Foreign Exchange Market

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FOREIGN EXCHANGE MARKET MEANING: It is the mechanism for exchanging one currency for another. A means to reduce exposure to the risk to fluctuating exchange rates. It is by far the largest market in the world, interms of cash value traded &includes trading b/w large banks, central banks, currency speculators, multinational corporations, govt and other financial markets & institutions.





The foreign exchange market is unique because of::

The foreign exchange market is unique because of: Its trading volume. The extreme liquidity of the market. The large number of &variety of, traders in the market. Its geographical dispersion. Its long trading hours-24hrs a day(except on weekends) The variety of factors that affects exchange rate.


FOREIGN EXCHANGE IN INDIA Early years post independence 1947-1977: Bretton Woods system Devaluation in 1966 & 1971 Eventual breakdown of Bretton Woods system


FOREIGN EXCHANGE IN INDIA Formative years 1978-1992: Intra-day trading Daily announcement by the RBI High levels of regulations Effects of FERA

Characteristics: :

Characteristics: The world wide volume of foreign exchange trading is enormous & it has ballooned in recent years. New technologies, such as internet links are used among the major foreign exchange trading centers(London, New York, Tokyo, Frank furt & Singapore) The integration of financial centers implies that there can be no significant arbitrage. -the process of buying currency at cheap and sell it high price.


FOREIGN EXCHANGE IN INDIA Post Liberalization Era 1992- present: Market determined exchange rate Restrictions on current A/c transactions were relaxed Internal Technical Group on FOREX Market(2005) set up by RBI made further recommendations for Liberalization

Functions of Foreign exchange market::

Functions of Foreign exchange market: Transfer of purchasing power. Financing of Inventory in transit. Hedging facilities. Currency conversions. Reducing foreign exchange risks: the risk exist that the exchange values of national currency may fluctuate i.e. Transaction exposure


MARKET PARTICIPANTS Banks The interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. A large bank may trade billions of dollars daily. Commercial companies These are companies seeking foreign exchange to pay for goods or services. They trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates.


MARKET PARTICIPANTS Central Banks National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, interest rates and often have official or unofficial target rates for their currencies. Hedge funds as speculators 70% to 90% of foreign exchange transaction are speculative


MARKET PARTICIPANTS Investment management firms typically manage large accounts on behalf of customers such as pension funds and endowments use the foreign exchange market to facilitate transactions in foreign securities Retail foreign exchange brokers They participate indirectly through brokers or banks Non-bank foreign exchange companies Companies offer currency exchange and international payments to private individuals and companies Money transfer/remittance companies They perform high-volume low-value transfers generally by economic migrants back to their home country.


SIX TYPES OF MARKETS Spot Forward Future Swap Option Exchange traded funds


SPOT MARKET Its given by all major newspapers. Major currencies have 4 different rates, Spot price, 2) 30 days, 3) 90 days and 4) 180 days Bid-Ask Spread is used to calculate the fee charged by bank in terms of large transaction. Bid = The price at which the bank is willing to buy Ask = The price it will sell the currency Percentage Spread Formula (PS) is used,


FORWARD MARKET “An agreement between a bank and a customer to deliver a specified amount of currency against another currency at a specified future date and at a fixed exchange rate”. The main purpose of forward market is Hedging that is the act of reducing exchange rate risk. Two Methods involved in Forward market are: Outright Rate : Quoted to commercial customers. Swap Rate : Quoted in the interbank market as a discount or premium.


FORWARD MARKET Calculating the forward Premium/Discount: = F-S x 12 x 100 S n where F = The forward rate of exchange S = The spot rate of exchange n = The number of months in the forward contract


Future Market Exchange traded forward transaction. Standard contract size and maturity date. Interest inclusive and usually for 3 months. Swap Market Most prevalent market. Two parties exchange currencies for a particular period and reverse the same transaction at a pre decided latter date.

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Option Market It is a derivative where the owner has the right but not the obligation to exchange money from one currency to another at a pre agreed rate and date. It is the largest and most liquid market. Exchange traded funds They are open end investment companies that can be traded anytime throughout the course of the day.

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