Concepts Relating To Foreign

Exchange
 Foreign Exchange Management
• Foreign Exchange Management is a great
dynamic task of MNC’s and those involves
themselves in international business.
• It is said, in Foreign Exchange dealings, long
term means, not longer than 10 minutes. That
is transactions have to be executed very
quickly in order to book gains or avoid loses.
 Macro Aspects of Foreign Exchange

• Foreign Exchange refers to stock of foreign

money an entity is having.
• Foreign Exchange as an action refers to
simultaneous transaction of one currency for
another.
 Currency codes for uniform identification
• In a global trade codes are used for different
currencies.
These currency codes are:
• USD = US Dollar, EUR= Euro, JPY= Japanese
Yen,
• GBP= British Pond, CHF= Swiss Franc,
• AUD= Australian Dollar, NZD= New Zealand
Dollar, INR= Indian Rupee.
• Exchange Rate : Exchange Rate is the value of
one currency expressed in terms of another.
• The exchange rate between two currencies
specifies how much one currency is worth in
terms of the other.
• E.g. an exchange rate of 63 rupees to the
United States Dollar means that a sum of Rs
63 is worth the same a USD 1.
 Dynamics Of Foreign Exchange rates :
• Forex rates dynamically change, round the
day, round the week, round the year.
• It is the market without holidays.
• As Forex rates change, the value of
transactions change resulting in changes in
expected revenues or gains, expenses or
losses, and net worth.
• Indian Importers are pretty happy as US Dollar
is cheaper and that the imports are cheaper.
Same time exporters get the hit.
• If the US dollar is costly exporters will going to
be get benefited.
• Hence ,there is a need of deep analyses and
timely action and reaction as signals or signs.
 Foreign Exchange Market

• According to H.E. Evitt, “ That section of

economic science which deals with the means
and methodology by which rights to wealth in
one country’s currency are converted into
rights to wealth in terms of another country’s
currency.”
• Foreign Exchange is the process or system of
converting one national currency into another,
and of transferring money from one country
to another.
• The Foreign Exchange Regulation Act,
1973( FERA) states : Foreign Exchange as
foreign currency includes all deposits, and
balance payable in foreign currency and drafts,
traveller’s cheque expressed in Indian
currency, but payable in any foreign currency.
 Functions of Foreign Exchange Market
• The Foreign Exchange market is a market in
which foreign transactions take place.
• It is a market in which national currencies are
bought and sold against one another.

• A Foreign Exchange market perform following

important functions:
 Transfer of Purchasing Power

• The primary function of a Foreign Exchange

market is the transfer of purchasing power
from one country to another from one
currency to another.
• This exchange plays a vital role in facilitating
international trade and capital movements.
 Provision of Credit

• For international trade depends to a great

extent on credit facilities.
• Exporter may get pre-shipment and post-
shipment credit.
• The Dollar- Euro market has emerged as a
major international credit market.
• Pre -shipment Finance is issued by a financial
institution when the seller want the payment of
the gods before shipment.
• The main objective behind shipment finance is
to enable exporter to :
• - Procure raw materials.
• - Carry out manufacturing process.
• - provide a secure warehouse for goods and
raw materials.
• - Process the goods.
• - Ship the goods to the buyer.
 Provisions For Hedging Facilities

• Another important function of Foreign

Exchange market is to provide hedging
facilities .
• Hedging refers to covering of exports risks,
and it provides a mechanism to exporters and
importers to guard themselves against losses
arising from fluctuations in exchange rates.
Methods of Affecting International Payments

