FOREIGN EXCHANGE MARKET

Chapter 1: INTRODUCTION Foreign Exchange Market Overview

Globally, operatio ! i the "orei# e$%ha #e &ar'et !tarte( i a &a)or *ay a"ter the brea'(o* o" the +retto ,oo(! !y!te& i 1-.1, *hi%h al!o &ar'e( the be#i i # o" "loati # e$%ha #e rate re#i&e! i !e/eral %o0 trie!1 O/er the year!, the "orei# e$%ha #e &ar'et ha! e&er#e( a! the lar#e!t &ar'et i the *orl(1 The (e%a(e o" the 1--2! *it e!!e( a per%eptible poli%y !hi"t i &a y e&er#i # &ar'et! to*ar(! reorie tatio o" their "i a %ial &ar'et! i ter&! o" e* pro(0%t! a ( i !tr0&e t!, (e/elop&e t o" i !tit0tio al a ( &ar'et i "ra!tr0%t0re a ( reali# &e t o" re#0latory !tr0%t0re %o !i!te t *ith the liberali3e( operatio al "ra&e*or'1 The %ha #i # %o to0r! *ere &irrore( i a rapi( e$pa !io o" "orei# e$%ha #e &ar'et i ter&! o" parti%ipa t!, tra !a%tio /ol0&e!, (e%li e i tra !a%tio %o!t! a ( &ore e""i%ie t &e%ha i!&! o" ri!' tra !"er1 The ori#i o" the "orei# e$%ha #e &ar'et i I (ia %o0l( be tra%e( to the year 1-.4 *he ba '! i I (ia *ere per&itte( to 0 (erta'e i tra5(ay tra(e i "orei# e$%ha #e1 Ho*e/er, it *a! i the 1--2! that the I (ia "orei# e$%ha #e &ar'et *it e!!e( "ar rea%hi # %ha #e! alo # *ith the !hi"t! i the %0rre %y re#i&e i I (ia1 The e$%ha #e rate o" the r0pee, that *a! pe##e( earlier *a! "loate( partially i Mar%h 1--6 a ( "0lly i Mar%h 1--7 "ollo*i # the re%o&&e (atio ! o" the Report o" the Hi#h 8e/el Co&&ittee o +ala %e o" 9ay&e t! :Chair&a : Dr1C1 Ra #ara)a ;1 The 0 i"i%atio o" the e$%ha #e rate *a! i !tr0&e tal i (e/elopi # a &ar'et5(eter&i e( e$%ha #e rate o" the r0pee a ( a i&porta t !tep i the pro#re!! to*ar(! %0rre t a%%o0 t %o /ertibility, *hi%h *a! a%hie/e( i A0#0!t 1--<1 A "0rther i&pet0! to the (e/elop&e t o" the "orei# e$%ha #e &ar'et i I (ia *a! pro/i(e( *ith the !etti # 0p o" a E$pert Gro0p o Forei# E$%ha #e Mar'et! i I (ia :Chair&a : =hri O191 =o(ha i;, *hi%h !0b&itte( it! report i >0 e 1--?1 The Gro0p &a(e !e/eral re%o&&e (atio ! "or (eepe i # a ( *i(e i # o" the I (ia "orei# e$%ha #e &ar'et1 Co !e@0e tly, be#i i # "ro& >a 0ary 1--A, *i(e5ra #i # re"or&! ha/e bee 0 (erta'e i the I (ia "orei# e$%ha #e &ar'et1 A"ter al&o!t a (e%a(e, a I ter al Te%h i%al Gro0p o the Forei# E$%ha #e Mar'et *a! %o !tit0te( to 0 (erta'e a %o&prehe !i/e re/ie* o" the &ea!0re! i itiate( by the Re!er/e +a ' a ( i(e ti"y area! "or "0rther liberali3atio or rela$atio o" re!tri%tio ! i a &e(i0&5ter& "ra&e*or'1 The &o&e to0! (e/elop&e t! o/er the pa!t "e* year! are re"le%te( i the e ha %e( ri!'5beari # %apa%ity o" ba '! alo # *ith ri!i # "orei# e$%ha #e tra(i # /ol0&e! a ( "i er &ar#i !1 The "orei# e$%ha #e &ar'et ha! a%@0ire( (epth 1The %o (itio ! i the "orei# e$%ha #e &ar'et ha/e al!o #e erally re&ai e( or(erly1 ,hile it i! ot po!!ible "or a y %o0 try to re&ai %o&pletely 0 a""e%te( by (e/elop&e t! i i ter atio al &ar'et!, I (ia *a! able to 'eep the !pillo/er e""e%t o" the A!ia %ri!i! to a &i i&0& thro0#h %o !ta t &o itori # a ( ti&ely a%tio , i %l0(i # re%o0r!e to !tro # &o etary &ea!0re!, *he e%e!!ary, to pre/e t e&er#e %e o" !el" "0l"illi # !pe%0lati/e a%ti/itie! I to(ayB! *orl( o e%o o&y i! !el" !0""i%ie t, !o there i! ee( "or e$%ha #e o" #oo(! a ( !er/i%e! a&o #!t the (i""ere t %o0 trie!1 =o i thi! #lobal /illa#e, 0 li'e i the pri&iti/e a#e the e$%ha #e o" #oo(! a ( !er/i%e! i! o lo #er %arrie( o0t o barter ba!i!1 E/ery !o/erei# %o0 try i the *orl( ha! a %0rre %y that i! le#al te (er i it! territory a ( thi! %0rre %y (oe! ot a%t a! &o ey o0t!i(e it! bo0 (arie!1 =o *he e/er a %o0 try b0y! or !ell! #oo(! a ( !er/i%e! "ro& or to 1C9a#e

FOREIGN EXCHANGE MARKET a other %o0 try, the re!i(e t! o" t*o %o0 trie! ha/e to e$%ha #e %0rre %ie!1 =o *e %a i&a#i e that i" all %o0 trie! ha/e the !a&e %0rre %y the there i! o ee( "or "orei# e$%ha #e1

Need for Foreign Exchange:

Co !i(er a %a!e, I (ia %o&pa y e$port! %otto "abri%! to U=A a ( i /oi%e! the #oo(! i U= (ollar1 The A&eri%a i&porter *ill pay the a&o0 t i U= (ollar, a! the !a&e i! hi! ho&e %0rre %y1 Ho*e/er the I (ia e$porter re@0ire! r0pee! &ea ! hi! ho&e %0rre %y "or pro%0ri # ra* &aterial! a ( "or pay&e t to the labor %har#e! et%1 Th0! he *o0l( ee( e$%ha #i # U= (ollar "or r0pee1 I" the I (ia e$porter! i /oi%e their #oo(! i r0pee!, the i&porter i U=A *ill #et hi! (ollar %o /erte( i r0pee a ( pay the e$porter1 Fro& the abo/e e$a&ple *e %a i "er that i %a!e #oo(! are bo0#ht or !ol( o0t!i(e the %o0 try, e$%ha #e o" %0rre %y i! e%e!!ary1 =o&eti&e! it al!o happe ! that the tra !a%tio ! bet*ee t*o %o0 trie! *ill be !ettle( i the %0rre %y o" thir( %o0 try1

About foreign exchange market:

9arti%0larly "or "orei# e$%ha #e &ar'et there i! o &ar'et pla%e %alle( the "orei# e$%ha #e &ar'et1 It i! &e%ha i!& thro0#h *hi%h o e %o0 tryB! %0rre %y %a be e$%ha #e i1e1 bo0#ht or !ol( "or the %0rre %y o" a other %o0 try1 The "orei# e$%ha #e &ar'et (oe! ot ha/e a y #eo#raphi% lo%atio 1 Forei# e$%ha #e &ar'et i! (e!%ribe( a! a OTC :o/er the %o0 ter; &ar'et a! there i! o phy!i%al pla%e *here the parti%ipa t &eet! to e$e%0te the (eal!, a! *e !ee i the %a!e o" !to%' e$%ha #e1 The lar#e!t "orei# e$%ha #e &ar'et i! i 8o (o , "ollo*e( by the Ne* Dor', To'yo, E0ri%h a ( Fra '"0rt1 The &ar'et! are !it0ate( thro0#ho0t the (i""ere t ti&e 3o e o" the #lobe i !0%h a *ay that o e &ar'et i! %lo!i # the other i! be#i i # it! operatio 1 There"ore it i! !tate( that "orei# e$%ha #e &ar'et i! "0 %tio i # thro0#ho0t 6< ho0r! a (ay1 I &o!t &ar'et U= (ollar i! the /ehi%le %0rre %y, /i31, the %0rre %y !0e( to (o&i ate i ter atio al tra !a%tio 1 I I (ia, "orei# e$%ha #e ha! bee #i/e a !tat0tory (e"i itio 1 =e%tio 6 :b; o" "orei# e$%ha #e re#0latio ACT, 1-.7 !tate!: Forei# e$%ha #e &ea ! "orei# %0rre %y a ( i %l0(e!: All deposits, credits and balance payable in any foreign currency and any draft, travelers cheques, letter of credit and bills of exchange. Expressed or drawn in India currency but payable in any foreign currency. A y i !tr0&e t payable, at the optio o" (ra*ee or hol(er thereo" or a y other party thereto, either i I (ia %0rre %y or i "orei# %0rre %y or partly i o e a ( partly i the other1 I or(er to pro/i(e "a%ilitie! to &e&ber! o" the p0bli% a ( "orei# er! /i!iti # I (ia, "or e$%ha #e o" "orei# %0rre %y i to I (ia %0rre %y a ( /i%e5/er!a R+I ha! #ra te( to /ario0! "ir&! a ( i (i/i(0al!, li%e !e to 0 (erta'e &o ey5%ha #i # b0!i e!! at !ea!Fairport a ( to0ri!& pla%e o" to0ri!t i tere!t i I (ia1 +e!i(e! %ertai a0thori3e( (ealer! i "orei# e$%ha #e :ba '!; ha/e al!o bee per&itte( to ope e$%ha #e b0rea0!1 Follo*i # are the &a)or bi"0r%atio !: Full fledge moneychangers G they are the "ir&! a ( i (i/i(0al! *ho ha/e bee a0thori3e( to ta'e both, p0r%ha!e a ( !ale tra !a%tio *ith the p0bli%1 Restricted moneychanger G they are !hop!, e&poria a ( hotel! et%1 that ha/e bee a0thori3e( o ly to p0r%ha!e "orei# %0rre %y to*ar(! %o!t o" #oo(! !0pplie( or !er/i%e! re (ere( by the& or "or %o /er!io i to r0pee!1 Authori ed dealers G they are o e *ho %a 0 (erta'e all type! o" "orei# e$%ha #e tra !a%tio 1 +a '! are o ly the a0thori3e( (ealer!1 The o ly e$%eptio ! are Tho&a! %oo', *e!ter 0 io , 6C9a#e

FOREIGN EXCHANGE MARKET UAE e$%ha #e *hi%h tho0#h, a ( ot a ba ' i! a AD1 E/e a&o # the ba '! R+I ha! %ate#ori3e( the& a! "ollo*!: +ra %h A G They are the bra %he! that ha/e No!tro a ( Ho!tro a%%o0 t1 +ra %h + G The bra %h that %a (eal i all other tra !a%tio b0t (o ot &ai tai No!tro a ( Ho!tro aF%B! "all 0 (er thi! %ate#ory1 For I (ia *e %a %o %l0(e that "orei# e$%ha #e re"er! to "orei# &o ey, *hi%h i %l0(e! ote!, %he@0e!, bill! o" e$%ha #e, ba ' bala %e a ( (epo!it! i "orei# %0rre %ie!1

Foreign Exchange Market: An Assessment

The %o ti 0o0! i&pro/e&e t i &ar'et i "ra!tr0%t0re ha! ha( it! i&pa%t i ter&! o" e ha %e( (epth, li@0i(ity a ( e""i%ie %y o" the "orei# e$%ha #e &ar'et1 The t0r o/er i the I (ia "orei# e$%ha #e &ar'et ha! #ro* !i# i"i%a tly i both the !pot a ( (eri/ati/e! !e#&e t! i the re%e t pa!t1 Alo # *ith the i %rea!e i o !hore t0r o/er, a%ti/ity i the o""!hore &ar'et ha! al!o a!!0&e( i&porta %e1 ,ith the #ra(0al ope i # 0p o" the %apital a%%o0 t, the pro%e!! o" pri%e (i!%o/ery i the I (ia "orei# e$%ha #e &ar'et ha! i&pro/e( a! re"le%te( i the bi(5a!' !prea( a ( "or*ar( pre&ia beha/ior1

Foreign Exchange Market !urnover

A! per the Trie ial Ce tral +a ' =0r/ey by the +a ' "or I ter atio al =ettle&e t! :+I=; o IForei# E$%ha #e a ( Deri/ati/e! Mar'et A%ti/ityJ, #lobal "orei# e$%ha #e &ar'et a%ti/ity ro!e &ar'e(ly bet*ee 6221 a ( 622< 1The !tro # #ro*th i t0r o/er &ay be attrib0te( to t*o relate( "a%tor!1 Fir!t, the pre!e %e o" %lear tre (! a ( hi#her /olatility i "orei# e$%ha #e &ar'et! bet*ee 6221 a ( 622< le( to tra(i # &o&e t0&, *here i /e!tor! too' lar#e po!itio ! i %0rre %ie! that "ollo*e( per!i!te t appre%iati # tre (!1 =e%o (, po!iti/e i tere!t rate (i""ere tial! e %o0ra#e( the !o5%alle( I%arry tra(i #J, i.e., i /e!t&e t! i hi#h i tere!t rate %0rre %ie! "i a %e( by po!itio ! i lo* i tere!t rate %0rre %ie!1 The #ro*th i o0tri#ht "or*ar(! bet*ee 6221 a ( 622< re"le%t! hei#hte e( i tere!t i he(#i #1 ,ithi the EM %o0 trie!, tra(itio al "orei# e$%ha #e tra(i # i A!ia %0rre %ie! #e erally re%or(e( &0%h "a!ter #ro*th tha the #lobal total bet*ee 6221 a ( 622<1 Gro*th rate! i t0r o/er "or Chi e!e re &i bi, I (ia r0pee, I (o e!ia r0piah, Korea *o a ( e* Tai*a e!e (ollar e$%ee(e( 122 per %e t bet*ee April 6221 a ( April 622<1 De!pite !i# i"i%a t #ro*th i the "orei# e$%ha #e &ar'et t0r o/er, the !hare o" &o!t o" the EME! i total #lobal t0r o/er, ho*e/er, %o ti 0e( to re&ai lo*1 The I (ia "orei# e$%ha #e &ar'et ha! #ro* &a i"ol( o/er the la!t !e/eral year!1 The (aily a/era#e t0r o/er i&pre!!e( a !0b!ta tial pi%' 0p "ro& abo0t U= K ? billio (0ri # 1--.5-4 to U= K 14 billio (0ri # 622?52A1 The t0r o/er ha! ri!e %o !i(erably to U= K 67 billio (0ri # 622A52. :0p to Febr0ary 622.; *ith the (aily t0r o/er %ro!!i # U= K 7? billio o %ertai (ay! (0ri # O%tober a ( No/e&ber 622A1 The i ter5ba ' to &er%ha t t0r o/er ratio ha! hal/e( "ro& ?16 (0ri # 1--.5-4 to 61A (0ri # 622?52A, re"le%ti # the #ro*i # parti%ipatio i the &er%ha t !e#&e t o" the "orei# e$%ha #e &ar'et1 M0&bai alo e a%%o0 t! "or al&o!t 42 per %e t o" the "orei# e$%ha #e t0r o/er1 7C9a#e

FOREIGN EXCHANGE MARKET T0r o/er i the "orei# e$%ha #e &ar'et *a! A1A ti&e! o" the !i3e o" I (iaB! bala %e o" pay&e t! (0ri # 622?52A a! %o&pare( *ith ?1< ti&e! i 62225211 ,ith the (eepe i # o" the "orei# e$%ha #e &ar'et a ( i %rea!e( t0r o/er, i %o&e o" %o&&er%ial ba '! thro0#h trea!0ry operatio ! ha! i %rea!e( %o !i(erably1 9ro"it "ro& "orei# e$%ha #e tra !a%tio ! a%%o0 te( "or &ore tha 62 per %e t o" total pro"it! o" the !%he(0le( %o&&er%ial ba '! (0ri # 622<52? a ( 622?52A

