Forex Exchange Operation- useful for CAIIB and Certificate Course on Foreign Exchange

 

Forex Exchange Operation:

 

What is Forex Exchange?

Forex Exchange is used to denote Foreign Currency i.e. Currency of any country as well as the exchange of currency of one country into that of another.

Section 2 of Foreign Exchange Management Act-1999 defines the foreign exchange as:

1.  All deposits, credits and balance payable in foreign currency and any drafts, traveler’s cheque, letter of credit and bill of exchange expressed or drawn in Indian currency and payable in foreign currency.

2.    Any instrument payable at the option of the drawee or holder, thereof or any other party thereto, either in Indian currency or in foreign currency, or partly in one and partly in other.

 

Foreign Exchange: $-USD, ¥-JPY €-Euro, £-Sterling, AUD, CAD etc.

 

Forex Market:

Forex Market is communication-based market, with no boundaries and operates round the clock.  It comprises a large spectrum of market participants, which include individuals, business entities, commercial bank, investment bank, etc.

 

Features of forex market:

Ø  A 24-hour market

Ø  An over-the-counter market (OTC)

Ø  A global market with no barriers/ no specific location.

Ø  A market that supports large capital and trade flows.

Ø  Highly liquid market

Ø  High fluctuation currency rates (every 4 seconds)

Ø  Settlement effected by time zone factor

Ø  Market effected by government policies & controls.

 

Exchange Rate:

 The price or the ratio or the unit at which one currency is exchanged for another currency:

1 USD= 72.49 INR

 

Two-way quotes or buy-sell.  1 USD= 72.49/51 INR.

 

Types of quoting exchange rate.

 

Sl No	Types of Rate	Trade	Contract date	Settlement Day
1	Today (Cash or Ready	Cash or ready or TOD basis	Today (T)	Same day
2	Tomorrow (TOM)	TOM Basis	Today (T)	Next working day (T+1)
3	SPOT	SPOT Basis	Today (T)	Second working day(T+2)
4	Forward	Forward Basis	Today (T)	Any day after spot (>T+2)

 

In the forex market, all rates quoted are generally SPOT Rates.

The volume, depth and volatility of the spot market is higher due to large participation of market players in the spot trade.

 

Forward Rate- Forward Rates are derived from spot rate, and are the function of sot rate, forward premium/discount of the currency being quoted.

 

Forward Rate= Spot Rate+ Premium or Spot Rate-Discount.

Note: (if you are buying, margin would be subtracted or if purchasing margin would be added)

  

Direct & Indirect quotes:

 

Direct Quotes: Under direct quote, local currency is variable.

 1 USD= 72.49 INR.

Indirect Quotes: under indirect quotes, the local currency remain fixed.

Rs.100= 1.38 USD

 

Note: In case of GBP, Euro, AUD, and NZD, the currencies are quoted as indirect rate.

1 GBP=1.38 USD

 

Bid and Offered Rate:

The buying rate is referred as Bid Rate and selling rate is referred as Offered Rate.

1 USD=72.49/51 INR

The quoting bank is bidding (buying) for USD at 72.49 and is offering ( selling) the USD at 72.51.

Cross Rate:

Where rate for a particular currency pair is not directly available, the price for the said currency pair is then obtained indirectly with the help of cross rate mechanism.

If,

USD/INR= 72.49/51 (1 USD= 72.49/51 INR)

GBP/USD=1.38/40(1 GBP=1.38/40 USD)

 

What is GBP/INR=?

GBP/USD*USD/INR=72.49*1.38=100.04

                                  72.51*1.40=101.51

GBP/INR=100.04/51

 

Fixed Rate and Floating Rate:

 

The fixed exchange rate is the official rate set by the monetary authorities for one or more currencies. It is usually pegged to one or more currencies. Under floating exchange rate, the value of the currency is decided by supply and demand factors for a particular currency.

 

Per cent and Per Mille.

A percentage is a proportion per hundred while per mille means per thousand.

 

EUR/USD=1.1910/20

Value Date:

This is the term used to define the date on which payment of funds or an entry to an account becomes actually effective and/or subjected to interest.

Factors Determining Exchange Rate:

 

(a)  Fundamental Reasons

 

Ø  Balance of Payments-

Ø  Economic Growth Rate

Ø  Fiscal Policy

Ø  Monetary Policy

Ø  Interest Rates

Ø  Political issues

 

(b)  Technical Reasons

 

Ø  Capital tends to move from lower yielding to higher yielding currencies, and results is movement in exchange rate.

 

(c)  Speculation

 

Ø  Speculative deals provide depth & liquidity to the market and at times act as a cushion too if the views do not lead to a contagious effect.