• Following methods to affect international

payments:
Telegraphic Transfer : A sum can be
transferred from a bank in one county to bank
in another country by cable or telex.
• Thus, quickest method of transferring funds
from one centre to another.
• Bank Drafts and Cheques : International
payments may be made by means of cheques
and bank drafts. Bank drafts is widely used.
• A bank draft is drawn on a bank instead of a
customer’s personal account.
• Its value is depend on the standing of a bank
which is widely known, and not on the credit-
worthiness of a firm or individual known only
a limited number of people.
• Foreign Bill Of Exchange : A bill of exchange is
an unconditional order in writing, addressed
by one person to another, requiring the
person to whom it is addressed to pay a
certain sum on demand or on a specified
future date.
 Spot, Forward Exchanges :
• The term spot exchanges refers to the class of
foreign exchange transactions requires the
immediate delivery.
• In practice the settlement takes place within two
days in most markets.
• The rate of exchange effective for the spot
transactions known as ‘spot rate’ and the market
for such transactions as the ‘spot market’
• The forward transaction is an agreement
between two parties, requiring the delivery at
some specified future date of a specified
amount of foreign currency by one of the
parties, against payment in domestic currency
by the other party, at the price agreed upon in
the agreement.
Types of Foreign Exchange
Market
 Inter- Bank Market
• Dealings between banks who are authorised
dealers in foreign exchange used to be large in
size.
• About 700 banks worldwide act as market
makers in ‘Foreign Exchange’.
• International commercial banks communicate
with one another instantly and securely with
tools as:
• A) SWIFT : Society for Worldwide Interbank Financial
Telecommunications.

• B) CHIPS : Clearing House Inter-bank Payment System.

• C) ECHO : Exchange Clearing House Limited, the first

global clearing house for settling inter- bank FOREX
transactions.
• D) Merchant Deals Market : Dealing Between
authorized dealers and others such as
business entities.
• It is also known as client market or retail
market.
• E) Wholesale Market : In this sort of Foreign
Exchange market , Large Scale foreign
exchange dealings especially interbank deals
and deals involving large corporations take
place.
• F) Retail Market : Small foreign exchange deals
involving less than e.g. $ 10000.

• G) Over the counter market : In over the

counter the dealers directly settle accounts.
• No clearing house is involved.
• H) foreign exchange dealings are done in an
exchange and settlements are through
clearing house of the exchange.
• I) Hedging Market : foreign exchange deals
that are done to cover risk of exposure in
currencies.
• J ) Spot Market : Spot market is market for
delivery normally two days after the deal.

• Suppose there is a buying on 10-10-2015

about $ 100,000 in the spot market . It is to be
delivered on 12-10-2015.
• K) Forward Market : Forward market is a
market for future delivery, but rate or price is
determined .
• Forward is used by importers to buy forward
foreign exchange needed in future and by
exporters to sell forward the foreign exchange
receivable in future.
• Speculators use forward market to speculate .
• If speculators expect a particular currency to
depreciate they will sell forward the currency .
• If their expectation is appreciation of a
currency , they will buy forward the currency.
L ) Arbitrage Market : Simultaneous buying ( or
selling) in one market and selling ( or Buying)
in another market to profit out of price
differences is arbitrage.
• M) Option Market :
• An options contract involves one person
known as option writer or option seller giving
another called option buyer the right to buy
( in call option ) or right to sell ( in put option)
at a specified price per unit called the strike on
or before a certain day .
• N ) Future market : Future contract is a
market for future delivery, but rate or price is
predetermined.
• Well known future markets are :
• LIFFE : London International Financial Future
Exchange.
• TIFFE : Tokyo International Financial Future
Exchange.
SIFFE : Singapore International Financial Future
Exchange., etc.
Types of Foreign Exchange Rates
 i) Direct and Indirect Rates

• Direct rate expresses units of home currency

per unit of foreign currency.
• In India, Rs./$ is the style of giving quotation.
This is direct quotation , as numerator
currency is domestic.
• This was adopted first time in UK.
• The given rate units of the numerator
currency exchange for 1 unit of the
denominator currency.
 ii) Bid and Ask Rates

• When somebody call for a Foreign exchange

quotation from a Foreign exchange dealer , he
gives two rates, : the first rate one at which the
dealers purchases and the second one at which
he sells .
• E.g. spot rates: Pond/ $ = 0.48158/0.48350.
• The dealer is prepared to buy $ at pond 0.48158
per $ and sell $ at Pond 0.48350 per $.
• The buying rate is called ‘bid’ rate and the
selling rate is called ‘offer’ or ask rate.
• The buying rate is less than the selling rate.
 iii) Spot and Forward Rates