<C9a#e

FOREIGN EXCHANGE MARKET

Chapter 6: HI=TORD, +A=IC CONCE9T= AND TRADING 98ATFORM= Forex Market: A "istorical #ers$ective Early %tages: &'()*&'))
The e/ol0tio o" I (iaB! "orei# e$%ha #e &ar'et &ay be /ie*e( i li e *ith the !hi"t! i I (iaB! e$%ha #e rate poli%ie! o/er the la!t "e* (e%a(e! "ro& a par /al0e !y!te& to a ba!'et5pe# a ( "0rther to a &a a#e( "loat e$%ha #e rate !y!te&1 D0ri # the perio( "ro& 1-<. to 1-.1, I (ia "ollo*e( the par /al0e !y!te& o" e$%ha #e rate1 I itially the r0peeB! e$ter al par /al0e *a! "i$e( at <11? #rai ! o" "i e #ol(1 The Re!er/e +a ' &ai tai e( the par /al0e o" the r0pee *ithi the per&itte( &ar#i o" L1 per %e t 0!i # po0 ( !terli # a! the i ter/e tio %0rre %y1 =i %e the !terli #5(ollar e$%ha #e rate *a! 'ept !table by the U= &o etary a0thority, the e$%ha #e rate! o" r0pee i ter&! o" #ol( a! *ell a! the (ollar a ( other %0rre %ie! *ere i (ire%tly 'ept !table1 The (e/al0atio o" r0pee i =epte&ber 1-<- a ( >0 e 1-AA i ter&! o" #ol( re!0lte( i the re(0%tio o" the par /al0e o" r0pee i ter&! o" #ol( to 6144 a ( 1147 #rai ! o" "i e #ol(, re!pe%ti/ely1 The e$%ha #e rate o" the r0pee re&ai e( 0 %ha #e( bet*ee 1-AA a ( 1-.11 Gi/e the "i$e( e$%ha #e re#i&e (0ri # thi! perio(, the "orei# e$%ha #e &ar'et "or all pra%ti%al p0rpo!e! *a! (e"0 %t1 +a '! *ere re@0ire( to 0 (erta'e o ly %o/er operatio ! a ( &ai tai a M!@0areB or M ear !@0areB po!itio at all ti&e!1 The ob)e%ti/e o" e$%ha #e %o trol! *a! pri&arily to re#0late the (e&a ( "or "orei# e$%ha #e "or /ario0! p0rpo!e!, *ithi the li&it !et by the a/ailable !0pply1 The Forei# E$%ha #e Re#0latio A%t i itially e a%te( i 1-<. *a! pla%e( o a per&a e t ba!i! i 1-?.1 I ter&! o" the pro/i!io ! o" the A%t, the Re!er/e +a ', a ( i %ertai %a!e!, the Ce tral Go/er &e t %o trolle( a ( re#0late( the (eali #! i "orei# e$%ha #e pay&e t! o0t!i(e I (ia, e$port a ( i&port o" %0rre %y ote! a ( b0llio , tra !"er! o" !e%0ritie! bet*ee re!i(e t! a ( o 5re!i(e t!, a%@0i!itio o" "orei# !e%0ritie!, et%1 ,ith the brea'(o* o" the +retto ,oo(! =y!te& i 1-.1 a ( the "loatatio o" &a)or %0rre %ie!, the %o (0%t o" e$%ha #e rate poli%y po!e( a !erio0! %halle #e to all %e tral ba '! *orl( *i(e a! %0rre %y "l0%t0atio ! ope e( 0p tre&e (o0! opport0 itie! "or &ar'et player! to tra(e i %0rre %ie! i a bor(erle!! &ar'et1 I De%e&ber 1-.1, the r0pee *a! li 'e( *ith po0 ( !terli #1 =i %e !terli # *a! "i$e( i ter&! o" U= (ollar 0 (er the =&ith!o ia A#ree&e t o" 1-.1, the r0pee al!o re&ai e( !table a#ai !t (ollar1 I or(er to o/er%o&e the *ea' e!!e! a!!o%iate( *ith a !i #le %0rre %y pe# a ( to e !0re !tability o" the e$%ha #e rate, the r0pee, *ith e""e%t "ro& =epte&ber 1-.?, *a! pe##e( to a ba!'et o" %0rre %ie!1 The %0rre %y !ele%tio a ( *ei#ht! a!!i# e( *ere le"t to the (i!%retio o" the Re!er/e +a '1 The %0rre %ie! i %l0(e( i the ba!'et a! *ell a! their relati/e *ei#ht! *ere 'ept %o "i(e tial i or(er to (i!%o0ra#e !pe%0latio 1 It *a! aro0 ( thi! ti&e that ba '! i I (ia be%a&e i tere!te( i tra(i # i "orei# e$%ha #e

Formative #eriod: &')+*&'',

The i&pet0! to tra(i # i the "orei# e$%ha #e &ar'et i I (ia %a&e i 1-.4 *he ba '! i I (ia *ere allo*e( by the Re!er/e +a ' to 0 (erta'e i tra5(ay tra(i # i "orei# e$%ha #e a ( *ere re@0ire( to %o&ply *ith the !tip0latio o" &ai tai i # M!@0areB or M ear !@0areB po!itio o ly at the %lo!e o" b0!i e!! ho0r! ea%h (ay1 The e$te t o" po!itio *hi%h %o0l( be le"t 0 %o/ere( o/er i#ht :the ope po!itio ; a! *ell a! the li&it! 0p to *hi%h (ealer! %o0l( tra(e (0ri # the (ay *a! to be (e%i(e( by the &a a#e&e t o" ba '!1 The e$%ha #e rate o" the r0pee ?C9a#e

FOREIGN EXCHANGE MARKET (0ri # thi! perio( *a! o""i%ially (eter&i e( by the Re!er/e +a ' i ter&! o" a *ei#hte( ba!'et o" %0rre %ie! o" I (iaB! &a)or tra(i # part er! a ( the e$%ha #e rate re#i&e *a! %hara%teri3e( by (aily a o0 %e&e t by the Re!er/e +a ' o" it! b0yi # a ( !elli # rate! to the A0thori3e( Dealer! :AD!; "or 0 (erta'i # &er%ha t tra !a%tio !1 The !prea( bet*ee the b0yi # a ( the !elli # rate! *a! 21? per %e t a ( the &ar'et be#a to tra(e a%ti/ely *ithi thi! ra #e1 AD! *ere al!o per&itte( to tra(e i %ro!! %0rre %ie! :o e %o /ertible "orei# %0rre %y /er!0! a other;1 Ho*e/er, o Mpo!itio B i thi! re#ar( %o0l( ori#i ate i o/er!ea! &ar'et!1 A! opport0 itie! to &a'e pro"it! be#a to e&er#e, &a)or ba '! i I (ia !tarte( @0oti # t*o *ay pri%e! a#ai !t the r0pee a! *ell a! i %ro!! %0rre %ie! a (, #ra(0ally, tra(i # /ol0&e! be#a to i %rea!e1 Thi! le( to the a(optio o" *i(ely (i""ere t pra%ti%e! :!o&e o" the& bei # irre#0lar; a ( the ee( *a! "elt "or a %o&prehe !i/e !et o" #0i(eli e! "or operatio o" ba '! e #a#e( i "orei# e$%ha #e b0!i e!!1 A%%or(i #ly, the MG0i(eli e! "or I ter al Co trol o/er Forei# E$%ha #e +0!i e!!B, *ere "ra&e( "or a(optio by the ba '! i 1-411 The "orei# e$%ha #e &ar'et i I (ia till the early 1--2!, ho*e/er, re&ai e( hi#hly re#0late( *ith re!tri%tio ! o e$ter al tra !a%tio !, barrier! to e try, lo* li@0i(ity a ( hi#h tra !a%tio %o!t!1 The e$%ha #e rate (0ri # thi! perio( *a! &a a#e( &ai ly "or "a%ilitati # I (iaB! i&port!1 The !tri%t %o trol o "orei# e$%ha #e tra !a%tio ! thro0#h the Forei# E$%ha #e Re#0latio ! A%t :FERA; ha( re!0lte( i o e o" the lar#e!t a ( &o!t e""i%ie t parallel &ar'et! "or "orei# e$%ha #e i the *orl(, i.e., the ha*ala :0 o""i%ial; &ar'et1 +y the late 1-42! a ( the early 1--2!, it *a! re%o# i3e( that both &a%roe%o o&i% poli%y a ( !tr0%t0ral "a%tor! ha( %o trib0te( to bala %e o" pay&e t! (i""i%0ltie!1 De/al0atio ! by I (iaB! %o&petitor! ha( a##ra/ate( the !it0atio 1 Altho0#h e$port! ha( re%or(e( a hi#her #ro*th (0ri # the !e%o ( hal" o" the 1-42! :"ro& abo0t <17 per %e t o" GD9 i 1-4.544 to abo0t ?14 per %e t o" GD9 i 1--25-1;, tra(e i&bala %e! per!i!te( at aro0 ( 7 per%e t o" GD91 Thi! %o&bi e( *ith a pre%ipito0! "all i i /i!ible re%eipt! i the "or& o" pri/ate re&itta %e!, tra/el a ( to0ri!& ear i #! i the year 1--25-1 le( to "0rther *i(e i # o" %0rre t a%%o0 t (e"i%it1 The *ea' e!!e! i the e$ter al !e%tor *ere a%%e t0ate( by the G0l" %ri!i! o" 1--25-11 A! a re!0lt, the %0rre t a%%o0 t (e"i%it *i(e e( to 716 per %e t o" GD9 i 1--25-1 a ( the %apital "lo*! al!o (rie( 0p e%e!!itati # the a(optio o" e$%eptio al %orre%ti/e !tep!1 It *a! a#ai !t thi! ba%'(rop that I (ia e&bar'e( o !tabili3atio a ( !tr0%t0ral re"or&! i the early 1--2!1

#ost*Reform #eriod: &'', onwards

Thi! pha!e *a! &ar'e( by *i(e ra #i # re"or& &ea!0re! ai&e( at *i(e i # a ( (eepe i # the "orei# e$%ha #e &ar'et a ( liberali3atio o" e$%ha #e %o trol re#i&e!1 A %re(ible &a%roe%o o&i%, !tr0%t0ral a ( !tabili3atio pro#ra&&e e %o&pa!!i # tra(e, i (0!try, "orei# i /e!t&e t, e$%ha #e rate, p0bli% "i a %e a ( the "i a %ial !e%tor *a! p0t i pla%e %reati # a e /iro &e t %o (0%i/e "or the e$pa !io o" tra(e a ( i /e!t&e t1 It *a! re%o# i3e( that tra(e poli%ie!, e$%ha #e rate poli%ie! a ( i (0!trial poli%ie! !ho0l( "or& part o" a i te#rate( poli%y "ra&e*or' to i&pro/e the o/erall pro(0%ti/ity, %o&petiti/e e!! a ( e""i%ie %y o" the e%o o&i% !y!te&, i #e eral, a ( the e$ter al !e%tor, i parti%0lar1 A! a !tabil!atio &ea!0re, a t*o !tep (o* *ar( e$%ha #e rate a()0!t&e t by - per %e t a ( 11 per %e t bet*ee >0ly 1 a ( 7, 1--1 *a! re!orte( to %o0 ter the &a!!i/e (ra*(o* i the "orei# e$%ha #e re!er/e!, to i !till %o "i(e %e a&o # i /e!tor! a ( to i&pro/e (o&e!ti% %o&petiti/e e!!1 A t*o5!tep a()0!t&e t o" e$%ha #e rate i >0ly 1--1 e""e%ti/ely bro0#ht to %lo!e the re#i&e o" a pe##e( e$%ha #e rate1 AC9a#e

FOREIGN EXCHANGE MARKET A"ter the G0l" %ri!i! i 1--25-1, the broa( "ra&e*or' "or re"or&! i the e$ter al !e%tor *a! lai( o0t i the Report o" the Hi#h 8e/el Co&&ittee o +ala %e o" 9ay&e t! :Chair&a : Dr1 C1 Ra #ara)a ;1 Follo*i # the re%o&&e (atio ! o" the Co&&ittee to &o/e to*ar(! the &ar'et5 (eter&i e( e$%ha #e rate, the 8iberali3e( E$%ha #e Rate Ma a#e&e t =y!te& :8ERM=; *a! p0t i pla%e i Mar%h 1--6 i itially i /ol/i # a (0al e$%ha #e rate !y!te&1 U (er the 8ERM=, all "orei# e$%ha #e re%eipt! o %0rre t a%%o0 t tra !a%tio ! :e$port!, re&itta %e!, etc1; *ere re@0ire( to be !0rre (ere( to the A0thori3e( Dealer! :AD!; i "0ll1 The rate o" e$%ha #e "or %o /er!io o" A2 per %e t o" the pro%ee(! o" the!e tra !a%tio ! *a! the &ar'et rate @0ote( by the AD!, *hile the re&ai i # <2 per%e t o" the pro%ee(! *ere %o /erte( at the Re!er/e +a 'B! o""i%ial rate1 The AD!, i t0r , *ere re@0ire( to !0rre (er the!e <2 per %e t o" their p0r%ha!e o" "orei# %0rre %ie! to the Re!er/e +a '1 They *ere "ree to retai the bala %e A2 per %e t o" "orei# e$%ha #e "or !elli # i the "ree &ar'et "or per&i!!ible tra !a%tio !1 The 8ERM= *a! e!!e tially a tra !itio al &e%ha i!& a ( a (o* *ar( a()0!t&e t i the o""i%ial e$%ha #e rate too' pla%e i early De%e&ber 1--6 a ( 0lti&ate %o /er#e %e o" the (0al rate! *a! &a(e e""e%ti/e "ro& Mar%h 1, 1--7, lea(i # to the i tro(0%tio o" a &ar'et5(eter&i e( e$%ha #e rate re#i&e1 The (0al e$%ha #e rate !y!te& *a! repla%e( by a 0 i"ie( e$%ha #e rate !y!te& i Mar%h 1--7, *hereby all "orei# e$%ha #e re%eipt! %o0l( be %o /erte( at &ar'et (eter&i e( e$%ha #e rate!1 O 0 i"i%atio o" the e$%ha #e rate!, the o&i al e$%ha #e rate o" the r0pee a#ai !t both the U= (ollar a! al!o a#ai !t a ba!'et o" %0rre %ie! #ot a()0!te( lo*er, *hi%h al&o!t 0lli"ie( the i&pa%t o" the pre/io0! i "latio (i""ere tial1 The re!tri%tio ! o a 0&ber o" other %0rre t a%%o0 t tra !a%tio ! *ere rela$e(1 The 0 i"i%atio o" the e$%ha #e rate o" the I (ia r0pee *a! a i&porta t !tep to*ar(! %0rre t a%%o0 t %o /ertibility, *hi%h *a! "i ally a%hie/e( i A0#0!t 1--<, *he I (ia a%%epte( obli#atio ! 0 (er Arti%le HIII o" the Arti%le! o" A#ree&e t o" the IMF1 ,ith the r0pee be%o&i # "0lly %o /ertible o all %0rre t a%%o0 t tra !a%tio !, the ri!'5beari # %apa%ity o" ba '! i %rea!e( a ( "orei# e$%ha #e tra(i # /ol0&e! !tarte( ri!i #1 Thi! *a! !0pple&e te( by *i(e5ra #i # re"or&! 0 (erta'e by the Re!er/e +a ' i %o )0 %tio *ith the Go/er &e t to re&o/e &ar'et (i!tortio ! a ( (eepe the "orei# e$%ha #e &ar'et1 The pro%e!! ha! bee &ar'e( by M#ra(0ali!&B *ith &ea!0re! bei # 0 (erta'e a"ter e$te !i/e %o !0ltatio ! *ith e$pert! a ( &ar'et parti%ipa t!1 The re"or& pha!e be#a *ith the =o(ha i Co&&ittee :1--<; *hi%h i it! report !0b&itte( i 1--? &a(e !e/eral re%o&&e (atio ! to rela$ the re#0latio ! *ith a /ie* to /itali3i # the "orei# e$%ha #e &ar'et1 I a((itio , !e/eral i itiati/e! ai&e( at (i!&a tli # %o trol! a ( pro/i(i # a e abli # e /iro &e t to all e titie! e #a#e( i "orei# e$%ha #e tra !a%tio ! ha/e bee 0 (erta'e !i %e the &i(51--2!1 The "o%0! ha! bee o (e/elopi # the i !tit0tio al "ra&e*or' a ( i %rea!i # the i !tr0&e t! "or e""e%ti/e "0 %tio i #, e ha %i # tra !pare %y a ( liberali3i # the %o (0%t o" "orei# e$%ha #e b0!i e!! !o a! to &o/e a*ay "ro& &i%ro &a a#e&e t o" "orei# e$%ha #e tra !a%tio ! to &a%ro &a a#e&e t o" "orei# e$%ha #e "lo*!1 A I ter al Te%h i%al Gro0p o the Forei# E$%ha #e Mar'et! :622?; !et 0p by the Re!er/e +a ' &a(e /ario0! re%o&&e (atio ! "or "0rther liberali3atio o" the e$ta t re#0latio !1 =o&e o" the re%o&&e (atio ! !0%h a! "ree(o& to %a %el a ( reboo' "or*ar( %o tra%t! o" a y te or, .C9a#e

