WORLD MONETARY SYSTEM

• In 1971 the US dollar was delinked with gold. Put differently, it

was allowed to “float”. This brought about a dramatic change
in the international monetary system. The system of fixed
exchange rates, where devaluations and revaluations occurred
only very rarely, gave way to a system of floating exchange
rates.
• Since governments of most countries intervene in the exchange
markets, in a smaller or bigger way, we have ‘managed’ or
‘dirty float’.
• The exchange rate regime of the Indian rupee has evolved over
time moving in the direction of less rigid controls and current
account convertibility.
 MULTINATIONAL CORPORATIONS

Companies go global for the following reasons:

• Trade barriers
• Imperfect labour markets

• Intangible assets

• Vertical integration

• Product life cycle

• Diversification

• Shareholder diversification
 FOREIGN EXCHANGE MARKETS
AND RATES

The foreign exchange market is the market where one

country’s currency is traded for another’s. It is the largest
financial market in the world. The daily turnover in this
market in mid –2003 was estimated to be about $ 1500 billion.
Most of the trading, however, is confined to a few currencies:
the U.S dollar ($) , the Japanese Yen (¥), the Euro (€), the
British pound sterling (£) , and the Swiss franc (SF), Exhibit
37.1 lists some of the currencies along with their symbols
CURRENCIES AND THEIR SYMBOLS
Country Currency Symbol
Australia Dollar A$
Canada Dollar Can $
Denmark Krone Dkr
EMU Euro €
Finland Markka FM
India Rupee Rs
Iran Rial Rl
Japan Yen ¥
Kuwait Dinar KD
Mexico Peso Ps
Norway Krone NKr
Saudi Arabia Riyal SR
Singapore Dollar S$
South Africa Rand R
Sweden Krona Skr
Switzerland Franc SF
United Kingdom Pound £
United States Dollar $
 INTERNATIONAL FOREIGN
EXCHANGE MARKET

• The key participants are importers, exporters, traders,

brokers, speculators, and portfolio managers.

• Essentially an ‘over the counter’ market.

• Virtually a 24-hour market.

• Speculative transactions account for more than 95

percent of turnover
 FOREIGN EXCHANGE
MARKET IN INDIA

• RBI, banks, and business firms are the key

participants

• RBI plays a key role in setting the day-to-day

rates.

• Business firms can’t resort to speculative

transactions
 EXCHANGE RATES
Indicative on Friday January 02,2015

IMPORT EXPORT

Forward (Months) Spot Currency Spot Forward (Months)

6 3 1 TT* Bill TT* Bill 1 3 6

65.71 64.56 63.79 63.34 63.38 US Dollar 63.3 63.24 63.77 64.55 65.69

79.29 77.83 76.85 76.29 76.33 Euro 76.2 76.18 76.8 77.77 79.18

101.1 99.44 98.29 97.63 97.68 Pound Sterling 97.5 97.49 98.28 99.46 101.2

54.61 53.6 52.92 52.54 52.57 Japanese Yen* 52.5 52.45 52.89 53.55 54.53

66.11 64.82 63.95 63.48 63.51 Swiss Franc 63.4 63.36 63.9 64.71 65.93

10.65 10.46 10.33 10.25 10.26 Danish Kroner 10.2 10.23 10.32 10.45 10.64

Source : State Bank of India, Chennai

 SPOT RATES
In the foreign exchange market, a spot rate refers to the rate applicable to
transactions in which settlement is done in two business days after the
date of transaction. To understand spot rate quotations, we will use the
ACI (Association Cambiste International) conventions, which are
followed in the inter-bank market. These conventions are as follows:

• A pair of currencies is denoted by the 3-letter SWIFT codes for

the currencies separated by an oblique or a hyphen.
Examples: GBP/CHF : Great Britain Pound-Swiss Franc
USD/INR : US Dollar-Indian Rupee
• In a pair, the first currency is the ‘base’ currency and the second
currency is the ‘quoted’ currency.
• The exchange rate quotation reflects the number of units of the quoted
currency per unit of the base currency. Thus a GBP/INR quotation
reflects the number of India rupees for British pound.
• A quotation consists of two prices separated by a hyphen or slash.
The first price is the bid price; this is the price at which the dealer is
willing to buy. The second price is the ask price; this is the price at
which the dealer is willing to sell. An illustrative quotation is given
below:
USD/INR Spot : 65.000/65.5400