• Spot market in Foreign exchange refers to

buying and selling Foreign exchange , with
payments and delivery taking place normally
in 2 days after.
• Spot with same day settlement is called ‘cash’
or ready market and next day settlement is
called ‘ tom market’, the term “ tom” means
tomorrow.
• Forward market in foreign market refers to
transactions which are performed at a future
specified period, but the rate are settled at the
time the contracts are made.
• The essence of forward transaction is that a
trade of exchange is fixed now to ward off
market uncertainties.
Exchange Rates Regimes
• An exchange – rate regime is the way an
authority manages its currency in relation to
other currencies and the foreign exchange
market.
• It is closely related to the monetary policy, and
depend generally on same factors.
• Floating rates are the most common exchange
rate regime today.
• For Example, The Dollar, Euro, Yen, and British
Pound all are floating currencies.
• However, since central banks frequently
intervene to avoid excessive appreciation or
depreciation these regimes are often called
‘Managed Float’.
• Central bank itself indulge in sell and purchase
activities to manage the price of the currency.
• All major economies from developed
countries allow the value of their currencies to
float under the market forces.
• Floating rates are preferable if a country’s
economy is strong enough to withstand the
constant change in the value of its currency.
• If a depreciation occurs , the relative price of
exports in overseas markets falls, making
exports more competitive, while the price of
imports in the home market goes up i.e.
making imports appear more expensive.
• The second key advantage of ‘floating
exchange rates’ is that it gives the government
or monetary authority a flexibility in
determining interest rates.
• This is because interest rates do not have to
be set to keep the value of the exchange rate
with in pre determined bands.
 Pegged Exchange Rates

• Pegged foreign exchange rates are

compromise between floating rates and fixed
rates.
• Under Pegged rates , a country allows its
currency to fluctuate within a fixed band,
around a periodically adjusted central value.
• Pegged rates are more suitable for
transitioning developing economy,
comparatively small economy.
• They allow both stability and a certain degree
of market adjustments .
• Countries hope that economic improvements
can bring in the foreign currency reserves,
required to keep the stated rates.
• When an economy fails to produce the
expected results, such a system cannot
maintain the fixed value for long.
• When a country has pegged currency it
typically means that the country wants to
maintain a steady exchange rate to build
stable trade relations.
• If a country’s currency constantly fluctuating
relative to major currencies, it discourages
potential trade partners who are worried
about unfavourable changes in exchanges.
• For Example : Oil rich countries like Saudi
Arabia, Venezuela have their currencies
pegged to the US Dollar as the US is major
importer.
• As Dollar price is not prone to sudden
fluctuations.
 Fixed Exchange Rate
• Fixed rates are those that have direct
convertibility towards another currency.
• The smaller economies of developing
countries use fixed foreign exchange rates to
promote trade and attract foreign
investments.
• For example, by fixing its currency against the
currencies of other countries, a country keep
exports prices affordable to foreign buyers and
accumulates trade surplus over time.
• Fixed currency rates also allow a country to
assure foreign investors of the stable value of
their investments in the country.
 Difference between fix and floating exchange rates :-

. A fixed exchange rate denotes a nominal

exchange rate that is set firmly by the
monetary authority of the country with the
respect to a foreign currency.
• On the other hand floating exchange rate is
determined in foreign exchange market
depending upon demand and supply of the
currency , and it generally fluctuates
constantly.
The Mint Parity Theory
FACTORS Affecting Exchange Rate
 a.)GDP of the Countries

• Exchange rate trend must reflect the trend in

the economic growth of the countries and
that GDP size, the growth in that, influence
exchange rate.
• The more healthy and robust a country’s
economy, the better its currency will perform.
b.) Government budget deficit or surpluses

• The market usually reacts negatively to

widening government budget deficits, and
positively to narrowing budget deficits.
• The impact is reflected in the value of a
country’s currency.
 c.) Balance of trade levels and Trends

• The trade flow between countries illustrates

the demand for goods and services, which in
turns indicates demand for a country’s
currency to conduct trade.
• Surpluses and deficits in trade of goods and
services reflect the competitiveness of a
nation’s economy.
• For example, trade deficits may have negative
impact on a nation’s currency.
 d.) Inflation levels and Trends