FOREIGN EXCHANGE MARKET (ele#atio o" po*er! to AD! "or #ra t o" per&i!!io to %orporate! to he(#e their e$po!0re to %o&&o(ity pri%e ri!' i the i ter atio al %o&&o(ity e$%ha #e!F&ar'et! a ( e$te !io o" the tra(i # ho0r! o" the i ter5ba ' "orei# e$%ha #e &ar'et ha/e !i %e bee i&ple&e te(1 Alo # *ith the!e !pe%i"i% &ea!0re! ai&e( at (e/elopi # the "orei# e$%ha #e &ar'et, &ea!0re! to*ar(! liberali3i # the %apital a%%o0 t *ere al!o i&ple&e te( (0ri # the la!t (e%a(e, #0i(e( to a lar#e e$te t !i %e 1--. by the Report o" the Co&&ittee o Capital A%%o0 t Co /ertibility :Chair&a : =hri =1=1 Tarapore;1 Hario0! re"or& &ea!0re! !i %e the early 1--2! ha/e ha( a pro"o0 ( e""e%t o the &ar'et !tr0%t0re, (epth, li@0i(ity a ( e""i%ie %y o" the I (ia "orei# e$%ha #e &ar'et

-asic .once$ts in Forex !rading -id and Ask Rate:

The bi(Fa!' !prea( i! the (i""ere %e bet*ee the pri%e at *hi%h a ba ' or &ar'et &a'er *ill !ell :Na!'N, or No""erN; a ( the pri%e at *hi%h a &ar'et ta'er *ill b0y :Nbi(N; "ro& a *hole!ale or retail %0!to&er1 The %0!to&er *ill b0y "ro& the &ar'et5&a'er at the hi#her Na!'N pri%e, a ( *ill !ell at the lo*er Nbi(N pri%e, th0! #i/i # 0p the N!prea(N a! the %o!t o" %o&pleti # the tra(e1

Margin !rading:
Forei# e$%ha #e i! or&ally tra(e( o &ar#i 1 A relati/ely !&all (epo!it %a %o trol &0%h lar#er po!itio ! i the &ar'et1 For tra(i # the &ai %0rre %ie!, =a$o +a ' re@0ire! a 1O &ar#i (epo!it1 Thi! &ea ! that i or(er to tra(e o e &illio (ollar!, yo0 ee( to pla%e )0!t U=D 12,222 by *ay o" !e%0rity1 I other *or(!, yo0 *ill ha/e obtai e( a #eari # o" 0p to 122 ti&e!1 Thi! &ea ! that a %ha #e o", !ay 6O, i the 0 (erlyi # /al0e o" yo0r tra(e *ill re!0lt i a 622O pro"it or lo!! o yo0r (epo!it1

%to$*loss disci$line:
There are !i# i"i%a t opport0 itie! a ( ri!'! i "orei# e$%ha #e &ar'et!1 A##re!!i/e tra(er! &i#ht e$perie %e pro"itFlo!! !*i #! o" 62572O (aily1 Thi! %all! "or !tri%t !top5lo!! poli%ie! i po!itio ! that are &o/i # a#ai !t yo01 Fort0 ately, there are o (aily li&it! o "orei# e$%ha #e tra(i # a ( o re!tri%tio ! o tra(i # ho0r! other tha the *ee'e (1 Thi! &ea ! that there *ill early al*ay! be a opport0 ity to rea%t to &o/e! i the &ai %0rre %y &ar'et! a ( a lo* ri!' o" #etti # %a0#ht *itho0t the opport0 ity o" #etti # o0t1 O" %o0r!e, the &ar'et %a &o/e /ery "a!t a ( a !top5lo!! or(er i! by o &ea ! a #0ara tee o" #etti # o0t at the (e!ire( le/el1 For !pe%0lati/e tra(i #, it i! re%o&&e (e( to pla%e prote%ti/e !top5lo!! or(er!1

%$ot and forward trading:

,he yo0 tra(e "orei# e$%ha #e yo0 are or&ally @0ote( a !pot pri%e1 Thi! &ea ! that i" yo0 ta'e o "0rther !tep!, yo0r tra(e *ill be !ettle( a"ter t*o b0!i e!! (ay!1 Thi! e !0re! that yo0r tra(e! are 0 (erta'e !0b)e%t to !0per/i!io by re#0latory a0thoritie! "or yo0r o* prote%tio a ( !e%0rity1 I" yo0 are a %o&&er%ial %0!to&er, yo0 &ay ee( to %o /ert the %0rre %ie! "or i ter atio al pay&e t!1 I" yo0 are a i /e!tor, yo0 *ill or&ally *a t to !*ap yo0r tra(e "or*ar( to a later (ate1 Thi! %a be 0 (erta'e o a (aily ba!i! or "or a lo #er perio( at a ti&e1 4C9a#e

FOREIGN EXCHANGE MARKET O"te i /e!tor! *ill !*ap their tra(e! "or*ar( a y*here "ro& a *ee' or t*o 0p to !e/eral &o th! (epe (i # o the ti&e "ra&e o" the i /e!t&e t1 Altho0#h a "or*ar( tra(e i! "or a "0t0re (ate, the po!itio %a be %lo!e( o0t at a y ti&e 5 the %lo!i # part o" the po!itio i! the !*appe( "or*ar( to the !a&e "0t0re /al0e (ate1

.urrency !raded Across /lobe 0 1ndia

!he FO2R ma3or currency $airs EURFU=D U=DF>9D U=DFCHF G+9FU=D .urrency .rosses EURFCHF EURF>9D G+9F>9D EURFG+9 .urrencies traded in 1ndia: U=DFINR EURFINR G+9FINR >9DFINR .urrency Exchanges in 1ndia: 11 MCX =to%' E$%ha #e :MCX G =X; 61 Natio al =to%' E$%ha #e :N=E; 71 U ite( =to%' E$%ha #e :U=E; The (aily t0r o/er o" N=E a ( MCX G =X to#ether i! aro0 ( 72,222 %r1 -C9a#e

FOREIGN EXCHANGE MARKET

1ndian #ers$ective of !rading #latforms

!rade %tation
It i! the pre&ier bro'era#e tra(i # plat"or& "or r0le5ba!e( tra(i #1 A ( *e ha/e the a*ar(! to pro/e it1 ,hether yo0 tra(e !to%'!, optio !, "0t0re! or "ore$, Tra(e =tatio o""er! 0 i@0ely po*er"0l !trate#y %reatio a ( te!ti # tool!, %0!to&i3able a alyti%! a ( "0lly a0to&ate( tra(i # te%h olo#y i a !i #le tra(i # plat"or&1 Features 11 Create a 0 li&ite( 0&ber o" tra(i # !trate#ie! 61 +a%' te!t a ( opti&i3e the !trate#ie! 71 Mo itor &0ltiple &ar'et! %ystematic F0lly a0to&ate( port"olio !ol0tio ,eb5ba!e( ea!y5to50!e tra(i # 8o* %o!t tra(i # Tra !pare t tra(e re!0lt! Di/er!i"i%atio a ( ri!' &a a#e&e t optio ! Co&prehe !i/e o li e /i(eo t0torial! a ( FAP O e a%%o0 t, t*o plat"or&! 5 *or'! i parallel *ith MetaTra(er < Choi%e o" o/er .2 i (epe (e t tra(i # !trate#ie! a ( 62 pre(e"i e( port"olio! No !0b!%riptio or &ai te a %e "ee! U=D ?22 &i i&0& (epo!it Mi i&0& tra(e !i3e 211 lot 6- %0rre %y pair! U li&ite( a%%e!! to Alpari A%a(e&y a ( Alpari Re!ear%h F0lly a0to&ate( tra(i # Tra(e oti"i%atio ! by e5&ail "or ope e(F%lo!e( tra(e! A/ailable i - la #0a#e!

Al$ari 4irect #ro

Alpari Dire%t 9ro i! a i !tit0tio al5le/el plat"or& that o""er! the &o!t (ire%t ro0te to opti&0& li@0i(ity a ( i !tit0tio al5le/el pri%e! "ro& the *orl(B! lea(i # ba '!, a ( hi#hly %o&petiti/e !prea(! o &a)or %0rre %ie!1 De!i# e( "or i !tit0tio !, &o ey &a a#er! a ( i (i/i(0al!, Alpari Dire%t 9ro %ater! "or tho!e *ho *a t to tra(e hi#h /ol0&e! *ith the "a!te!t e$e%0tio !pee(!, "0ll &ar'et (epth a ( !ophi!ti%ate( or(er &a a#e&e t optio !1 Features Fast*track to li5uidity 12 C 9 a # e

FOREIGN EXCHANGE MARKET Alpari Dire%t 9ro i! a a(/a %e( i !tit0tio al5le/el plat"or& (e!i# e( "or &o ey &a a#er!, i !tit0tio al tra(er! a ( i /e!tor! *a ti # to tra(e hi#h /ol0&e! *ith the "a!te!t e$e%0tio !pee(! :&ar'et e$e%0tio ;, "0ll &ar'et (epth a ( !ophi!ti%ate( or(er &a a#e&e t1 Non*4ealing 4esk execution F0lly a0to&ate( pro%e!!i # *itho0t a y &a 0al i ter/e tio %0t! o0t a y ob!ta%le! bet*ee yo0r tra(e a ( the &ar'et1 Goi # (ire%t, *ith tra(e! e$e%0te( at the hi#he!t !pee( a ( *ith &i i&0& late %y &ea ! yo0 %a rea%t i !ta tly to opport0 itie! a! they ari!e1 6now the de$th of the market in full Hie* the &o!t %o&prehe !i/e pi%t0re o" the &ar'et *ith %0rre t or(er! (i!playe( by pri%e a ( /ol0&e1 Thi! pro/i(e! a &ore tra !pare t pi%t0re o" the Fore$ &ar'et a ( the be!t opport0 ity to &a'e the &o!t i "or&e( tra(i # (e%i!io ! po!!ible1 Manage more orders more effectively A %o&prehe !i/e !0ite o" or(er! a ( or(er &a a#e&e t optio ! allo* yo0 to e$e%0te !ophi!ti%ate( !trate#ie! ba!e( o pre%i!e ti&i # a ( &0ltiple or(er type! e abli # better %o trol o" or(er ti&i # a ( e$e%0tio 1

Fa%tor! A""e%ti # Forei# E$%ha #e

There are /ario0! "a%tor! a""e%ti # the e$%ha #e rate o" a %0rre %y1 They %a be %la!!i"ie( a! "0 (a&e tal "a%tor!, te%h i%al "a%tor!, politi%al "a%tor! a ( !pe%0lati/e "a%tor!1 Fundamental factors: The "0 (a&e tal "a%tor! are ba!i% e%o o&i% poli%ie! "ollo*e( by the #o/er &e t i relatio to i "latio , bala %e o" pay&e t po!itio , 0 e&ploy&e t, %apa%ity 0tili3atio , tre (! i i&port a ( e$port, et%1 Nor&ally, other thi #! re&ai i # %o !ta t the %0rre %ie! o" the %o0 trie! that "ollo* !o0 ( e%o o&i% poli%ie! *ill al*ay! be !tro #er1 =i&ilarly, %o0 trie! ha/i # bala %e o" pay&e t !0rpl0! *ill e )oy a "a/orable e$%ha #e rate1 Co /er!ely, "or %o0 trie! "a%i # bala %e o" pay&e t (e"i%it, the e$%ha #e rate *ill be a(/er!e1 !echnical factors: I tere!t rate!: Ri!i # i tere!t rate! i a %o0 try &ay lea( to i "lo* o" hot &o ey i the %o0 try, thereby rai!i # (e&a ( "or the (o&e!ti% %0rre %y1 Thi! i t0r %a0!e! appre%iatio i the /al0e o" the (o&e!ti% %0rre %y1 I "latio rate: Hi#h i "latio rate i a %o0 try re(0%e! the relati/e %o&petiti/e e!! o" the e$port !e%tor o" that %o0 try1 8o*er e$port! re!0lt i a re(0%tio i (e&a ( o" the (o&e!ti% %0rre %y a ( there"ore the %0rre %y (epre%iate!1 E$%ha #e rate poli%y a ( Ce tral +a ' i ter/e tio !: E$%ha #e rate poli%y o" the %o0 try i! the &o!t i&porta t "a%tor i "l0e %i # (eter&i atio o" e$%ha #e rate!1 For e$a&ple, a %o0 try &ay (e%i(e to "ollo* a "i$e( or "le$ible e$%ha #e rate re#i&e, a ( ba!e( o thi!, e$%ha #e rate &o/e&e t! &ay be le!!F&ore "re@0e t1 F0rther, #o/er &e t! !o&eti&e! parti%ipate i "orei# e$%ha #e &ar'et thro0#h it! Ce tral ba ' i or(er to %o trol the (e&a ( or !0pply o" (o&e!ti% %0rre %y1 11 C 9 a # e

FOREIGN EXCHANGE MARKET

#olitical factors: 9oliti%al !tability al!o i "l0e %e! the e$%ha #e rate!1 E$%ha #e rate! are !0!%eptible to politi%al i !tability a ( %a be /ery /olatile (0ri # ti&e! o" politi%al %ri!e!1 %$eculation: =pe%0lati/e a%ti/itie! by tra(er! *orl(*i(e al!o a""e%t e$%ha #e rate &o/e&e t!1 For e$a&ple, i" !pe%0lator! thi ' that the %0rre %y o" a %o0 try i! o/er/al0e( a ( *ill (e/al0e i ear "0t0re, they *ill p0ll o0t their &o ey "ro& that %o0 try re!0lti # i re(0%e( (e&a ( "or that %0rre %y a ( (epre%iati # it! /al0e1

16 C 9 a # e

FOREIGN EXCHANGE MARKET

CHA9TER 7: FEMA, EXCHANGE RATE =D=TEM, MARKET 9ARTICI9ANT= AND =TRUCTURE Foreign Exchange Management Act7 &'''
The %ha #e i the e tire approa%h to*ar(! e$%ha #e %o trol re#0latio ha! bee the re!0lt o" the repla%e&e t o" the Forei# E$%ha #e Re#0latio A%t, 1-.7, by the Forei# E$%ha #e Ma a#e&e t A%t, 1---1 The latter %a&e i to e""e%t "ro& >0 e 1, 62221 The %ha #e i the prea&ble it!el" !i# i"ie! the (ra&ati% %ha #e i approa%h 55 "ro& N for the conservation of the foreign exchange resourcesN i FERA 1-.7, to Nfacilitate external trade and paymentsN 0 (er FEMA 1---1 A y FEMA /iolatio ! are %i/il, ot %ri&i al, o""e %e!, attra%ti # &o etary pe altie!, a ( ot arre!t! or i&pri!o &e t1 The !%he&e o" FEMA a ( the oti"i%atio ! i!!0e( there 0 (er ta'e i to the a%%o0 t the %o /ertibility o" the r0pee "or all %0rre t a%%o0 t tra !a%tio !1 I (ee(, there i! o* #e eral "ree(o& to a0thori3e( (ealer! to !ell %0rre %y "or &o!t %0rre t a%%o0 t tra !a%tio !1 O e ol( li&itatio %o ti 0e!1 All tra !a%tio ! i "orei# e$%ha #e ha/e to be *ith a0thori3e( (ealer!, i1e1 ba '! a0thori3e( to a%t a! (ealer! i "orei# e$%ha #e by the Re!er/e +a '1 The ori#i al r0le!, re#0latio !, oti"i%atio !, et%1, 0 (er FEMA are %o tai e( i the A1D1 :M1A1 !erie!; Cir%0lar No1 11 o" May 1A, 62221 =0b!e@0e t %ir%0lar! ha/e bee i!!0e( 0 (er the A191 :DIR !erie!; o&e %lat0re1 It i! ob/io0!ly i&po!!ible to i %orporate all the %0rre t re#0latio ! i a boo' o" thi! type, parti%0larly !i %e the re#0latio ! 'eep %ha #i #1 A o0tli e o" the ba!i% "ra&e*or' o" e$%ha #e %o trol 0 (er FEMA i! i A e$0re ?171 +0t it! %o te t! !ho0l( ot be %o !i(ere( a! either (e"i iti/e or %0rre t a ( tho!e i tere!te( ee( to 'eep 0p *ith the /ario0! %ir%0lar! a ( other %o&&0 i%atio ! o the !0b)e%t1

