FOREIGN

EXCHANGE
MARKETS
Part 2
PARVESH AGHI
 FORWARD CONTRACT
& RATES
BASICS

Saturday, October 17, 2020 2

Forward exchange rate quotation
Forward contract is an
agreement between two Forward rate is quoted with Spot rate :
counterparts to exchange spot rate and the forward
currencies on a future date margin separately $1 = Rs 75.53/ 54
at a rate fixed in the contract.

6-month forward rate as 6- month forward rate

40/44 1$ = 75.93 /98

3
Forward exchange rate quotation

If the price on a future date is If the price on a future date is

higher, then the currency is said lower, then the currency is said to
to be at forward premium be at forward discount

In the example, US dollar is at a

premium and the forward
premium of USD for six months
is 40/44 paise for buying and
selling rate respectively in the
interbank market
4
Forward premium/ discount
A forward premium is a situation in which the
forward or expected future price for a currency is
greater than the spot price.

A forward premium is frequently measured as the

difference between the current spot rate and the
forward rate.

When a forward premium is negative, is it is

equivalent to a discount.

5
Forward Market
As with the case of spot rates, there
is a bid/ask spread on forward rates.

Forward rates may also contain a

premium or discount.
• If the forward rate exceeds the existing spot
rate, it contains a premium.
• If the forward rate is less than the existing
spot rate, it contains a discount.
6
Forward Market
Annualized forward premium/discount
=
forward rate – spot rate  360
spot rate n
where n is the number of days to maturity
Example: Suppose $ spot rate = Rs 76.12
90-day $ forward rate = Rs 77.05

Rs 77.05 – Rs 76.12 360

x x 100 = 4.88 %
Rs 76.12 90

So, $ forward premium = 4.88%

7
Forward Market
Annualized forward premium/discount
= forward rate – spot rate  360
spot rate n
where n is the number of days to maturity
Example: Suppose $ spot rate = Rs 76.12
one year $ forward rate = Rs 79.97

Required :
Calculate $ forward premium/ discounts %

8
Forward Market
Annualized forward premium/discount
= forward rate – spot rate  360
spot rate n
where n is the number of days to maturity
Example: Suppose $ spot rate = Rs 76.12
one year $ forward rate = Rs 79.97
Rs79.97 – Rs 76.12 x 360 x 100 = +5.05 %
Rs 76.12 360

So,$ forward premium = + 5.05%

9
Forward Market
Annualized forward premium/discount
= forward rate – spot rate  360
spot rate n
where n is the number of days to maturity
Example: Suppose £ spot rate = $1.250
90-day £ forward rate = $1.243
Required
Calculate £ forward premium /discount

10
Forward Market
Annualized forward premium/discount

= forward rate – spot rate  360

spot rate n
where n is the number of days to maturity

Example: Suppose £ spot rate = $1.250

90-day £ forward rate = $1.243.

$1.243 – $1.250 x 360 x 100= - 2.24%

$1.250 90

So, £ forward discount = 2.24%

11
Forward point determination
The number of ‘basis
The points are added to
points’ from the spot
the spot rate when the
rate to arrive at the
[foreign] currency is at a
forward rate are forward
premium
points(or Swap points)

deducted from the spot

rate when the [foreign]
This is when the rates are
currency is at a discount,
quoted in direct method
to arrive at the forward
rate.
12
Forward point determination

In case of indirect rate The forward points

quotations, the process represent the interest
will be exactly the rate differential between
opposite. the two currencies

Forward points are

equivalent to pips in the
spot market

13
Forward point determination
if the spot exchange
if the outright forward
rate is GBP 1 =
points are 5-8
1.6000 - 1.6010 USD

then the outright

forward exchange rate
quote is GBP 1 = $
1.6005 - 1.6018

14
Forward point determination
the currency which If there is an aberration
carries lower interest to this, arbitration They are quoted to an
rate is always at a opportunity arises, accuracy of 1/100thof
premium versus the which itself will push one point.
other currency. the prices to equilibrium

if EUR/USD rates for forward point is 5

spot and 90 days because one pip or
forward are 1.1323 & point is worth 0.0001
1.1328 in EUR/USD.

15
Question
When is a foreign currency most likely trading at a forward premium?
A. When the forward rate expressed in the domestic currency is below the spot rate
B. When the forward rate expressed in the foreign/domestic currency is in equilibrium
C. When the forward rate expressed in the domestic currency is above the spot rate

Saturday, October 17, 2020 16

Answer
When is a foreign currency most likely trading at a forward premium?