• A currency will lose value if there is a high

level of inflation in the country or if inflation
levels are perceived to be rising.
• The reason behind that is because inflation
erodes purchasing power, thus demand for
that particular currency will be less.
 e.) Political conditions
• Internal, regional and international political
conditions and events can have a profound
effect on currency markets.
• For instance, political instability can have a
negative impact on a nation’s economy.
• Also, events in one country in a region may
spur positive or negative interest in a
neighbouring country and, in the process,
affect its currency.
 f.) Market Psychology

• Market psychology influences the foreign

exchange market in a variety of ways.
• Unsettling international events can lead to a
think to the investors for seeking a “ safe
haven” or place where they can invest safely.
• There is tendency for the price of a currency
to reflect the impact of a particular action
before it occurs. This may be referred to as a
market being “ oversold” or “overbought”
situations.
History of Indian Rupee
Exchange Rate
• The current currency of India “ Rupee” derives
its origin from the word RUP which means
Silver.

• The derivation term rupee was used to

indicate the coins issued during 15th century.
• The original Rupee was a silver coin weighing
175 grains, about 11.34 grams., which was used
in India for along period of time, that is even
during British India.

• Formerly the rupee was divided into 16 annas,

64 paise, or 192 pies.
• The earliest generation of Indian currency was
in Silver.
 Paper Currency
• The generation of paper rupees was initialized
by the Bank of Hindustan and General bank of
Bengal and Bihar.
• Later in the “ Paper Currency Act of 1861, the
Government had the monopoly of note issue
throughout the vast expanse of India.
• The Reserve Bank Of India was established in
the 1935, with its central office at Calcutta.
• During the initial course of its operation, it had
to continue issuing the Government notes
until it was ready with its own series of Notes.
• The Reserve Bank Of India issued the first five
rupee note bearing the portrait of George VI
in 1938.
• This was followed by Rs 10 in February, Rs 100
in March, Rs 1000and 10000 in June 1938 .
• The first The Reserve Bank issues were signed
by the second Governor, Sir James Taylor.
• In 1957, the decimalization system developed,
where a Rupee was divided into 100 Naya
Paisa, which later was termed as simple “
Paise”.
 A summary of Decimalisation of the rupee:
• From 1835 , Currency system, 1 Rupee= 16
annas= 64 paise= 192 pies.
• From 1 April 1957, 1 rupee = 100 naya paise.
• From 1 June 1964, 1 rupee =100 paise.
• The Indian Coinage Act was amended in
September 1955 for the adoption of a decimal
system for coinage.
• The Act came into force with effect from 1
April 1957.
• It was divided into 100 paisa instead of 16
annas.
 Early Paper Issues

• Note issued by the Bank of Bengal can be

categorised in the following series :
• Unifaced Series : The early notes of the Bank
of Bengal were printed only on one side and in
denominations of Rs. 100, Rs 250, Rs500.etc.
 British India Issues:
• The paper currency Act of 1861 gave the
Government the monopoly of note issue
throughout th British India.
• The management of paper currency was
entrusted by the ‘Account General and
Controller of currency’.
 Victoria Portrait Series

• The first set of British India notes were the

‘Victoria Portrait’ series issued in
denominations of 10, 20, 50, 100, AND 1000.
 George V Series

• A series carrying the portrait of George V were

introduced in 1923, these notes were issued
in denominations of Rs 1, 2&1/2 , 5, 10 50,
100, 1000 and 10000.
 Reserve Bank issues during British India

• The Reserve Bank of India was formally

inaugurated on Monday , April1, 1935, with its
central office in Calcutta.
• Section 22 of the RBI Act, 1934 empowered it
to continue issuing Government of India
notes.
• .
• The bank issued the first five rupee note with
portrait of George VI in 1938.
• The George VI series continued till 1947.
 Republic Of India Issues

• After Independence of India , the government

brought out the new design Rupee. 1 note in
1949.
• In 1953, Hindi was displayed prominently on
the new notes.
• High denomination notes , like 10000 notes
was demonetised in 1978.
• The Mahatma Gandhi series was introduced in
1996.
• New features included a changed watermark,
windowed security thread , intaglio features
for the visually handicapped.
Year Exchange rates- Rupees per US $
1925 0.10
1947 1
1952 5
1975 10.409
1985 12.369
1995 32.427
2005 48.336
2008 42.51
2013 (May) 56.25
2014( July) 60.082
2015(September) 66.219