#artici$ants in foreign exchange market

Market #layers 9layer! i the I (ia &ar'et i %l0(e :a; AD!, &o!tly ba '! *ho are a0thori3e( to (eal i "orei# e$%ha #e, :b; Forei# e$%ha #e bro'er! *ho a%t a! i ter&e(iarie!, a ( :%; C0!to&er! G i (i/i(0al!, %orporate!, *ho ee( "orei# e$%ha #e "or their tra !a%tio !1 Tho0#h %0!to&er! are &a)or player! i the "orei# e$%ha #e &ar'et, "or all pra%ti%al p0rpo!e! they (epe ( 0po AD! a ( bro'er!1 I the !pot "orei# e$%ha #e &ar'et, "orei# e$%ha #e tra !a%tio ! *ere earlier (o&i ate( by bro'er!1 Ne/erthele!!, the !it0atio ha! %ha #e( *ith the e/ol/i # &ar'et %o (itio !, a! o* the tra !a%tio ! are (o&i ate( by AD!1 +ro'er! %o ti 0e to (o&i ate the (eri/ati/e! &ar'et1 The Re!er/e +a ' i ter/e e! i the &ar'et e!!e tially to e !0re or(erly &ar'et %o (itio !1 The Re!er/e +a ' 0 (erta'e! !ale!Fp0r%ha!e! o" "orei# %0rre %y i perio(! o" e$%e!! (e&a (F!0pply i the &ar'et1 Forei# E$%ha #e Dealer!B A!!o%iatio o" I (ia :FEDAI; play! a !pe%ial role i the "orei# e$%ha #e &ar'et "or e !0ri # !&ooth a ( !pee(y #ro*th o" the 17 C 9 a # e

FOREIGN EXCHANGE MARKET "orei# e$%ha #e &ar'et i all it! a!pe%t!1 All AD! are re@0ire( to be%o&e &e&ber! o" the FEDAI a ( e$e%0te a 0 (erta'i # to the e""e%t that they *o0l( abi(e by the ter&! a ( %o (itio !tip0late( by the FEDAI "or tra !a%ti # "orei# e$%ha #e b0!i e!!1 The FEDAI i! al!o the a%%re(iti # a0thority "or the "orei# e$%ha #e bro'er! i the i terba ' "orei# e$%ha #e &ar'et1 The li%e !e! "or AD! are i!!0e( to ba '! a ( other i !tit0tio !, o their re@0e!t, 0 (er =e%tio 12:1; o" the Forei# E$%ha #e Ma a#e&e t A%t, 1---1 AD! ha/e bee (i/i(e( i to (i""ere t %ate#orie!1 All !%he(0le( %o&&er%ial ba '!, *hi%h i %l0(e p0bli% !e%tor ba '!, pri/ate !e%tor ba '! a ( "orei# ba '! operati # i I (ia, belo # to %ate#ory I o" AD!1 All 0p#ra(e( "0ll "le(#e( &o ey %ha #er! :FFMC!; a ( !ele%t re#io al r0ral ba '! :RR+!; a ( %o5operati/e ba '! belo # to %ate#ory II o" AD!1 =ele%t "i a %ial i !tit0tio ! !0%h a! EXIM +a ' belo # to %ate#ory III o" AD!1 C0rre tly, there are 4A :Cate#ory I; A(! operati # i I (ia o0t o" *hi%h "i/e are %o5operati/e ba '! 1All &er%ha t tra !a%tio ! i the "orei# e$%ha #e &ar'et ha/e to be e%e!!arily 0 (erta'e (ire%tly thro0#h AD!1 Ho*e/er, to pro/i(e (epth a ( li@0i(ity to the i ter5ba ' !e#&e t, A(! ha/e bee per&itte( to 0tili3e the !er/i%e! o" bro'er! "or better pri%e (i!%o/ery i their i ter5ba ' tra !a%tio !1 I or(er to "0rther i %rea!e the !i3e o" the "orei# e$%ha #e &ar'et a ( e able it to ha (le lar#e "lo*!, it i! #e erally "elt that &ore AD! !ho0l( be e %o0ra#e( to parti%ipate i the &ar'et &a'i #1 The 0&ber o" parti%ipa t! *ho %a #i/e t*o5*ay @0ote! al!o ee(! to be i %rea!e(1 The %0!to&er !e#&e t o" the "orei# e$%ha #e &ar'et %o&pri!e! &a)or p0bli% !e%tor 0 it!, %orporate! a ( b0!i e!! e titie! *ith "orei# e$%ha #e e$po!0re1 It i! #e erally (o&i ate( by !ele%t lar#e p0bli% !e%tor 0 it! !0%h a! I (ia Oil Corporatio , ONGC, +HE8, =AI8, Mar0ti U(yo# a ( al!o the Go/er &e t o" I (ia :"or (e"e !e a ( %i/il (ebt !er/i%e; a! al!o bi# pri/ate !e%tor %orporate! li'e Relia %e Gro0p, Tata Gro0p a ( 8ar!e a ( To0bro, a&o # other!1 I re%e t year!, "orei# i !tit0tio al i /e!tor! :FII!; ha/e e&er#e( a! &a)or player! i the "orei# e$%ha #e &ar'et1 The &ai player! i "orei# e$%ha #e &ar'et are a! "ollo*!: 11 .ustomers: The %0!to&er! *ho are e #a#e( i "orei# tra(e parti%ipate i "orei# e$%ha #e &ar'et by a/aili # o" the !er/i%e! o" ba '!1 E$porter! re@0ire %o /erti # the (ollar! i to r0pee a ( i&porter! re@0ire %o /erti # r0pee i to the (ollar!, a! they ha/e to pay i (ollar! "or the #oo(!F!er/i%e! they ha/e i&porte(1 61 .ommercial -ank: They are &o!t a%ti/e player! i the "ore$ &ar'et1 Co&&er%ial ba ' (eali #! *ith i ter atio al tra !a%tio o""er !er/i%e! "or %o /er!io o" o e %0rre %y i to a other1 They ha/e *i(e et*or' o" bra %he!1 Typi%ally ba '! b0y "orei# e$%ha #e "ro& e$porter! a ( !ell! "orei# e$%ha #e to the i&porter! o" #oo(!1 A! e/ery ti&e the "orei# e$%ha #e bo0#ht or o/er!ol( po!itio 1 The bala %e a&o0 t i! !ol( or bo0#ht "ro& the &ar'et1 71 .entral -ank:

1< C 9 a # e

FOREIGN EXCHANGE MARKET I all %o0 trie! Ce tral ba ' ha/e bee %har#e( *ith the re!po !ibility o" &ai tai i # the e$ter al /al0e o" the (o&e!ti% %0rre %y1 Ge erally thi! i! a%hie/e( by the i ter/e tio o" the ba '1

<1 Exchange -rokers: Fore$ bro'er! play /ery i&porta t role i the "orei# e$%ha #e &ar'et1 Ho*e/er the e$te t to *hi%h !er/i%e! o" "orei# bro'er! are 0tili3e( (epe (! o the tra(itio a ( pra%ti%e pre/aili # at a parti%0lar "ore$ &ar'et %e ter1 I I (ia a! per FEDAI #0i(eli e the A(! are "ree to (eal (ire%tly a&o # the&!el/e! *itho0t #oi # thro0#h bro'er!1 The bro'er! are ot a&o # to allo*e( to (eal i their o* a%%o0 t all o/er the *orl( a ( al!o i I (ia1 ?1 Overseas Forex Market: To(ay the (aily #lobal t0r o/er i! e!ti&ate( to be &ore tha U= K 11? trillio a (ay1 The i ter atio al tra(e ho*e/er %o !tit0te! har(ly ? to . O o" thi! total t0r o/er1 The re!t o" tra(i # i *orl( "ore$ &ar'et i! %o !tit0te( o" "i a %ial tra !a%tio a ( !pe%0latio 1 A! *e ' o* that the "ore$ &ar'et i! 6<5ho0r &ar'et, the (ay be#i ! *ith To'yo a ( therea"ter =i #apore ope !, therea"ter I (ia, "ollo*e( by +ahrai , Fra '"0rt, 9ari!, 8o (o , Ne* Dor', =y( ey, a ( ba%' to To'yo1 A1 %$eculators: The !pe%0lator! are the &a)or player! i the "ore$ &ar'et1 +a ' (eali # are the &a)or !pe%0lator! i the "ore$ &ar'et *ith a /ie* to &a'e pro"it o a%%o0 t o" "a/orable &o/e&e t i e$%ha #e rate, ta'e po!itio i1e1 i" they "eel that rate o" parti%0lar %0rre %y i! li'ely to #o 0p i !hort ter&1 They b0y that %0rre %y a ( !ell it a! !oo a! they are able to &a'e @0i%' pro"it1 .or$oration8s parti%0larly &0lti atio al %orporatio a ( tra ! atio al %orporatio ha/i # b0!i e!! operatio beyo ( their atio al "ro tier! a ( o a%%o0 t o" their %a!h "lo*! bei # lar#e a ( i &0lti %0rre %ie! #et i to "orei# e$%ha #e e$po!0re!1 ,ith a /ie* to &a'e a(/a ta#e o" e$%ha #e rate &o/e&e t i their "a/or they either (elay %o/eri # e$po!0re! or (o ot %o/er 0 til %a!h "lo* &ateriali3e1 1ndividual li'e !hare (eali # al!o 0 (erta'e the a%ti/ity o" b0yi # a ( !elli # o" "orei# e$%ha #e "or boo'i # !hort ter& pro"it!1 They al!o b0y "orei# %0rre %y !to%'!, bo (! a ( other a!!et! *itho0t %o/eri # the "orei# e$%ha #e e$po!0re ri!'1 Thi! al!o re!0lt! i !pe%0latio !1

Exchange rate %ystem

Co0 trie! o" the *orl( ha/e bee e$%ha #i # #oo(! a ( !er/i%e! a&o #!t the&!el/e!1 Thi! ha! bee #oi # o "ro& ti&e i&&e&orial1 The *orl( ha! %o&e a lo # *ay "ro& the (ay! o" barter tra(e1 ,ith the i /e tio o" &o ey the "i#0re! a ( proble&! o" barter tra(e ha/e (i!appeare(1 The barter tra(e ha! #i/e *ay to e$%ha #e( o" #oo(! a ( !er/i%e! "or %0rre %ie! i !tea( o" #oo(! a ( !er/i%e!1 The r0pee *a! hi!tori%ally li 'e( *ith po0 ( !terli #1 I (ia *a! a "o0 (er &e&ber o" the IMF1 D0ri # the e$i!te %e o" the "i$e( e$%ha #e rate !y!te&, the i ter/e tio %0rre %y o" the Re!er/e +a ' o" I (ia :R+I; *a! the +riti!h po0 (, the R+I e !0re( &ai te a %e o" the e$%ha #e rate by !elli # a ( b0yi # po0 ( a#ai !t r0pee! at "i$e( rate!1 The i terba ' rate there"ore r0le( the R+I ba (1 D0ri # the "i$e( e$%ha #e rate era, there *a! o ly 1? C 9 a # e

FOREIGN EXCHANGE MARKET o e &a)or %ha #e i the parity o" the r0pee5 (e/al0atio i >0 e 1-AA1 Di""ere t %o0 trie! ha/e a(opte( (i""ere t e$%ha #e rate !y!te& at (i""ere t ti&e1

The "ollo*i # are !o&e o" the e$%ha #e rate !y!te& "ollo*e( by /ario0! %o0 trie!1

!he /old %tandard

Ma y %o0 trie! ha/e a(opte( #ol( !ta (ar( a! their &o etary !y!te& (0ri # the la!t t*o (e%a(e! o" the 1-he %e t0ry1 Thi! !y!te& *a! i /o#0e till the o0tbrea' o" ,orl( ,ar 11 U (er thi! !y!te& the partie! o" %0rre %ie! *ere "i$e( i ter& o" #ol(1 There *ere t*o &ai type! o" #ol( !ta (ar(: &9 /old s$ecie standard Gol( *a! re%o# i3e( a! &ea ! o" i ter atio al !ettle&e t "or re%eipt! a ( pay&e t! a&o #!t %o0 trie!1 Gol( %oi ! *ere a a%%epte( &o(e o" pay&e t a ( &e(i0& o" e$%ha #e i (o&e!ti% &ar'et al!o1 A %o0 try *a! !tate( to be o #ol( !ta (ar( i" the "ollo*i # %o (itio *ere !ati!"ie(: Mo etary a0thority, #e erally the %e tral ba ' o" the %o0 try, #0ara tee( to b0y a ( !ell #ol( i 0 re!tri%te( a&o0 t! at the "i$e( pri%e1 Melti # #ol( i %l0(i # #ol( %oi !, a ( p0tti # it to (i""ere t 0!e! *a! "reely allo*e(1 I&port a ( e$port o" #ol( *a! "reely allo*e(1 The total &o ey !0pply i the %o0 try *a! (eter&i e( by the @0a t0& o" #ol( a/ailable "or &o etary p0rpo!e1 ,9 /old -ullion %tandard: U (er thi! !y!te&, the &o ey i %ir%0latio *a! either partly o" e tirely paper a ( #ol( !er/e( a! re!er/e a!!et "or the &o ey !0pply1 Ho*e/er, paper &o ey %o0l( be e$%ha #e( "or #ol( at a y ti&e1 The e$%ha #e rate /arie( (epe (i # 0po the #ol( %o te t o" %0rre %ie!1 Thi! *a! al!o ' o* a! IMi t 9arity TheoryJ o" e$%ha #e rate!1 The #ol( b0llio !ta (ar( pre/aile( "ro& abo0t 14.2 0 til 1-1<, a ( i ter&itte tly therea"ter 0 til 1-<<1 ,orl( ,ar I bro0#ht a e ( to the #ol( !ta (ar(1

-retton :oods %ystem

D0ri # the *orl( *ar!, e%o o&ie! o" al&o!t all the %o0 trie! !0""ere(1 I or(er to %orre%t the bala %e o" pay&e t! (i!e@0ilibri0&, &a y %o0 trie! (e/al0e( their %0rre %ie!1 Co !e@0e tly, the i ter atio al tra(e !0""ere( a (eathblo*1 I 1-<<, "ollo*i # ,orl( ,ar II, the U ite( =tate! a ( &o!t o" it! allie! rati"ie( the +retto ,oo(! A#ree&e t, *hi%h !et 0p a a()0!table parity e$%ha #e5rate !y!te& 0 (er *hi%h e$%ha #e rate! *ere "i$e( :9e##e(; *ithi arro* i ter/e tio li&it! :pe#!; by the U ite( =tate! a ( "orei# %e tral ba '! b0yi # a ( !elli # "orei# %0rre %ie!1 Thi! a#ree&e t, "o!tere( by a e* !pirit o" i ter atio al %ooperatio , *a! i re!po !e to "i a %ial %hao! that ha( rei# e( be"ore a ( (0ri # the *ar1 I a((itio to !etti # 0p "i$e( e$%ha #e paritie! :par /al0e!; o" %0rre %ie! i relatio !hip to #ol(, the a#ree&e t e!tabli!he( the I ter atio al Mo etary F0 ( :IMF; to a%t a! the I%0!to(ia J o" the !y!te&1 U (er thi! !y!te& there *ere 0 %o trollable %apital "lo*!, *hi%h lea( to &a)or %o0 trie! !0!pe (i # their obli#atio to i ter/e e i the &ar'et a ( the +retto ,oo( =y!te&, *ith it! "i$e( paritie!, 1A C 9 a # e

FOREIGN EXCHANGE MARKET *a! e""e%ti/ely b0rie(1 Th0!, the *orl( e%o o&y ha! bee li/i # thro0#h a era o" "loati # e$%ha #e rate! !i %e the early 1-.21

Floating Rate %ystem

I a tr0ly "loati # e$%ha #e rate re#i&e, the relati/e pri%e! o" %0rre %ie! are (e%i(e( e tirely by the &ar'et "or%e! o" (e&a ( a ( !0pply1 There i! o atte&pt by the a0thoritie! to i "l0e %e e$%ha #e rate1 ,here #o/er &e t i ter"ere!B (ire%tly or thro0#h /ario0! &o etary a ( "i!%al &ea!0re! i (eter&i i # the e$%ha #e rate, it i! ' o* a! &a a#e( o" (irty "loat1 9URCHA=ING 9O,ER 9ARITD :999; 9ro"e!!or G0!ta/ Ca!!el, a =*e(i!h e%o o&i!t, i tro(0%e( thi! !y!te&1 The theory, to p0t i !i&ple ter&! !tate! that %0rre %ie! are /al0e( "or *hat they %a b0y a ( the %0rre %ie! ha/e o i tri !i% /al0e atta%he( to it1 There"ore, 0 (er thi! theory the e$%ha #e rate *a! to be (eter&i e( a ( the !ole %riterio bei # the p0r%ha!i # po*er o" the %o0 trie!1 A! per thi! theory i" there *ere o tra(e %o trol!, the the bala %e o" pay&e t! e@0ilibri0& *o0l( al*ay! be &ai tai e(1 Th0! i" 1?2 INR b0y a "o0 tai pe a ( the !a&e "o0 tai pe %a be bo0#ht "or U=D 6, it %a be i "erre( that !i %e 6 U=D or 1?2 INR %a b0y the !a&e "o0 tai pe , there"ore U=D 6 Q INR 1?21For e$a&ple I (ia ha! a hi#her rate o" i "latio a! %o&pare( to %o0 try U= the #oo(! pro(0%e( i I (ia *o0l( be%o&e %o!tlier a! %o&pare( to #oo(! pro(0%e( i U=1 Thi! *o0l( i (0%e i&port! i I (ia a ( al!o the #oo(! pro(0%e( i I (ia bei # %o!tlier *o0l( lo!e i i ter atio al %o&petitio to #oo(! pro(0%e( i U=1 Thi! (e%rea!e i e$port! o" I (ia a! %o&pare( to e$port! "ro& U= *o0l( lea( to (e&a ( "or the %0rre %y o" U= a ( e$%e!! !0pply o" %0rre %y o" I (ia1 Thi! i t0r , %a0!e %0rre %y o" I (ia to (epre%iate i %o&pari!o o" %0rre %y o" U= that i! ha/i # relati/ely &ore e$port!1