A. When the forward rate expressed in the domestic currency is below the spot rate

B. When the forward rate expressed in the foreign/domestic currency is in equilibrium

C. When the forward rate expressed in the domestic currency is above the spot rate

Answer c

© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA Saturday, October 17, 2020 17

Broken period forward rate
The forward rate that is available
in the interbank market cannot bank quotes swap points for
be applied as such for customer one month end, 2 month end
transactions. The broken period and so on….. till 12 month
concept becomes relevant in end.
such situations.

The forward points ‘grow’

However, sometimes
uniformly throughout and
customers need swap point
arithmetical proportionate for
for 2.5 months, 45 days etc.
the applicable date is arrived
as per requirement
at

Saturday, October 17, 2020 18

Inter Bank Rates

They are for large standard
amounts with standardized
due dates i.e. end of January,
end of February and so on.
However, in customer
transactions, the amounts There could be an export bill
are not only smaller & for for euro 12,345.67 getting
odd amounts, but the due realized on 10thJanuary or
date could be also a non 23rdFebruary and so on
standardized one

Thus the forward rate that is

available in the interbank
market [in the form of The broken period concept
forward points for February, becomes relevant in such
for March and so on] cannot situations.
be applied as such for
customer transactions
Exercise 3
On April 3, 2016, a Bank quotes the following
Spot exchange Rate (US $ 1) INR 66.2525 INR 67.5945
2 months’ swap points 70 90
3 months’ swap points 160 186
In a spot transaction, delivery is made after two days.

20
Solution
Swap Points for 2 months and 15 days
  Bid Ask

Swap Points for 2 months (a) 70 90

Swap Points for 3 months (b) 160 186

Swap Points for 30 days (c) = (b) – (a) 90 96

Swap Points for 15 days (d) = (c)/2 45 48

Swap Points for 2 months & 15 days (e) = (a) + (d) 115 138

21
Solution
Foreign Exchange Rates for 20th June 2016
  Bid Ask

Spot Rate (a) 66.2525 67.5945

Swap Points for 2 months & 15 days (b) 0.0115 0.0138

  66.2640 67.6083

22
solution
Annual Rate of Premium
  Bid Ask
Spot Rate (a) 66.2525 67.5945
Foreign Exchange Rates for 20th June 66.2640 67.6083
2016 (b)

Premium (c) 0.0115 0.0138

Total (d) = (a) + (b) 132.5165 135.2028
Average (d) / 2 66.2583 67.6014
0.0115 12 0.0138 12
Premium  × 100  × 100
66.2583 2.5 67.6014 2.5

= 0.0833% = 0.0980%

23
exercise
If the present interest rate for 6 months borrowings in India is 10% per annum and the corresponding rate in
USA is 3% per annum, and the US$ is selling in India at Rs 74.50/$.

Then :

(i) Will US $ be at a premium or at a discount in the Indian forward market?

(ii) Find out the expected 6 month forward rate for US$ in India.

(iii) Find out the rate of forward premium/discount

Inter bank rates

which are applicable to

Interbank exchange rates
transaction among banks
are wholesale rates

Forward rate that is

available in the interbank
market cannot be
applied as such for
customer transactions
25
INTER BANK MARKET

The forex interbank market is the wholesale currency arena

The interbank market is the global network utilized by financial institutions to trade
currencies between themselves.

Most interbank trading is proprietary, meaning that it takes place on behalf of the
banks' own accounts and also it is done by banks on behalf of large customers

Saturday, October 17, 2020 26

Inter bank rates
if the forward margin for forward rate can be
if the spot rate for US
two months is 10 paise calculated as Rs 72.10
Dollar is 72
[premium] per USD

Thus if the bank wishes to

keep a margin of say 3
and quote a rate of
paise, it will quote a rate
72.07 for an exporter
of Rs 72.13 for an
importer

27
Exchange rates
Exchange rate applicable
for transaction between
two banks/forex dealers
Rates rounded to 4
is known as Inter Bank
decimal in multiples of
Rate. Normally, inter-
0.0025.
bank rates are quoted
upto 4 digit after
decimal.

Saturday, October 17, 2020 28

5 Mts Break
Exchange margin
Inter bank rates

Bid rate Ask rate

Deduct margin from the buying Add margin to the selling

rate rate

Inter bank bid rate – margin = Inter bank ask rate + margin
merchant bid rate = merchant ask rate

Saturday, October 17, 2020 30

Example

Quotation for US$ in the inter-bank market is as follows:

Spot Rs 75.2900/2975 per US$
Exchange margin is 0.10%
Determine the spot merchant rates from the above information
Rates rounded to 4 decimal in multiples of 0.0025.

Saturday, October 17, 2020 31

Answer
BID ASK
Inter Bank Rate : USD 1= Rs 75.2900 Rs 75. 2975
Exchange margin is 0.10% Deduct margin Add margin

Margin .075290 .0752975

Merchant rates 75.2147 75.3728
Rates rounded to 4 decimal in 75.2150 75.3725
multiples of 0.0025.