This quotation means that the dealer will buy one US dollar for Rs.
65.000 and will sell one US dollar for Rs. 65.5400.
 BID-ASK SPREAD
The bid-ask spread - the difference between bid and ask prices –
reflects the breadth, depth, and volatility of the currency market. The
spread is normally expressed in percentage terms as follows:

Ask price – Bid price

Percent spread = x 100
Bid price

For example, the percentage spread for the dollar quote Rs. 65.5000
– 65.5400 works out to 0.088 percent.

65.5400 – 65.5000
Percent spread = X 100 = 0.061 percent
65.5000
 CROSS-EXCHANGE RATE QUOTATIONS
To develop the concept of a cross-rate, let us for the time being
ignore the transaction cost. Given the exchange rate between
currencies A and B and currencies B and C, you can derive the
exchange rate between currencies A and C. In general,
S (A/C) = S (A/B) x S (B/C)
Note that S (A/C) represents the spot rate between currencies A
and C, and so on.
To illustrate consider the following rates:
S (INR/USD) = 0.0226
S (USD/CHF) = 1.2381
 CROSS-EXCHANGE RATE QUOTATIONS

Given the above rates you can calculate the exchange rate
between INR and CHF.
S (INR/CHF) = S (INR/USD) x S (USD/CHF)
= 0.0226 x 1.2381 = 0.0280

Most commonly, cross-rate calculations are done to establish

the exchange rates between two currencies that are quoted
against the US dollar but are not quoted against each other.
 FORWARD RATE QUOTATION
In the foreign exchange market, forward transactions are also
possible in which the rate is fixed today but the settlement is at
some specified date in the future. Such rates are called forward
rates. Banks normally quote forward rates for maturities in whole
calendar months – such as 1, 2, 3, and 6 months – but will tailor a
forward deal to suit the customer’s requirements.
For commercial customers banks usually give an outright
quotation in the same way as they give for a spot transaction. Thus
a quote like
USD/INR 3 – Month Forward: 66.5220/66.6210
means that the bank (dealer) will buy one US dollar for Rs.
66.5220 or sell one US dollar for Rs. 66.6210 for a delivery to be
made after 3 months.
FORWARD PREMIUMS AND DISCOUNTS
Consider the following spot and forward quotes
USD/INR Spot : 66.5020 / 66.5120
USD/INR 1-month forward : 66.5420 / 66.5620
The US dollar is costlier in the forward market than in the spot
market. Put differently, it is at a forward premium in relation to the
Indian rupee.
With two-way quotations, you cannot quantify the premium or
discount in a unique way. One way to quantify the annual percentage
premium or discount is as follows.
Forward (USD/INR)mid – Spot (USD/INR)mid
x 12 x 100
Spot (USD/INR)mid
FORWARD PREMIUMS AND DISCOUNTS
In this formula, the mid rate is simply the arithmetic average of the
bid and ask rates. Note that multiplication by 12 converts the
monthly premium (or discount) to annual premium (or discount) and
multiplication by 100 translates it into percentage terms.
Applying this formula to the USD/INR spot and forward quotes
given above, we get:

66.5520 –66.5070
= 0.68percent
66.5070
This means that the annual forward premium on US dollar in relation
to Indian rupee is 0.68 percent.
 FORWARD PREMIUM OR DISCOUNT

Forward rate – Spot rate 12

Forward premium = x
or discount
Spot rate Forward contract
length in months
For example if the spot rate of the U.S dollar is Rs.43.26 and the
three month forward rate is Rs.43.80, the annualised forward
premium works out to :
63.80 - 63.26 12
Forward premium = x
63.26 3
= 0.0341 or 3.41 percent