Foreign Exchange Market %tructure

Market %egments Forei# e$%ha #e &ar'et a%ti/ity i &o!t EME! ta'e! pla%e o !hore *ith &a y %o0 trie! prohibiti # o !hore e titie! "ro& 0 (erta'i # the operatio ! i o""!hore &ar'et! "or their %0rre %ie!1 =pot &ar'et i! the pre(o&i a t "or& o" "orei# e$%ha #e &ar'et !e#&e t i (e/elopi # a ( e&er#i # &ar'et %o0 trie!1 A %o&&o "eat0re i! the te (e %y o" i&porter!Fe$porter! a ( other e (50!er! to loo' at e$%ha #e rate &o/e&e t! a! a !o0r%e o" ret0r *itho0t a(opti # appropriate ri!' &a a#e&e t pra%ti%e!1 Thi!, at ti&e!, %reate! 0 e/e !0pply(e& a ( %o (itio !, o"te ba!e( o MM e*! a ( /ie*!BB1 The la%' o" "or*ar( &ar'et (e/elop&e t re"le%t! &a y "a%tor!, i %l0(i # li&ite( e$%ha #e rate "le$ibility, the de facto e$%ha #e rate i !0ra %e pro/i(e( by the %e tral ba ' thro0#h i ter/e tio !, ab!e %e o" a yiel( %0r/e o *hi%h to ba!e the "or*ar( pri%e! a ( !hallo* &o ey &ar'et!, i *hi%h &ar'et5&a'i # ba '! %a he(#e the &at0rity ri!'! i&pli%it i "or*ar( po!itio ! :Ca ale!5Kril)e 'o, 622<;1 Mo!t "orei# e$%ha #e &ar'et! i (e/elopi # %o0 trie! are either p0re (ealer &ar'et! or a %o&bi atio o" (ealer a ( a0%tio &ar'et!1 I the (ealer &ar'et!, !o&e (ealer! be%o&e &ar'et &a'er! a ( play a %e tral role i the (eter&i atio o" e$%ha #e rate! i "le$ible e$%ha #e rate re#i&e!1 The bi( o""er !prea( re"le%t! &a y "a%tor!, i %l0(i # the le/el o" %o&petitio a&o # &ar'et &a'er!1 I &o!t o" the EME!, a %o(e o" %o (0%t e!tabli!he! the pri %iple! that #0i(e the 1. C 9 a # e

FOREIGN EXCHANGE MARKET operatio ! o" the (ealer! i the "orei# e$%ha #e &ar'et!1 It i! the %e tral ba ', or pro"e!!io al (ealer! a!!o%iatio , *hi%h or&ally i!!0e! the %o(e o" %o (0%t :Ca ale!5Kril)e 'o, 622<;1 I a0%tio &ar'et!, a a0%tio eer or a0%tio &e%ha i!& allo%ate! "orei# e$%ha #e by &at%hi # !0pply a ( (e&a ( or(er!1 I p0re a0%tio &ar'et!, or(er i&bala %e! are %leare( o ly by e$%ha #e rate a()0!t&e t!1 90re a0%tio &ar'et !tr0%t0re! are, ho*e/er, o* rare a ( they #e erally pre/ail i %o&bi atio *ith (ealer &ar'et!1 The I (ia "orei# e$%ha #e &ar'et i! a (e%e trali3e( &0ltiple (ealer!hip &ar'et %o&pri!i # t*o !e#&e t! G the !pot a ( the (eri/ati/e! &ar'et1 I the !pot &ar'et, %0rre %ie! are tra(e( at the pre/aili # rate! a ( the !ettle&e t or /al0e (ate i! t*o b0!i e!! (ay! ahea(1 The t*o5(ay perio( #i/e! a(e@0ate ti&e "or the partie! to !e ( i !tr0%tio ! to (ebit a ( %re(it the appropriate ba ' a%%o0 t! at ho&e a ( abroa(1 The (eri/ati/e! &ar'et e %o&pa!!e! "or*ar(!, !*ap! a ( optio !1 Tho0#h "or*ar( %o tra%t! e$i!t "or &at0ritie! 0p to o e year, &a)ority o" "or*ar( %o tra%t! are "or o e &o th, three &o th!, or !i$ &o th!1 For*ar( %o tra%t! "or lo #er perio(! are ot a! %o&&o be%a0!e o" the 0 %ertai tie! i /ol/e( a ( relate( pri%i # i!!0e!1 A !*ap tra !a%tio i the "orei# e$%ha #e &ar'et i! a %o&bi atio o" a !pot a ( a "or*ar( i the oppo!ite (ire%tio 1 A! i the %a!e o" other EME!, the !pot &ar'et i! the (o&i a t !e#&e t o" the I (ia "orei# e$%ha #e &ar'et1 The (eri/ati/e !e#&e t o" the "orei# e$%ha #e &ar'et i! a!!0&i # !i# i"i%a %e a ( the a%ti/ity i thi! !e#&e t i! #ra(0ally ri!i #1

Fundamentals in Exchange Rate

E$%ha #e rate i! a rate at *hi%h o e %0rre %y %a be e$%ha #e i to a other %0rre %y, !ay U=D Q R!1<41 Thi! rate i! the rate o" %o /er!io o" U= (ollar i to I (ia r0pee a ( /i%e /er!a1 Methods of ;uoting Rate There are t*o &etho(! o" @0oti # e$%ha #e rate!1 1; 4irect method: Forei# %0rre %y i! 'ept %o !ta t a ( ho&e %0rre %y i! 'ept /ariable1 I (ire%t @0otatio , the pri %iple a(opte( by ba ' i! to b0y at a lo*er pri%e a ( !ell at hi#her pri%e1 6; 1ndirect method: Ho&e %0rre %y i! 'ept %o !ta t a ( "orei# %0rre %y i! 'ept /ariable1 Here the !trate#y 0!e( by ba ' i! to b0y hi#h a ( !ell lo*1 I I (ia *ith e""e%t "ro& a0#0!t 6, 1--7, all the e$%ha #e rate! are @0ote( i (ire%t &etho(1 It i! %0!to&ary i "orei# e$%ha #e &ar'et to al*ay! @0ote t*o rate! &ea ! o e "or b0yi # a ( a other rate "or !elli #1 Thi! help! i eli&i ati # the ri!' o" bei # #i/e ba( rate! i1e1 i" a party %o&e! to ' o* *hat the other party i te (! to (o i1e1 b0y or !ell, the "or&er %a ta'e the letter "or a ri(e1 There are t*o partie! i a e$%ha #e (eal o" %0rre %ie!1 To i itiate the (eal o e party a!'! "or @0ote "ro& a other party a ( other party @0ote! a rate1 The party a!'i # "or a @0ote i! ' o* a!B a!'i # party a ( the party #i/i # a @0ote! i! ' o* a! @0oti # party1 The a(/a ta#e o" t*oG*ay @0ote i! a! 0 (er The &ar'et %o ti 0o0!ly &a'e! a/ailable pri%e "or b0yer! or !eller! T*o *ay pri%e! li&it the pro"it &ar#i o" the @0oti # ba ' a ( %o&pari!o o" o e @0ote *ith a other @0ote %a be (o e i !ta ta eo0!ly1 A! it i! ot e%e!!ary a y player i the &ar'et to i (i%ate *hether he i te (! to b0y or !ale "orei# %0rre %y, thi! e !0re! that the @0oti # ba ' %a ot ta'e a(/a ta#e by &a ip0lati # the pri%e!1 14 C 9 a # e

FOREIGN EXCHANGE MARKET It a0to&ati%ally i !0re! that ali# &e t o" rate! *ith &ar'et rate!1 T*o *ay @0ote! le ( (epth a ( li@0i(ity to the &ar'et, *hi%h i! !o /ery e!!e tial "or e""i%ie t &ar'et1 I t*o *ay @0ote! the "ir!t rate i! the rate "or b0yi # a ( a other "or !elli #1 ,e !ho0l( 0 (er!ta ( here that, i I (ia the ba '!, *hi%h are a0thori3e( (ealer, al*ay!, @0ote rate!1 =o the rate! @0ote(5 b0yi # a ( !elli # i! "or ba '! poi t o" /ie* o ly1 It &ea ! that i" e$porter! *a t to !ell the (ollar! the the ba ' *ill b0y the (ollar! "ro& hi& !o *hile %al%0latio the "ir!t rate *ill be 0!e( *hi%h i! b0yi # rate, a! the ba ' i! b0yi # the (ollar! "ro& e$porter1 The !a&e %a!e *ill happe i /er!ely *ith i&porter a! he *ill b0y (ollar! "ro& the ba ' a ( ba ' *ill !ell (ollar! to i&porter1

Factors Affecting Exchange Rates

I "ree &ar'et, it i! the (e&a ( a ( !0pply o" the %0rre %y *hi%h !ho0l( (eter&i e the e$%ha #e rate! b0t (e&a ( a ( !0pply i! the (epe (e t o &a y "a%tor!, *hi%h are 0lti&ately the %a0!e o" the e$%ha #e rate "l0%t0atio , !o&eti&e! *il(1 The /olatility o" e$%ha #e rate! %a ot be tra%e( to the !i #le rea!o a ( %o !e@0e tly, it be%o&e! (i""i%0lt to pre%i!ely (e"i e the "a%tor! that a""e%t e$%ha #e rate!1 Ho*e/er, the &ore i&porta t a&o # the& are a! "ollo*!: R %trength of Economy E%o o&i% "a%tor! a""e%ti # e$%ha #e rate! i %l0(e he(#i # a%ti/itie!, i tere!t rate!, i "latio ary pre!!0re!, tra(e i&bala %e, a ( e0ro &ar'et a%ti/itie!1 Ir/i # "i!her, a A&eri%a e%o o&i!t, (e/elope( a theory relati # e$%ha #e rate! to i tere!t rate!1 Thi! propo!itio , ' o* a! the "i!her e""e%t, !tate! that i tere!t rate (i""ere tial! te ( to re"le%t e$%ha #e rate e$pe%tatio 1 O the other ha (, the p0r%ha!i #5 po*er parity theory relate! e$%ha #e rate! to i "latio ary pre!!0re!1 I it! ab!ol0te /er!io , thi! theory !tate! that the e@0ilibri0& e$%ha #e rate e@0al! the ratio o" (o&e!ti% to "orei# pri%e!1 The relati/e /er!io o" the theory relate! %ha #e! i the e$%ha #e rate to %ha #e! i pri%e ratio!1 R #olitical Factor The politi%al "a%tor i "l0e %i # e$%ha #e rate! i %l0(e the e!tabli!he( &o etary poli%y alo # *ith #o/er &e t a%tio o ite&! !0%h a! the &o ey !0pply, i "latio , ta$e!, a ( (e"i%it "i a %i #1 A%ti/e #o/er &e t i ter/e tio or &a ip0latio !, !0%h a! %e tral ba ' a%ti/ity i the "orei# %0rre %y &ar'et, al!o ha/e a i&pa%t1 Other politi%al "a%tor! i "l0e %i # e$%ha #e rate! i %l0(e the politi%al !tability o" a %o0 try a ( it! relati/e e%o o&i% e$po!0re :the per%ei/e( ee( "or %ertai le/el! a ( type! o" i&port!;1 Fi ally, there i! al!o the i "l0e %e o" the i ter atio al &o etary "0 (1 R Ex$ectation of the Foreign Exchange Market 9!y%holo#i%al "a%tor! al!o i "l0e %e e$%ha #e rate!1 The!e "a%tor! i %l0(e &ar'et a ti%ipatio , !pe%0lati/e pre!!0re!, a ( "0t0re e$pe%tatio !1 A "e* "i a %ial e$pert! are o" the opi io that i to(ayB! e /iro &e t, the o ly Mtr0!t*orthyB &etho( o" pre(i%ti # e$%ha #e rate! by #0t "eel1 +ob E/eli #, /i%e pre!i(e t o" "i a %ial &ar'et! at =G, i! %orporate "i a %eB! top "orei# e$%ha #e "ore%a!ter "or 1---1 e/eli #B! #0t "eeli # ha!, (e"i e( %o /e tio , a ( hi! &etho( pro/e( 0 %a ily a%%0rate i "orei# e$%ha #e "ore%a!ti # i 1--41=G e (e( the %orporate "i a %e "ore%a!ti # year *ith a 61AAO error o/erall, the &o!t a%%0rate a&o # 1- ba '!1 The 1- C 9 a # e

FOREIGN EXCHANGE MARKET !e%ret to e/eli #B! i t0itio o a y %0rre %y i! 'eepi # abrea!t o" *orl( e/e t!1 A y e/e t, "ro& a (e%laratio o" *ar to a "ai ti # politi%al lea(er, %a ta'e it! toll o a %0rre %yB! /al0e1 To(ay, i !tea( o" "or&al &o(al!, &o!t "ore%a!ter! rely o a a&al#a& that i! part e%o o&i% "0 (a&e tal!, part &o(el a ( part )0(#&e t1

CHA9TER <: HEDGING, HEDGING IN=TRUMENT= S HEDGING =TRATEGIE= .or$orate "edging for Foreign Exchange Risk in 1ndia
I 1-.1, the +retto ,oo(! !y!te& o" a(&i i!teri # "i$e( "orei# e$%ha #e rate! *a! aboli!he( i "a/o0r o" &ar'et5(eter&i atio o" "orei# e$%ha #e rate!T a re#i&e o" "l0%t0ati # e$%ha #e rate! *a! i tro(0%e(1 +e!i(e! &ar'et5(eter&i e( "l0%t0atio !, there *a! a lot o" /olatility i other &ar'et! aro0 ( the *orl( o*i # to i %rea!e( i "latio a ( the oil !ho%'1 Corporate! !tr0##le( to %ope *ith the 0 %ertai ty i pro"it!, %a!h "lo*! a ( "0t0re %o!t!1 It *a! the that "i a %ial (eri/ati/e! G "orei# %0rre %y, i tere!t rate, a ( %o&&o(ity (eri/ati/e! e&er#e( a! &ea ! o" &a a#i # ri!'! "a%i # %orporatio !1 I I (ia, e$%ha #e rate! *ere (ere#0late( a ( *ere allo*e( to be (eter&i e( by &ar'et! i 1--71 The e%o o&i% liberali3atio o" the early i etie! "a%ilitate( the i tro(0%tio o" (eri/ati/e! ba!e( o i tere!t rate! a ( "orei# e$%ha #e1 Ho*e/er (eri/ati/e 0!e i! !till a hi#hly re#0late( area (0e to the partial %o /ertibility o" the r0pee1 C0rre tly "or*ar(!, !*ap! a ( optio ! are a/ailable i I (ia a ( the 0!e o" "orei# %0rre %y (eri/ati/e! i! per&itte( "or he(#i # p0rpo!e! o ly1 The ai& i! to pro/i(e a per!pe%ti/e o &a a#i # the ri!' that "ir&B! "a%e (0e to "l0%t0ati # e$%ha #e rate!1 It i /e!ti#ate! the pr0(e %e i i /e!ti # re!o0r%e! to*ar(! the p0rpo!e o" he(#i # a ( the i tro(0%e! the tool! "or ri!' &a a#e&e t1 The!e are the applie( i the I (ia %o te$t1 The &oti/atio o" thi! !t0(y %a&e "ro& the re%e t ri!e i /olatility i the &o ey &ar'et! o" the *orl( a ( parti%0larly i the U= Dollar, (0e to *hi%h I (ia e$port! are "a!t #ai i # a %o!t (i!a(/a ta#e1 He(#i # *ith (eri/ati/e i !tr0&e t! i! a "ea!ible !ol0tio to thi! !it0atio 1 Thi! report i! or#a i!e( i A !e%tio !1 The e$t !e%tio pre!e t! the e%e!!ity o" "orei# e$%ha #e ri!' &a a#e&e t a ( o0tli e! the pro%e!! o" &a a#i # thi! ri!'1 =e%tio 7 (i!%0!!e! the /ario0! (eter&i a t! o" he(#i # (e%i!io ! by "ir&!, "ollo*e( by a o/er/ie* o" %orporate he(#i # i I (ia i =e%tio <1 E/i(e %e "ro& &a)or I (ia "ir&! "ro& (i""ere t !e%tor! i! !0&&ari3e( here a ( =e%tio ? %o %l0(e!1