Saturday, October 17, 2020 32

Example

Quotation for US$ in the inter-bank market is as follows:

Spot Rs 62.6800/ 62.7200
Exchange margin is 0.10%
Determine the spot merchant rates from the above information
Rates rounded to 4 decimal in multiples of 0.0025.

© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA Saturday, October 17, 2020 33

Answer
BID ASK
Inter Bank Rate : USD 1= Rs 62.6800 Rs 62. 7200
Exchange margin is 0.10% Deduct margin Add margin

Margin .06268 .06272

Merchant rates 62.6173 62.7827
Rates rounded to 4 decimal 62.6175 62.7825
in multiples of 0.0025.

Saturday, October 17, 2020 34

Class exercise

Quotation for US$ in the inter-bank market is as follows:

Spot Rs 73.5800/ 73.6200
Exchange margin is 0.12%
Determine the spot merchant rates from the above information
Rates rounded to 4 decimal in multiples of 0.0025.

© THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA Saturday, October 17, 2020 35

Answer
BID ASK
Inter Bank Rate : USD 1= Rs 73.5800 Rs 73. 6200
Exchange margin is 0.12% Deduct margin Add margin

Margin .088296. .088344

Merchant rates 73.4917 73.7083
Rates rounded to 4 decimal 73.4925 73.7100
in multiples of 0.0025.

Saturday, October 17, 2020 36

EXCHANGE RATE
DETERMINATION
EXCHANGE RATE DETERMINATION

The spot rate is the rate paid If the rate is quoted for
Exchange rates can be for for delivery within two delivery of foreign currency
spot or forward delivery. business days after the day at some future date, it is
the transaction takes place called the forward rate.

In the forward rate, the

exchange rate is established
at the time of the contract,
though payment and delivery
are not required until
maturity.
. Forward rates are usually
quoted for fixed periods of
30, 60, 90 or 180 days from
the day of the contract.

38
The Forward Market
A forward exchange rate
They agree to transact a
occurs when buyers and
specific amount of currency
sellers of currencies agree
at a specific rate at a
to deliver the currency at
specified future date
some future date.

and remains fixed for the

The forward exchange rate
contract period regardless of
is set and agreed by the
the fluctuations in the spot
parties
exchange rates in future.

39
The Forward Market

forward exchange contract The exchange rate is agreed

implies a forward delivery at today, though the actual
specified future date of one transactions of buying and
currency for a specified selling will take place on the
amount of another currency. specified date only.

40
Currency forward contract
A currency forward is a binding contract in the foreign exchange
market that locks in the exchange rate for the purchase or sale of
a currency on a future date.

A currency forward is essentially a customizable hedging tool that

does not involve an upfront margin payment.

The other major benefit of a currency forward is that its terms are
not standardized and can be tailored to a particular amount and for
any maturity or delivery period, unlike exchange-traded currency
futures.
41
Forward Contract
Banks offer their
Forward contracts are
important customers
usually offered by
forward contracts as
commercial banks
part of their business

It enables firms to
engage in
international trade
with limited exposure
to Foreign currency
risk
42
"Your time is limited, so don't waste
it living someone else's life. Don't be
trapped by dogma – which is living
with the results of other people's
thinking."
- -STEVE JOBS
 SPOT RATE on 26/08/2020 Bid/Ask: 74.217/ 74.227
Name Bid Ask BID ASK
USDINR 1M FWD 22.25 24.25 74.4395
74.4695
USDINR 2M FWD 47 49

USDINR 3M FWD 71.5 73.5

USDINR 4M FWD 98 100

USDINR 5M FWD 125.5 127

USDINR 6M FWD 151 152.5

USDINR 7M FWD 180 181.5

USDINR 8M FWD 217 218.5

USDINR 9M FWD 244 246

USDINR 10M FWD 272.75 274.25

USDINR 11M FWD 298.75 300.25

USDINR 1Y FWD 325.75 327.25

 SPOT RATE on 26/08/2020 Bid/Ask: 74.217/ 74.227
Name Bid Ask BID ASK
USDINR 1M FWD 22.25 24.25 74.4395
74.4695
USDINR 2M FWD 47 49 74.687
74.717
USDINR 3M FWD 71.5 73.5 74.932
74.962
USDINR 4M FWD 98 100 75.197
75.227
USDINR 5M FWD 125.5 127 75.472
75.497
USDINR 6M FWD 151 152.5 75.727
75.752
USDINR 7M FWD 180 181.5 76.017 76.042

