Financial Markets And Institutions

Foreign Exchange Market

Group Members
Name KP BP SS Roll No. 16 17 23

What is the Foreign Exchange Market

FOREX, an acronym for Foreign Exchange It is the oldest and largest financial market in the world Has no central trading floor where buyers and sellers meet Forex, unlike other financial markets, is not tied to an actual stock exchange. Forex is an over-the-counter (OTC) or off-exchange market. The foreign exchange market operates 24 hours a day, and, unlike the stock market, has no official openings or closings.

Trading can be done in nearly all currencies. These currencies are the U.S. dollar, the euro, the British pound, the Japanese yen, the Swiss franc, the Canadian dollar, New Zealand dollar and the Australian dollar. buys one currency and sells another in a simultaneous transaction always occurs in pairs The major participants in the foreign exchange market are: Commercial banks International corporations Nonbank financial institutions Central banks

Forward Exchange Rate

It refers to an exchange rate that is quoted and traded today but for delivery and payment on a specific future date. spot x future value of quote currency future value of quote currency

S(1 + rq)n S(1 + rb)n S= Spot Rate rq= Interest rate of Quote Currency Rb= Interest rate of a base currency N= Number of compounding periods

Spot Exchange Rate

The rate of a foreign-exchange contract for immediate delivery. Also known as "benchmark rates", "straightforward rates" or "outright rates", spot rates represent the price that a buyer expects to pay for a foreign currency in another currency
Though the spot exchange rate is said to be settled immediately, the globally accepted settlement cycle for foreign-exchange contracts is two days. Foreign-exchange contracts are therefore settled on the second day after the day the deal is made

Fixed Exchange Rate

A fixed exchange rate is a system where the exchange rate has a set value against another currency.

example, there was an increase in demand for the currency (shown by a shift from D1 to D2 below), this would normally lead to the exchange rate increasing. However, the exchange rate is fixed and so the authorities have to counter the effect of the increase in demand. They do this by supplying more of the currency. In other words they sell sterling and buy other currencies instead. This shifts the supply curve to S2, and maintains the fixed rate.

Floating rates

A floating exchange rate is one that is allowed to find its own level according to the forces of supply and demand

Exchange Rates Determinants

The business environment Stock market Political Factors Economic Data Government influence Productivity of an economy

Interest Rate Parity

difference between the (risk free) interest rates paid on two currencies should be equal to the differences between the spot and forward rates. lower rate

example 1. borrow in the currency with the 2. convert the cash at spot rates 3. enter into a forward contract to 4. 5. 6.

convert the cash plus the expected interest at the same rate invest the money at the higher rate convert back through the forward contract repay the principal and the interest, knowing the latter will be less than the interest received.

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