On 1th Sept, Your Customer requested you to issue a demand draft on New York for USD 25,000. Assuming: Spot USD 1 = Rs. 49.3575/3825 Exchange Margin = 0.15% What rate will you quote to your customer and what is the rupee amount payable by the customer?

TT Selling Rate
The Rate applicable is TT Selling Rate
Dollar/Rupee Market Spot Selling Rate = Rs. 49.3825 Add: Exchange Margin @ 0.10% on Rs. 49.3000 = Rs. 0.0740 = Rs. 49.4565

Rounded off to the nearest multiple of 0.0025 Exchange Rate quoted to customer = Rs. 49.4575 Amount payable by the customer for USD 25,000 @ Rs. 49.4575 per dollar = Rs. 12,36,438.

Bill Selling Rate

On 12th Feb your customer has received an import bill for USD 10,000. He asks you to retire the bill to the debit of his A/c. Assuming: Spot 1 USD = Rs. 48.7050/7200 Ex. Margin = 0.15% for TT Sells Ex. Margin = 0.20% for bills sell With what amount will you debit his account?

Bill Selling Rate

The bank is to quote Bill Selling Rate
Dollar/Rupee Market Spot Selling Rate Add: Exchange Margin (TT) @ 0.15% on Rs. 48.7200 Add: Exchange Margin (Bill) @ 0.20% on Rs. 48.7930 = Rs. 48.72000 = Rs. 0.07308 = Rs. 48.79308 = Rs. 0 .09759 = Rs. 48.89067

Rounded off to the nearest multiple of 0.0025 Exchange Rate quoted to customer = Rs. 48.8900 Customers A/c will be debited for USD 10,000 @ Rs. 48.8900 per dollar with Rs. 4,88,900.

Forward Exchange Contract (Selling Rate)

An import-customer of your bank wishes to book a forward contract with you on 2nd Aug, 2011 for sale to him of USD 1,50,000 on 30th Nov, 2011. Assuming: Spot 1 USD Spot/Aug Spot/Sept Spot/Oct Spot/Nov = Rs. 49.3700/3800 = Rs. 0300/0400 = Rs. 1100/1300 = Rs. 1900/2200 = Rs. 2700/3100

Ex Margin = 5 Paise Calculate the rate to be quoted to the customer.

Forward Exchange Contract (Selling Rate)

The Rate to the customer will be based on Spot/Nov rate in the market Dollar/Rupee Spot Selling Rate = Rs. 49.3800 Add: Premium for Spot/Nov = Rs. 0.3100 = Rs. 49.6900 Add: Ex. Margin = Rs. 0.0500 = Rs. 49.7400 The Selling Rate of USD on 30th Nov, 2011 is Rs. 49.7400 per dollar

Forward Exchange Contract (Buying Rate)

On 15th Sept, a customer requests for booking of a forward contract for export bill of USD 1,50,000 to be realized in month of December. Assuming: Spot 1 USD = Rs. 48.4500/5000 Spot/Oct = Rs. 1900/1800 Spot/Nov = Rs. 3200/3000 Spot/Dec = Rs. 4300/4100 Ex Margin = 0.05 Paise per dollar Calculate the rate to be quoted to the customer.

Forward Exchange Contract (Buying Rate)

The Rate to the customer will be based on Spot/Dec rate in the market Dollar/Rupee Spot Buying Rate = Rs. 48.4500 Less: Discount for Spot/Dec = Rs. (0.4100) = Rs. 48.0400 Less: Ex. Margin = Rs. (0.0500) = Rs. 47.9900 The Buying Rate is Rs. 47.9900 per dollar

Risk Associated With Forex Dealing Operations

Credit Risk Market Risk Liquidity Risk Gap Risk/Interest Rate Risk Operational Risk Exchange Risk Legal Risk System Risk Country Risk Sovereign Risk

RBI
RBI, as the central bank and the custodian of nation's foreign exchange reserves, has prescribed guidelines for Authorized Dealers (AD) to deal in Forex and handle currency transactions. FEMA 1999, also prescribes rules for persons, corporate, etc. in handling foreign currencies, as also transactions denominated therein.

Categorization of Authorized Dealers

Authorized Dealer Category I
Allowed to handle all types of forex transactions

Authorized Dealer Category II

Money Changers

Authorized Dealer Category III

Restricted Money Changers

FEDAI (Foreign Exchange Dealers Association of India)

Non-profit making body, formed in 1958 with the approval of RBI, consisting of Authorized Dealers as members. Prescribes guidelines and rules of the game for market operations, merchant rates, ex-im bills, quotations, holidays, interest on defaults, etc. It is mandatory to all Authorized Dealers (members) to follow the guidelines/directives issued by FEDAI.