USDINR 8M FWD 217 218.5 76.387 76.412

USDINR 9M FWD 244 246 76.657 76.687

USDINR 10M FWD 272.75 274.25 76.9445 76.9695

USDINR 11M FWD 298.75 300.25 77.2195 77.2295

USDINR 1Y FWD 325.75 327.25 77.4745 77.4995

 FUTURES NSE : 27-08-2020
Spot Price [ USDINR] : Rs 74.2500

Underlying Expiry Date LTP

USDINR 27-Aug-20 74.2875 
USDINR 28-Sep-20 74.4925 
USDINR 27-Oct-20 74.7350 
USDINR 25-Nov-20 74.9750 
USDINR 29-Dec-20 75.2400 
USDINR 27-Jan-21 75.5100 
 Underlying Expiry Date LTP
USDINR 24-Feb-21 75.7550 
USDINR 29-Mar-21 76.0050 
USDINR 28-Apr-21 76.2300 
USDINR 27-May-21 76.5475 
USDINR 28-Jun-21 76.9250 
USDINR 28-Jul-21 77.1300 

One year premium =77.13-74.25 = 2.88 = 2.88/74.25 =3.88%

 SPOT RATE on 26/08/2020 Bid/Ask: 74.217/ 74.227
Name Bid Ask BID ASK Futures
USDINR 1M FWD 22.25 24.25 74.4395
74.4695 74.2875 
USDINR 2M FWD 47 49 74.687
74.707 74.4925 
USDINR 3M FWD 71.5 73.5 74.932
74.952 74.7350 
USDINR 4M FWD 98 100 75.197
75.217 74.9750 
USDINR 5M FWD 125.5 127 75.472
75.497 75.2400 
USDINR 6M FWD 151 152.5 75.727
75.752 75.5100 
USDINR 7M FWD 180 181.5 76.017 76.042 75.7550 

USDINR 8M FWD 217 218.5 76.387 76.412 76.0050 

USDINR 9M FWD 244 246 76.657 76.687 76.2300 

USDINR 10M FWD 272.75 274.25 76.9445 76.9695 76.5475 

USDINR 11M FWD 298.75 300.25 77.2195 77.2295 76.9250 

USDINR 1Y FWD 325.75 327.25 77.4745 77.4995 77.1300 

MONTH OPEN CLOSE

Aug 74.90 74.27

Sep 74.27 74.32
Oct 74.32 73.69
Nov 73.69 73.62
Dec 73.62 73.83

FORECAST 2020
FORECAST 2021

Open Close
Jan 73.83 73.92
Feb 73.92 76.14
Mar 76.14 76.83
Apr 76.83 77.01
May 77.01 76.58
Jun 76.58 77.41
Jul 77.41 77.94
 FORECAST

73.16-
Aug 74.90 74.27 -0.8% -0.8%
75.38
73.21-
Sep 74.27 74.32 0.1% -0.8%
75.43
72.58-
Oct 74.32 73.69 -0.8% -1.6%
74.80
72.52-
Nov 73.69 73.62 -0.1% -1.7%
74.72
72.72-
Dec 73.62 73.83 0.3% -1.4%
74.94
 SPOT RATE on 26/08/2020 Bid/Ask: 74.217/ 74.227
Name BID ASK Futures Forecast
USDINR 1M FWD 74.4395 74.27
74.4695 74.2875 
USDINR 2M FWD 74.687 74.32
74.707 74.4925 
USDINR 3M FWD 74.932 73.69
74.952 74.7350 
USDINR 4M FWD 75.197 73.62
75.217 74.9750 
USDINR 5M FWD 75.472 73.83
75.497 75.2400 
USDINR 6M FWD 75.727 73.92
75.752 75.5100 
USDINR 7M FWD 76.017 76.042 75.7550  76.14

USDINR 8M FWD 76.387 76.412 76.0050  76.83

USDINR 9M FWD 76.657 76.687 76.2300  77.01

USDINR 10M FWD 76.9445 76.9695 76.5475  76.58

USDINR 11M FWD 77.2195 77.2295 76.9250  77.41

USDINR 1Y FWD 77.4745 77.4995 77.1300  77.94

Measuring Foreign Exchange Market
Activity: Average Electronic
Conversations Per Hour
Exhibit Global Currency Trading:
The Trading Day
Functions of the FOREX Market
The FOREX market is the mechanism by which participants
◦ Transfer purchasing power between countries
◦ This is necessary as international trade and capital transactions normally involve parties living in
countries with different national currencies
◦ Obtain or provides credit for international trade transactions
◦ Inventories in transit must be financed
◦ Minimize exposure to exchange rate risk
◦ FOREX markets provide instruments utilized in “hedging” or transferring risk to more willing
parties
Foreign Exchange Rates &
Quotations
Almost all European currencies, except two, are quoted the European way
◦ The Pound Sterling and the Euro are the exceptions
◦ Additionally, Australian and New Zealand dollars are also quoted in American terms
 Foreign Currency Quotations
Convention
Triangular Arbitrage