Foreign Exchange Risk Management: #rocess 0 Necessity

Fir&! (eali # i &0ltiple %0rre %ie! "a%e a ri!' :a 0 a ti%ipate( #ai Flo!!; o a%%o0 t o" !0((e F0 a ti%ipate( %ha #e! i e$%ha #e rate!, @0a ti"ie( i ter&! o" e$po!0re!1 E$po!0re i! (e"i e( a! a %o tra%te(, pro)e%te( or %o ti #e t %a!h "lo* *ho!e &a# it0(e i! ot %ertai at the &o&e t a ( (epe (! o the /al0e o" the "orei# e$%ha #e rate!1 The pro%e!! o" i(e ti"yi # ri!'! "a%e( by the "ir& a ( i&ple&e ti # the pro%e!! o" prote%tio "ro& the!e ri!'! by "i a %ial or operatio al he(#i # i! (e"i e( a! "orei# e$%ha #e ri!' &a a#e&e t1 Thi! paper li&it! it! !%ope to he(#i # o ly the "orei# e$%ha #e ri!'! "a%e( by "ir&!1

62 C 9 a # e

FOREIGN EXCHANGE MARKET

6inds of Foreign Exchange Ex$osure

Ri!' &a a#e&e t te%h i@0e! /ary *ith the type o" e$po!0re :a%%o0 ti # or e%o o&i%; a ( ter& o" e$po!0re1 A%%o0 ti # e$po!0re, al!o %alle( tra !latio e$po!0re, re!0lt! "ro& the ee( to re!tate "orei# !0b!i(iarie!B "i a %ial !tate&e t! i to the pare tB! reporti # %0rre %y a ( i! the !e !iti/ity o" et i %o&e to the /ariatio i the e$%ha #e rate bet*ee a "orei# !0b!i(iary a ( it! pare t1 E%o o&i% e$po!0re i! the e$te t to *hi%h a "ir&U! &ar'et /al0e, i a y parti%0lar %0rre %y, i! !e !iti/e to 0 e$pe%te( %ha #e! i "orei# %0rre %y1 C0rre %y "l0%t0atio ! a""e%t the /al0e o" the "ir&B! operati # %a!h "lo*!, i %o&e !tate&e t, a ( %o&petiti/e po!itio , he %e &ar'et !hare a ( !to%' pri%e1 C0rre %y "l0%t0atio ! al!o a""e%t a "ir&U! bala %e !heet by %ha #i # the /al0e o" the "ir&U! a!!et! a ( liabilitie!, a%%o0 t! payable, a%%o0 t! re%ei/able!, i /e tory, loa ! i "orei# %0rre %y, i /e!t&e t! :CD!; i "orei# ba '!T thi! type o" e%o o&i% e$po!0re i! %alle( bala %e !heet e$po!0re1 Tra !a%tio E$po!0re i! a "or& o" !hort ter& e%o o&i% e$po!0re (0e to "i$e( pri%e %o tra%ti # i a at&o!phere o" e$%ha #e5rate /olatility1 The &o!t %o&&o (e"i itio o" the &ea!0re o" e$%ha #e5rate e$po!0re i! the !e !iti/ity o" the /al0e o" the "ir&, pro$ie( by the "ir&B! !to%' ret0r , to a 0 a ti%ipate( %ha #e i a e$%ha #e rate1 Thi! i! %al%0late( by 0!i # the partial (eri/ati/e "0 %tio *here the (epe (a t /ariable i! the "ir&B! /al0e a ( the i (epe (e t /ariable i! the e$%ha #e rate :A(ler a ( D0&a!, 1-4<;1 Necessity of managing foreign exchange risk A 'ey a!!0&ptio i the %o %ept o" "orei# e$%ha #e ri!' i! that e$%ha #e rate %ha #e! are ot pre(i%table a ( that thi! i! (eter&i e( by ho* e""i%ie t the &ar'et! "or "orei# e$%ha #e are1 Re!ear%h i the area o" e""i%ie %y o" "orei# e$%ha #e &ar'et! ha! th0! "ar bee able to e!tabli!h o ly a *ea' "or& o" the e""i%ie t &ar'et hypothe!i! %o %l0!i/ely *hi%h i&plie! that !0%%e!!i/e %ha #e! i e$%ha #e rate! %a ot be pre(i%te( by a aly3i # the hi!tori%al !e@0e %e o" e$%ha #e rate!1:=oe e , 1-.-;1 Ho*e/er, *he the e""i%ie t &ar'et! theory i! applie( to the "orei# e$%ha #e &ar'et 0 (er "loati # e$%ha #e rate! there i! !o&e e/i(e %e to !0##e!t that the pre!e t pri%e! properly re"le%t all a/ailable i "or&atio 1:Gi((y a ( D0"ey, 1--6;1 Thi! i&plie! that e$%ha #e rate! rea%t to e* i "or&atio i a i&&e(iate a ( 0 bia!e( "a!hio , !o that o o e party %a &a'e a pro"it by thi! i "or&atio a ( i a y %a!e, i "or&atio o (ire%tio o" the rate! arri/e! ra (o&ly !o e$%ha #e rate! al!o "l0%t0ate ra (o&ly1 It i&plie! that "orei# e$%ha #e ri!' &a a#e&e t %a ot be (o e a*ay *ith by e&ployi # re!o0r%e! to pre(i%t e$%ha #e rate %ha #e!1 "edging as a tool to manage foreign exchange risk: There i! a !pe%tr0& o" opi io ! re#ar(i # "orei# e$%ha #e he(#i #1 =o&e "ir&! "eel he(#i # te%h i@0e! are !pe%0lati/e or (o ot "all i their area o" e$perti!e a ( he %e (o ot /e t0re i to he(#i # pra%ti%e!1 Other "ir&! are 0 a*are o" bei # e$po!e( to "orei# e$%ha #e ri!'!1 There are a !et o" "ir&! *ho o ly he(#e !o&e o" their ri!'!, *hile other! are a*are o" the /ario0! ri!'! they "a%e, b0t are 0 a*are o" the &etho(! to #0ar( the "ir& a#ai !t the ri!'1 There i! yet a other !et o" %o&pa ie! *ho belie/e !harehol(er /al0e %a ot be i %rea!e( by he(#i # the "ir&B! "orei# 61 C 9 a # e

FOREIGN EXCHANGE MARKET e$%ha #e ri!'! a! !harehol(er! %a the&!el/e! i (i/i(0ally he(#e the&!el/e! a#ai !t the !a&e 0!i # i !tr0&e t! li'e "or*ar( %o tra%t! a/ailable i the &ar'et or (i/er!i"y !0%h ri!'! o0t by &a ip0lati # their port"olio1 :Gi((y a ( D0"ey, 1--6;1 There are !o&e e$pla atio ! ba%'e( by theory abo0t the irrele/a %e o" &a a#i # the ri!' o" %ha #e i e$%ha #e rate!1 For e$a&ple, the I ter atio al Fi!her e""e%t !tate! that e$%ha #e rate! %ha #e! are bala %e( o0t by i tere!t rate %ha #e!, the 90r%ha!i # 9o*er 9arity theory !0##e!t! that e$%ha #e rate %ha #e! *ill be o""!et by %ha #e! i relati/e pri%e i (i%e!Fi "latio !i %e the 8a* o" O e 9ri%e !ho0l( hol(1 +oth the!e theorie! !0##e!t that e$%ha #e rate %ha #e! are e/e e( o0t i !o&e "or& or the other1 Al!o, the U bia!e( For*ar( Rate theory !0##e!t! that lo%'i # i the "or*ar( e$%ha #e rate o""er! the !a&e e$pe%te( ret0r a ( i! a 0 bia!e( i (i%ator o" the "0t0re !pot rate1 +0t the!e theorie! are per"e%tly playe( o0t i per"e%t &ar'et! 0 (er ho&o#e eo0! ta$ re#i&e!1 Al!o, e$%ha #e rate5li 'e( %ha #e! i "a%tor! li'e i "latio a ( i tere!t rate! ta'e ti&e to a()0!t a ( i the &ea *hile "ir&! !ta ( to lo!e o0t o a(/er!e &o/e&e t! i the e$%ha #e rate!. The e$i!te %e o" (i""ere t 'i (! o" &ar'et i&per"e%tio !, !0%h a! i %o&plete "i a %ial &ar'et!, po!iti/e tra !a%tio a ( i "or&atio %o!t!, probability o" "i a %ial (i!tre!! a ( a#e %y %o!t! a ( re!tri%tio ! o "ree tra(e &a'e "orei# e$%ha #e &a a#e&e t a appropriate %o %er "or %orporate &a a#e&e t1 :Gi((y a ( D0"ey, 1--6; It ha! al!o bee ar#0e( that a he(#e( "ir&, bei # le!! ri!'y %a !e%0re (ebt &ore ea!ily a ( thi! e )oy a ta$ a(/a ta#e :i tere!t i! e$%l0(e( "ro& ta$ *hile (i/i(e (! are ta$e(;1 Thi! *o0l( e#ate the Mo(i#lia i5Miller propo!itio a! !harehol(er! %a ot (0pli%ate !0%h ta$ a(/a ta#e!1 The MM ar#0&e t that !harehol(er! %a he(#e o their o* i! al!o ot /ali( o a%%o0 t o" hi#h tra !a%tio %o!t! a ( la%' o" ' o*le(#e abo0t "i a %ial &a ip0latio ! o the part o" !harehol(er!. There i! al!o a /a!t pool o" re!ear%h that pro/e! the e""i%a%y o" &a a#i # "orei# e$%ha #e ri!'! a ( a !i# i"i%a t a&o0 t o" e/i(e %e !ho*i # the re(0%tio o" e$po!0re *ith the 0!e o" tool! "or &a a#i # the!e e$po!0re!1 I o e o" the &ore re%e t !t0(ie!, Allaya i! a ( O"e' :6221; 0!e a &0lti/ariate a aly!i! o a !a&ple o" =S9 ?22 o 5"i a %ial "ir&! a ( %al%0late a "ir&! e$%ha #e5rate e$po!0re 0!i # the ratio o" "orei# !ale! to total !ale! a! a pro$y a ( i!olate the i&pa%t o" 0!e o" "orei# %0rre %y (eri/ati/e! :part o" "orei# e$%ha #e ri!' &a a#e&e t; o a "ir&B! "orei# e$%ha #e e$po!0re!1 They "i ( a !tati!ti%ally !i# i"i%a t a!!o%iatio bet*ee the ab!ol0te /al0e o" the e$po!0re! a ( the :ab!ol0te /al0e; o" the per%e ta#e 0!e o" "orei# %0rre %y (eri/ati/e! a ( pro/e that the 0!e o" (eri/ati/e! i "a%t re(0%e e$po!0re1 Risk Management and %ettlement of !ransactions in the Foreign Exchange Market The "orei# e$%ha #e &ar'et i! %hara%teri3e( by %o !ta t %ha #e! a ( rapi( i o/atio ! i tra(i # &etho(! a ( pro(0%t!1 ,hile the i o/ati/e pro(0%t! a ( *ay! o" tra(i # %reate e* po!!ibilitie! "or pro"it, they al!o po!e /ario0! 'i (! o" ri!'! to the &ar'et1 Ce tral ba '! all o/er the *orl(, there"ore, ha/e be%o&e i %rea!i #ly %o %er e( o" the !%ale o" "orei# e$%ha #e !ettle&e t ri!' a ( the i&porta %e o" ri!' &iti#atio &ea!0re!1 +ehi ( thi! #ro*i # a*are e!! are !e/eral e/e t! i the pa!t i *hi%h "orei# e$%ha #e !ettle&e t ri!' &i#ht ha/e re!0lte( i !y!te&i% ri!' i #lobal "i a %ial &ar'et!, i %l0(i # the "ail0re o" +a 'ha0! Her!tatt i 1-.< a ( the %lo!0re o" +CCI =A i 1--11

66 C 9 a # e

FOREIGN EXCHANGE MARKET The "orei# e$%ha #e !ettle&e t ri!' ari!e! be%a0!e the (eli/ery o" the t*o %0rre %ie! i /ol/e( i a tra(e 0!0ally o%%0r! i t*o (i""ere t %o0 trie!, *hi%h, i &a y %a!e! are lo%ate( i (i""ere t ti&e 3o e!1 Thi! ri!' i! o" parti%0lar %o %er to the %e tral ba '! #i/e the lar#e /al0e! i /ol/e( i !ettli # "orei# e$%ha #e tra !a%tio ! a ( the re!0lti # pote tial "or !y!te&i% ri!'1 Mo!t o" the ba '! i the EME! 0!e !o&e "or& o" &etho(olo#y "or &ea!0ri # the "orei# e$%ha #e !ettle&e t e$po!0re1 Ma y o" the!e ba '! 0!e the !i #le (ay &etho(, i *hi%h the e$po!0re i! &ea!0re( a! bei # e@0al to all "orei# e$%ha #e re%eipt! that are (0e o the (ay1 =o&e i !tit0tio ! 0!e a &0ltiple (ay approa%h "or &ea!0ri # ri!'1 Mo!t o" the ba '! i EME! 0!e !o&e "or& o" i (i/i(0al %o0 terparty li&it to &a a#e their e$po!0re!1 The!e li&it! are o"te applie( to the #lobal operatio ! o" the i !tit0tio 1 The!e li&it! are !o&eti&e! &o itore( by ba '! o a re#0lar ba!i!1 I %ertai %a!e!, there are !eparate li&it! "or "orei# e$%ha #e !ettle&e t e$po!0re!, *hile i other %a!e!, li&it! "or a##re#ate !ettle&e t e$po!0re! are %reate( thro0#h a ra #e o" i !tr0&e t!1 +ilateral obli#atio etti #, i )0ri!(i%tio ! *here it i! le#ally %ertai , i! a i&porta t *ay "or tra(e %o0 terpartie! to &iti#ate the "orei# e$%ha #e !ettle&e t ri!'1 Thi! pro%e!! allo*! tra(e %o0 terpartie! to o""!et their #ro!! !ettle&e t obli#atio ! to ea%h other i the %0rre %ie! they ha/e tra(e( a ( !ettle the!e obli#atio ! *ith the pay&e t o" a !i #le et a&o0 t i ea%h %0rre %y1 =e/eral e&er#i # &ar'et! i re%e t year! ha/e i&ple&e te( (o&e!ti% real ti&e #ro!! !ettle&e t :RTG=; !y!te&! "or the !ettle&e t o" hi#h /al0e a ( ti&e %riti%al pay&e t! to !ettle the (o&e!ti% le# o" "orei# e$%ha #e tra !a%tio !1 Apart "ro& ri!' re(0%tio , the!e i itiati/e! e able parti%ipa t! to a%ti/ely &a a#e the ti&e at *hi%h they irre/o%ably pay a*ay *he !elli # the (o&e!ti% %0rre %y, a ( re%o %ile "i al re%eipt *he p0r%ha!i # the (o&e!ti% %0rre %y1 9arti%ipa t!, there"ore, are able to re(0%e the (0ratio o" the "orei# e$%ha #e !ettle&e t ri!'1 Re%o# i3i # the !y!te&i% i&pa%t o" "orei# e$%ha #e !ettle&e t ri!', a i&porta t ele&e t i the i "ra!tr0%t0re "or the e""i%ie t "0 %tio i # o" the I (ia "orei# e$%ha #e &ar'et ha! bee the %leari # a ( !ettle&e t o" i ter5ba ' U=D5INR tra !a%tio !1 I p0r!0a %e o" the re%o&&e (atio ! o" the =o(ha i Co&&ittee, the Re!er/e +a ' ha( !et 0p the Cleari # Corporatio o" I (ia 8t(1 :CCI8; i 6221 to &iti#ate ri!'! i the I (ia "i a %ial &ar'et!1 The CCI8 %o&&e %e( !ettle&e t o" "orei# e$%ha #e operatio ! "or i ter5ba ' U=D5INR !pot a ( "or*ar( tra(e! "ro& No/e&ber 4, 6226 a ( "or i ter5ba ' U=D5INR %a!h a ( to& tra(e! "ro& Febr0ary ?, 622<1 The CCI8 0 (erta'e! !ettle&e t o" "orei# e$%ha #e tra(e! o a &0ltilateral et ba!i! thro0#h a pro%e!! o" o/atio a ( all !pot, %a!h a ( to& tra !a%tio ! are #0ara tee( "or !ettle&e t "ro& the tra(e (ate1 E/ery eli#ible "orei# e$%ha #e %o tra%t e tere( bet*ee &e&ber! #et! o/ate( or repla%e( by t*o e* %o tra%t! G bet*ee the CCI8 a ( ea%h o" the t*o partie!, re!pe%ti/ely1 Follo*i # the &0ltilateral etti # pro%e(0re, the et a&o0 t payable to, or re%ei/able "ro&, the CCI8 i ea%h %0rre %y i! arri/e( at, &e&ber5*i!e1 The R0pee le# i! !ettle( thro0#h the &e&ber!B %0rre t a%%o0 t! *ith the Re!er/e +a ' a ( the U=D le# thro0#h CCI8B! a%%o0 t *ith the !ettle&e t ba ' at Ne* Dor'1 The CCI8 !et! li&it! "or ea%h &e&ber ba ' o the ba!i! o" %ertai para&eter! !0%h a! &e&berB! %re(it rati #, et *orth, a!!et /al0e a ( &a a#e&e t @0ality1 The CCI8 !ettle( o/er -22,222 (eal! "or a #ro!! /ol0&e o" U= K 1,142 billio i 622?52A1 The CCI8 ha! %o !i!te tly e (ea/ore( to a(( /al0e to the !er/i%e! a ( ha! #ra(0ally bro0#ht the e tire #a&0t o" "orei# e$%ha #e tra !a%tio ! 0 (er it! p0r/ie*1 I ter&e(iatio , by the CCI8 th0!, 67 C 9 a # e

FOREIGN EXCHANGE MARKET pro/i(e! it! &e&ber! the be e"it! o" ri!' &iti#atio , i&pro/e( e""i%ie %y, lo*er operatio al %o!t a ( ea!ier re%o %iliatio o" a%%o0 t! *ith %orre!po (e t!1 A i!!0e relate( to the #0ara tee( !ettle&e t o" tra !a%tio ! by the CCI8 ha! bee the e$te !io o" thi! "a%ility to all "or*ar( tra(e! a! *ell1 Me&ber ba '! %0rre tly e %o0 ter proble&! i ter&! o" h0#e o0t!ta (i # "orei# e$%ha #e e$po!0re! i their boo'! a ( thi! %o&e! i the *ay o" their (oi # &ore tra(e! i the &ar'et1 Ri!'! o !0%h h0#e o0t!ta (i # tra(e! *ere "o0 ( to be /ery hi#h a ( !o *ere the %apital re@0ire&e t! "or !0pporti # !0%h tra(e!1 He %e, &a y &e&ber ba '! ha/e e$pre!!e( their (e!ire i !e/eral "ora that the CCI8 !ho0l( e$te ( it! #0ara tee to the!e "or*ar( tra(e! "ro& the tra(e (ate it!el" *hi%h %o0l( lea( to !i# i"i%a t i %rea!e i the li@0i(ity a ( (epth i the "or*ar( &ar'et1 The ri!'! that ba '! to(ay %arry i their boo'! o a%%o0 t o" lar#e o0t!ta (i # "or*ar( po!itio ! *ill al!o be !i# i"i%a tly re(0%e( :Gopi ath, 622?;1 Thi! ha! al!o bee o e o" the re%o&&e (atio ! o" the Co&&ittee o F0ller Capital A%%o0 t Co /ertibility1 A1?? Apart "ro& &a a#i # the "orei# e$%ha #e !ettle&e t ri!', parti%ipa t! al!o ee( to &a a#e &ar'et ri!', li@0i(ity ri!', %re(it ri!' a ( operatio al ri!' e""i%ie tly to a/oi( "0t0re lo!!e!1 A! per the #0i(eli e! "ra&e( by the Re!er/e +a ' "or ba '! to &a a#e ri!' i the i ter5ba ' "orei# e$%ha #e (eali #! a ( e$po!0re i (eri/ati/e &ar'et! a! &ar'et &a'er!, the boar(! o" (ire%tor! o" AD! :%ate#ory5I; are re@0ire( to "ra&e a appropriate poli%y a ( "i$ !0itable li&it! "or operatio ! i the "orei# e$%ha #e &ar'et1 The et o/er i#ht ope e$%ha #e po!itio a ( the a##re#ate #ap li&it! ee( to be appro/e( by the Re!er/e +a '1 The ope po!itio i! #e erally &ea!0re( !eparately "or ea%h "orei# %0rre %y %o !i!ti # o" the et !pot po!itio , the et "or*ar( po!itio , a ( the et optio ! po!itio 1 Hario0! li&it! "or e$po!0re, viz1, o/er i#ht, (ayli#ht, !top lo!!, #ap li&it, %re(it li&it, /al0e at ri!' :HaR;, etc., "or "orei# e$%ha #e tra !a%tio ! by ba '! are "i$e(1 ,ithi the %o to0r o" the!e li&it!, "ro t o""i%e o" the trea!0ry o" AD! tra !a%t! i the "orei# e$%ha #e &ar'et "or %0!to&er! a ( o* proprietary re@0ire&e t!1 The!e e$po!0re! are a%%o0 te(, %o "ir&e( a ( !ettle( by ba%' o""i%e, *hile &i(5o""i%e e/al0ate! the pro"it a ( &o itor! a(here %e to ri!' li&it! o a %o ti 0o0! ba!i!1 I the %a!e o" &ar'et ri!', &o!t ba '! 0!e a %o&bi atio o" &ea!0re&e t te%h i@0e! i %l0(i # HaR &o(el!1 The %re(it ri!' i! #e erally &ea!0re( a ( &a a#e( by &o!t ba '! o a a##re#ate %o0 ter5party ba!i! !o a! to i %l0(e all e$po!0re! i the 0 (erlyi # !pot a ( (eri/ati/e &ar'et!1 =o&e ba '! al!o &o itor %o0 try ri!' thro0#h %ro!!5bor(er %o0 try ri!' e$po!0re li&it!1 8i@0i(ity ri!' i! #e erally e!ti&ate( by &o itori # a!!et liability pro"ile i /ario0! %0rre %ie! i /ario0! b0%'et! a ( &o itori # %0rre %y5*i!e #ap! i /ario0! b0%'et!1 +a '! al!o tra%' bala %e! to be &ai tai e( o a (aily ba!i! i No!tro a%%o0 t!, re&itta %e! a ( %o&&itte( "orei# %0rre %y ter& loa ! *hile &o itori # li@0i(ity ri!'1 To !0& 0p, the "orei# e$%ha #e &ar'et !tr0%t0re i I (ia ha! 0 (er#o e !0b!ta tial tra !"or&atio "ro& the early 1--2!1 The &ar'et parti%ipa t! ha/e be%o&e (i/er!i"ie( a ( there are !e/eral i !tr0&e t! a/ailable to &a a#e their ri!'!1 =o0r%e! o" !0pply a ( (e&a ( i the "orei# e$%ha #e &ar'et ha/e al!o %ha #e( i li e *ith the !hi"t! i the relati/e i&porta %e i bala %e o" pay&e t! "ro& %0rre t to %apital a%%o0 t1 There ha! al!o bee %o !i(erable i&pro/e&e t i the &ar'et i "ra!tr0%t0re i ter&! o" tra(i # plat"or&! a ( !ettle&e t &e%ha i!&!1 Tra(i # i I (ia "orei# e$%ha #e &ar'et i! lar#ely %o %e trate( i the !pot !e#&e t e/e a! /ol0&e! i the (eri/ati/e! !e#&e t are o the ri!e1 =o&e o" the i!!0e! that ee( atte tio to "0rther i&pro/e the a%ti/ity i the (eri/ati/e! !e#&e t i %l0(e "le$ibility i the 0!e o" /ario0! i !tr0&e t!, e ha %i # the ' o*le(#e a ( 0 (er!ta (i # the at0re o" ri!' i /ol/e( 6< C 9 a # e

FOREIGN EXCHANGE MARKET i tra !a%ti # the (eri/ati/e pro(0%t!, re/ie*i # the role o" 0 (erlyi # i boo'i # "or*ar( %o tra%t! a ( #0ara tee( !ettle&e t! o" "or*ar(!1 +e!i(e!, &ar'et player! *o0l( ee( to a%@0ire the e%e!!ary e$perti!e to 0!e (i""ere t 'i (! o" i !tr0&e t! a ( &a a#e the ri!'! i /ol/e(1

Foreign Exchange Risk Management Framework

O %e a "ir& re%o# i3e! it! e$po!0re, it the ha! to (eploy re!o0r%e! i &a a#i # it1 A he0ri!ti% "or "ir&! to &a a#e thi! ri!' e""e%ti/ely i! pre!e te( belo* *hi%h %a be &o(i"ie( to !0it "ir&5 !pe%i"i% ee(! i1e1 !o&e or all the "ollo*i # tool! %o0l( be 0!e(1 Forecasts: A"ter (eter&i i # it! e$po!0re, the "ir!t !tep "or a "ir& i! to (e/elop a "ore%a!t o the &ar'et tre (! a ( *hat the &ai (ire%tio Ftre ( i! #oi # to be o the "orei# e$%ha #e rate!1 The perio( "or "ore%a!t! i! typi%ally A &o th!1 It i! i&porta t to ba!e the "ore%a!t! o /ali( a!!0&ptio !1 Alo # *ith i(e ti"yi # tre (!, a probability !ho0l( be e!ti&ate( "or the "ore%a!t %o&i # tr0e a! *ell a! ho* &0%h the %ha #e *o0l( be1 Risk Estimation: +a!e( o the "ore%a!t, a &ea!0re o" the alue at !is" :the a%t0al pro"it or lo!! "or a &o/e i rate! a%%or(i # to the "ore%a!t; a ( the probability o" thi! ri!' !ho0l( be a!%ertai e(1 The ri!' that a tra !a%tio *o0l( "ail (0e to mar"et#specific problems$ !ho0l( be ta'e i to a%%o0 t1 Fi ally, the =y!te&! Ri!' that %a ari!e (0e to i a(e@0a%ie! !0%h a! reporti # #ap! a ( i&ple&e tatio #ap! i the "ir&!B e$po!0re &a a#e&e t !y!te& !ho0l( be e!ti&ate(1 -enchmarking: Gi/e the e$po!0re! a ( the ri!' e!ti&ate!, the "ir& ha! to !et it! li&it "or ha (li # "orei# e$%ha #e e$po!0re1 The "ir& al!o ha! to (e%i(e *hether to &a a#e it! e$po!0re! o a %o!t %e tre or pro"it %e tre ba!i!1 A %o!t %e tre approa%h i! a (e"e !i/e o e a ( the &ai ai& i! e !0re that %a!h "lo*! o" a "ir& are ot a(/er!ely a""e%te( beyo ( a poi t1 A pro"it %e tre approa%h o the other ha ( i! a &ore a##re!!i/e approa%h *here the "ir& (e%i(e! to #e erate a et pro"it o it! e$po!0re o/er ti&e1 "edging: +a!e( o the li&it! a "ir& !et "or it!el" to &a a#e e$po!0re, the "ir&! the (e%i(e! a appropriate he(#i # !trate#y1 There are /ario0! "i a %ial i !tr0&e t! a/ailable "or the "ir& to %hoo!e "ro&: "0t0re!, "or*ar(!, optio ! a ( !*ap! a ( i!!0e o" "orei# (ebt1 He(#i # !trate#ie! a ( i !tr0&e t! are e$plore( i a !e%tio 1 %to$ <oss: The "ir&! ri!' &a a#e&e t (e%i!io ! are ba!e( o "ore%a!t! *hi%h are b0t e!ti&ate! o" rea!o ably 0 pre(i%table tre (!1 It i! i&perati/e to ha/e !top lo!! arra #e&e t! i or(er to re!%0e the "ir& i" the "ore%a!t! t0r o0t *ro #1 For thi!, there !ho0l( be %ertai &o itori # !y!te&! i pla%e to (ete%t %riti%al le/el! i the "orei# e$%ha #e rate! "or appropriate &ea!0re to be ta'e 1 Re$orting and Review: Ri!' &a a#e&e t poli%ie! are typi%ally !0b)e%te( to re/ie* ba!e( o perio(i% reporti #1 The report! &ai ly i %l0(e pro"itF lo!! !tat0! o ope %o tra%t! a"ter &ar'i # to &ar'et, the a%t0al e$%ha #eF i tere!t rate a%hie/e( o ea%h e$po!0re a ( pro"itability /i!5V5/i! the be %h&ar' a ( the e$pe%te( %ha #e! i o/erall e$po!0re (0e to "ore%a!te( e$%ha #eF i tere!t rate &o/e&e t!1 The re/ie* a aly!e! *hether the be %h&ar'! !et are /ali( a ( e""e%ti/e i %o trolli # the e$po!0re!, *hat the &ar'et tre (! are a ( "i ally *hether the o/erall !trate#y i! *or'i # or ee(! %ha #e1 6? C 9 a # e

FOREIGN EXCHANGE MARKET

"edging %trategies= 1nstruments

A (eri/ati/e i! a "i a %ial %o tra%t *ho!e /al0e i! (eri/e( "ro& the /al0e o" !o&e other "i a %ial a!!et, !0%h a! a !to%' pri%e, a %o&&o(ity pri%e, a e$%ha #e rate, a i tere!t rate, or e/e a i (e$ o" pri%e!1 The &ai role o" (eri/ati/e! i! that they reallo%ate ri!' a&o # "i a %ial &ar'et parti%ipa t!, help to &a'e "i a %ial &ar'et! &ore %o&plete1 Thi! !e%tio o0tli e! the he(#i # !trate#ie! 0!i # (eri/ati/e! *ith "orei# e$%ha #e bei # the o ly ri!' a!!0&e(1 Forwards A "or*ar( i! a &a(e5to5&ea!0re a#ree&e t bet*ee t*o partie! to b0yF!ell a !pe%i"ie( a&o0 t o" a %0rre %y at a !pe%i"ie( rate o a parti%0lar (ate i the "0t0re1 The (epre%iatio o" the re%ei/able %0rre %y i! he(#e( a#ai !t by !elli # a %0rre %y "or*ar(1 I" the ri!' i! that o" a %0rre %y appre%iatio :i" the "ir& ha! to b0y that %0rre %y i "0t0re !ay "or i&port;, it %a he(#e by b0yi # the %0rre %y "or*ar(1 E1#1 i" RI8 *a t! to b0y %r0(e oil i U= (ollar! !i$ &o th! he %e, it %a e ter i to a "or*ar( %o tra%t to pay INR a ( b0y U=D a ( lo%' i a "i$e( e$%ha #e rate "or INR5 U=D to be pai( a"ter A &o th! re#ar(le!! o" the a%t0al INR5Dollar rate at the ti&e1 I thi! e$a&ple the (o* !i(e i! a appre%iatio o" Dollar *hi%h i! prote%te( by a "i$e( "or*ar( %o tra%t1 The &ai a(/a ta#e o" a "or*ar( i! that it %a be tailore( to the !pe%i"i% ee(! o" the "ir& a ( a e$a%t he(#e %a be obtai e(1 O the (o* !i(e, the!e %o tra%t! are ot &ar'etable, they %a Bt be !ol( to a other party *he they are o lo #er re@0ire( a ( are bi (i #1 Futures A "0t0re! %o tra%t i! !i&ilar to the "or*ar( %o tra%t b0t i! &ore li@0i( be%a0!e it i! tra(e( i a or#a i3e( e$%ha #e i1e1 the "0t0re! &ar'et1 Depre%iatio o" a %0rre %y %a be he(#e( by !elli # "0t0re! a ( appre%iatio %a be he(#e( by b0yi # "0t0re!1 A(/a ta#e! o" "0t0re! are that there i! a %e tral &ar'et "or "0t0re! *hi%h eli&i ate! the proble& o" (o0ble %oi %i(e %e1 F0t0re! re@0ire a !&all i itial o0tlay :a proportio o" the /al0e o" the "0t0re; *ith *hi%h !i# i"i%a t a&o0 t! o" &o ey %a be #ai e( or lo!t *ith the a%t0al "or*ar(! pri%e "l0%t0atio !1 Thi! pro/i(e! a !ort o" le/era#e1 The pre/io0! e$a&ple "or a "or*ar( %o tra%t "or RI8 applie! here al!o )0!t that RI8 *ill ha/e to #o to a U=D "0t0re! e$%ha #e to p0r%ha!e !ta (ar(i3e( (ollar "0t0re! e@0al to the a&o0 t to be he(#e( a! the ri!' i! that o" appre%iatio o" the (ollar1 A! &e tio e( earlier, the tailorability o" the "0t0re! %o tra%t i! li&ite( i1e1 o ly !ta (ar( (e o&i atio ! o" &o ey %a be bo0#ht i !tea( o" the e$a%t a&o0 t! that are bo0#ht i "or*ar( %o tra%t!1 O$tions A %0rre %y Optio i! a %o tra%t #i/i # the ri#ht, ot the obli#atio , to b0y or !ell a !pe%i"i% @0a tity o" o e "orei# %0rre %y i e$%ha #e "or a other at a "i$e( pri%eT %alle( the E$er%i!e 9ri%e or =tri'e 9ri%e1 The "i$e( at0re o" the e$er%i!e pri%e re(0%e! the 0 %ertai ty o" e$%ha #e rate %ha #e! a ( li&it! the lo!!e! o" ope %0rre %y po!itio !1 Optio ! are parti%0larly !0ite( a! a he(#i # tool "or %o ti #e t %a!h "lo*!, a! i! the %a!e i bi((i # pro%e!!e!1 Call Optio ! are 0!e( i" the ri!' i! a 0p*ar( tre ( i pri%e :o" the %0rre %y;, *hile 90t Optio ! are 0!e( i" the ri!' i! a (o* *ar( tre (1 A#ai ta'i # the e$a&ple o" RI8 *hi%h ee(! to p0r%ha!e %r0(e oil i U=D i 6A C 9 a # e

FOREIGN EXCHANGE MARKET A &o th!, i" RI8 b0y! a Call optio :a! the ri!' i! a 0p*ar( tre ( i (ollar rate;, i1e1 the ri#ht to b0y a !pe%i"ie( a&o0 t o" (ollar! at a "i$e( rate o a !pe%i"ie( (ate, there are t*o !%e ario!1 I" the e$%ha #e rate &o/e&e t i! "a/orable i1e1 the (ollar (epre%iate!, the RI8 %a b0y the& at the !pot rate a! they ha/e be%o&e %heaper1 I the other %a!e, i" the (ollar appre%iate! %o&pare( to to(ayB! !pot rate, RI8 %a e$er%i!e the optio to p0r%ha!e it at the a#ree( !tri'e pri%e1 I either %a!e RI8 be e"it! by payi # the lo*er pri%e to p0r%ha!e the (ollar %wa$s A !*ap i! a "orei# %0rre %y %o tra%t *hereby the b0yer a ( !eller e$%ha #e e@0al i itial pri %ipal a&o0 t! o" t*o (i""ere t %0rre %ie! at the !pot rate1 The b0yer a ( !eller e$%ha #e "i$e( or "loati # rate i tere!t pay&e t! i their re!pe%ti/e !*appe( %0rre %ie! o/er the ter& o" the %o tra%t1 At &at0rity, the pri %ipal a&o0 t i! e""e%ti/ely re5!*appe( at a pre(eter&i e( e$%ha #e rate !o that the partie! e ( 0p *ith their ori#i al %0rre %ie!1 The a(/a ta#e! o" !*ap! are that "ir&! *ith li&ite( appetite "or e$%ha #e rate ri!' &ay &o/e to a partially or %o&pletely he(#e( po!itio thro0#h the &e%ha i!& o" "orei# %0rre %y !*ap!, *hile lea/i # the 0 (erlyi # borro*i # i ta%t1 Apart "ro& %o/eri # the e$%ha #e rate ri!', !*ap! al!o allo* "ir&! to he(#e the "loati # i tere!t rate ri!'1 Co !i(er a e$port orie te( %o&pa y that ha! e tere( i to a !*ap "or a otio al pri %ipal o" U=D 1 & at a e$%ha #e rate o" <6F(ollar1 The %o&pa y pay! U= A&o th! 8I+OR to the ba ' a ( re%ei/e! 11122O p1a1 e/ery A &o th! o 1!t >a 0ary S 1!t >0ly, till ? year!1 =0%h a %o&pa y *o0l( ha/e ear i #! i Dollar! a ( %a 0!e the !a&e to pay i tere!t "or thi! 'i ( o" borro*i # :i (ollar! rather tha i R0pee; th0! he(#i # it! e$po!0re!1 Foreign 4ebt Forei# (ebt %a be 0!e( to he(#e "orei# e$%ha #e e$po!0re by ta'i # a(/a ta#e o" the I ter atio al Fi!%her E""e%t relatio !hip1 Thi! i! (e&o !trate( *ith the e$a&ple o" a e$porter *ho ha! to re%ei/e a "i$e( a&o0 t o" (ollar! i a "e* &o th! "ro& pre!e t1 The e$porter !ta (! to lo!e i" the (o&e!ti% %0rre %y appre%iate! a#ai !t that %0rre %y i the &ea *hile !o, to he(#e thi!T he %o0l( ta'e a loa i the "orei# %0rre %y "or the !a&e ti&e perio( a ( %o /ert the !a&e i to (o&e!ti% %0rre %y at the %0rre t e$%ha #e rate1 The theory a!!0re! that the #ai reali3e( by i /e!ti # the pro%ee(! "ro& the loa *o0l( &at%h the i tere!t rate pay&e t :i the "orei# %0rre %y; "or the loa 1 Choi%e o" he(#i # i !tr0&e t! The literat0re o the %hoi%e o" he(#i # i !tr0&e t! i! /ery !%a t1 A&o # the a/ailable !t0(ie!, GW%3y et al1 :1--.; ar#0e! that %0rre %y !*ap! are &ore %o!t5e""e%ti/e "or he(#i # "orei# (ebt ri!', *hile "or*ar( %o tra%t! are &ore %o!t5e""e%ti/e "or he(#i # "orei# operatio ! ri!'1 Thi! i! be%a0!e "orei# %0rre %y (ebt pay&e t! are lo #5ter& a ( pre(i%table, *hi%h "it! the lo #5ter& at0re o" %0rre %y !*ap %o tra%t!1 Forei# %0rre %y re/e 0e!, o the other ha (, are !hort5ter& a ( 0 pre(i%table, i li e *ith the !hort5ter& at0re o" "or*ar( %o tra%t!1 A !0r/ey (o e by Mar!hall :6222; al!o poi t! o0t that %0rre %y !*ap! are better "or he(#i # a#ai !t tra !latio ri!', *hile "or*ar(! are better "or he(#i # a#ai !t tra !a%tio ri!'1 Thi! !t0(y al!o pro/i(e! a e%(otal e/i(e %e that pri%i # poli%y i! the &o!t pop0lar &ea ! o" he(#i # e%o o&i% e$po!0re!1

6. C 9 a # e

FOREIGN EXCHANGE MARKET The!e re!0lt! ho*e/er %a (i""er "or (i""ere t %0rre %ie! (epe (i # i the !e !iti/ity o" that %0rre %y to /ario0! &ar'et "a%tor!1 Re#0latio i the "orei# e$%ha #e &ar'et! o" /ario0! %o0 trie! &ay al!o !'e* !0%h re!0lt!

4eterminants of "edging 4ecisions

The &a a#e&e t o" "orei# e$%ha #e ri!', a! ha! bee e!tabli!he( !o "ar, i! a "airly %o&pli%ate( pro%e!!1 A "ir&, e$po!e( to "orei# e$%ha #e ri!', ee(! to "or&0late a !trate#y to &a a#e it, %hoo!i # "ro& &0ltiple alter ati/e!1 Thi! !e%tio e$plore! *hat "a%tor! "ir&! ta'e i to %o !i(eratio *he "or&0lati # the!e !trate#ie!1 #roduction and !rade vs9 "edging 4ecisions A i&porta t i!!0e "or &0lti atio al "ir&! i! the allo%atio o" %apital a&o # (i""ere t %o0 trie! pro(0%tio a ( !ale! a ( at the !a&e ti&e he(#i # their e$po!0re to the /aryi # e$%ha #e rate!1 Re!ear%h i thi! area !0##e!t! that the ele&e t! o" e$%ha #e rate 0 %ertai ty a ( the attit0(e to*ar( ri!' are irrele/a t to the &0lti atio al "ir&U! !ale! a ( pro(0%tio (e%i!io ! %&roll, '(()*. O ly the re/e 0e "0 %tio a ( %o!t o" pro(0%tio are to be a!!e!!e(, a (, the pro(0%tio a ( tra(e (e%i!io ! i &0ltiple %o0 trie! are i (epe (e t o" the he(#i # (e%i!io . The i&pli%atio o" thi! i (epe (e %e i! that the pre!e %e o" &ar'et! "or he(#i # i !tr0&e t! #reatly re(0%e! the %o&ple$ity i /ol/e( i a "ir&B! (e%i!io &a'i # a! it %a !eparate pro(0%tio a ( !ale! "0 %tio ! "ro& the "i a %e "0 %tio 1 The "ir& a/oi(! the ee( to "or& e$pe%tatio ! abo0t "0t0re e$%ha #e rate! a ( "or&0latio o" ri!' pre"ere %e! *hi%h e tail! hi#h i "or&atio %o!t!1 .ost of "edging He(#i # %a be (o e thro0#h the (eri/ati/e! &ar'et or thro0#h &o ey &ar'et! :"orei# (ebt;1 I either %a!e the %o!t o" he(#i # !ho0l( be the (i""ere %e bet*ee /al0e re%ei/e( "ro& a he(#e( po!itio a ( the /al0e re%ei/e( i" the "ir& (i( ot he(#e1 I the pre!e %e o" e""i%ie t &ar'et!, the %o!t o" he(#i # i the "or*ar( &ar'et i! the (i""ere %e bet*ee the "0t0re !pot rate a ( %0rre t "or*ar( rate pl0! a y tra !a%tio ! %o!t a!!o%iate( *ith the "or*ar( %o tra%t1 =i&ilarly, the e$pe%te( %o!t! o" he(#i # i the &o ey &ar'et are the tra !a%tio ! %o!t pl0! the (i""ere %e bet*ee the i tere!t rate (i""ere tial a ( the e$pe%te( /al0e o" the (i""ere %e bet*ee the %0rre t a ( "0t0re !pot rate!1 I e""i%ie t &ar'et!, both type! o" he(#i # !ho0l( pro(0%e !i&ilar re!0lt! at the !a&e %o!t!, be%a0!e i tere!t rate! a ( "or*ar( a ( !pot e$%ha #e rate! are (eter&i e( !i&0lta eo0!ly1 The %o!t! o" he(#i #, a!!0&i # e""i%ie %y i "orei# e$%ha #e &ar'et! re!0lt i p0re tra !a%tio %o!t!1 The three &ai ele&e t! o" the!e tra !a%tio %o!t! are bro'era#e or !er/i%e "ee! %har#e( by (ealer!, i "or&atio %o!t! !0%h a! !0b!%riptio to Re0ter report! a ( e*! %ha el! a ( a(&i i!trati/e %o!t! o" e$po!0re &a a#e&e t1 Factors affecting the decision to hedge foreign currency risk Re!ear%h i the area o" (eter&i a t! o" he(#i # !eparate! the (e%i!io o" a "ir& to he(#e "ro& that o" ho* &0%h to he(#e1 There i! %o %l0!i/e e/i(e %e to !0##e!t that "ir&! *ith lar#er !i3e, RSD e$pe (it0re a ( e$po!0re to e$%ha #e rate! thro0#h "orei# !ale! a ( "orei# tra(e are &ore li'ely to 0!e (eri/ati/e!1 : Allayanis and +fe", ,--'* Fir!t, the "ollo*i # !e%tio (e!%ribe! the "a%tor! that a""e%t the (e%i!io to he(#e a ( the the "a%tor! a""e%ti # the (e#ree o" he(#i # are %o !i(ere(1

64 C 9 a # e

FOREIGN EXCHANGE MARKET Firm si e Fir& !i3e a%t! a! a pro$y "or the %o!t o" he(#i # or e%o o&ie! o" !%ale1 Ri!' &a a#e&e t i /ol/e! "i$e( %o!t! o" !etti # 0p o" %o&p0ter !y!te&! a ( trai i #Fhiri # o" per!o el i "orei# e$%ha #e &a a#e&e t1 Moreo/er, lar#e "ir&! &i#ht be %o !i(ere( a! &ore %re(it*orthy %o0 terpartie! "or "or*ar( or !*ap tra !a%tio !, th0! "0rther re(0%i # their %o!t o" he(#i # . .he boo" value of assets is used as a measure of firm size. <everage A%%or(i # to the ri!' &a a#e&e t literat0re, "ir&! *ith hi#h le/era#e ha/e #reater i %e ti/e to e #a#e i he(#i # be%a0!e (oi # !o re(0%e! the probability, a ( th0! the e$pe%te( %o!t o" "i a %ial (i!tre!!1 Hi#hly le/ere( "ir&! a/oi( "orei# (ebt a! a &ea ! to he(#e a ( 0!e (eri/ati/e!1 <i5uidity and $rofitability: Fir&! *ith hi#hly li@0i( a!!et! or hi#h pro"itability ha/e le!! i %e ti/e to e #a#e i he(#i # be%a0!e they are e$po!e( to a lo*er probability o" "i a %ial (i!tre!! . /iquidity is measured by the quic" ratio, i.e. quic" assets divided by current liabilities*. 0rofitability is measured as E&I. divided by boo" assets. %ales growth =ale! #ro*th i! a "a%tor (eter&i i # (e%i!io to he(#e a! opport0 itie! are &ore li'ely to be a""e%te( by the 0 (eri /e!t&e t proble&1 For the!e "ir&!, he(#i # *ill re(0%e the probability o" ha/i # to rely o e$ter al "i a %i #, *hi%h i! %o!tly "or i "or&atio a!y&&etry rea!o !, a ( th0! e able the& to e )oy 0 i terr0pte( hi#h #ro*th1 .he measure of sales growth is obtained using the )#year geometric average of yearly sales growth rates. A! re#ar(! the (e#ree o" he(#i # Allaya i! a ( O"e' :6221; %o %l0(e that the !ole (eter&i a t! o" the (e#ree o" he(#i # are e$po!0re "a%tor! :"orei# !ale! a ( tra(e;1 I other *or(!, #i/e that a "ir& (e%i(e! to he(#e, the (e%i!io o" ho* &0%h to he(#e i! a""e%te( !olely by it! e$po!0re to "orei# %0rre %y &o/e&e t!1 Thi! (i!%0!!io hi#hli#ht! ho* ri!' &a a#e&e t !y!te&! ha/e to be altere( a%%or(i # to %hara%teri!ti%! o" the "ir&, he(#i # %o!t!, at0re o" operatio !, ta$ %o !i(eratio !, re#0latory re@0ire&e t! et%1 The e$t !e%tio (i!%0!!e! the!e i!!0e! i the I (ia %o te$t a ( re#0latory e /iro &e t1

6- C 9 a # e

FOREIGN EXCHANGE MARKET

CHA9TER ?: FINDING= AND CONC8U=ION Executive %ummary

Thi! pro)e%t #i/e! a i 5(epth a aly!i! a ( 0 (er!ta (i # o" Forei# E$%ha #e Mar'et! i I (ia1 It help! to 0 (er!ta ( the Hi!tory a ( the e/ol0tio o" the "orei# &ar'et i I (ia1 It #i/e! a o/er/ie* o" the %o (itio ! e$i!ti # i the %0rre t #lobal e%o o&y1 It #i/e! a o/er/ie* o" the Forei# e$%ha #e &ar'et1 It tal'! abo0t the "orei# e$%ha #e &a a#e&e t a%t appli%able a ( al!o #i/e! (etail! abo0t the parti%ipa t! i the "ore$ &ar'et!1 It al!o tal'! abo0t *hat are the !o0r%e! o" (e&a ( a ( !0pply o" "orei# e$%ha #e i the &ar'et all o/er the *orl(1 The report al!o tal'! abo0t the Forei# E$%ha #e tra(i # plat"or& a ( ho* the e""i%ie %y a ( the tra !pare %y i! &ai tai e(1 The report "o%0!e! o %orporate he(#i # "or "orei# e$%ha #e ri!' i I (ia1 The report %o tai ! (etail! abo0t !o&e %o&pa ie! Forei# E$po!0re a ( ho* they ha/e &ai tai e( it1 It al!o tal'! abo0t the (eter&i a t! to be ta'e %are o" *hile ta'i # %orporate he(#i # (e%i!io !1 It #i/e! i !i#ht! abo0t the Re#0latory #0i(eli e! "or the 0!e o" Forei# E$%ha #e (eri/ati/e!, De/elop&e t o" Deri/ati/e! &ar'et! i I (ia a ( al!o the He(#i # i !tr0&e t! "or I (ia "ir&!1 The report #i/e! a i 5(epth a aly!i! o" the %0rre %y ri!' &a a#e&e t by tal'i # abo0t *hat %0rre %y ri!' are, the type! o" %0rre %y ri!' G Tra !a%tio ri!', Tra !latio ri!' a ( E%o o&i% ri!'1 It al!o %o tai ! (etail! abo0t the %o&pa ie! i the i (e$ !e !e$ a ( i"ty !ho*i # their tra !a%tio i! "orei# %0rre %y li'e the i&port!, e$port!, 8oa !, I tere!t pay&e t! a ( the other e$pe !e!1 It the !ho*! the !e !iti/ity a aly!i! o" ho* the %0rre %y rate! i&pa%t the #ai !F pro"it! o" the %o&pa y1

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