EXCHANGE RATES

Foreign Exchange Rates express the value of one currency in terms of another currency. They involve: Base currency Terms currency Example : usually one unit of fixed amount currency : variable amounts of local currency : 1 EUR ! U"# 1.$%&% 1 'B( ! U"# 1.)%*%

+n an exchange rate of U"# 1 ! +,R &-.1% U"# is the commodity.base currency as it is this currency /hich is being priced and rupee is the terms.variable currency in /hich the price has been expressed. The foreign exchange transactions ta0e place at the exchange rate agreed to bet/een the t/o parties. The transactions /here foreign currencies are purchased by Ban0s from the customers are called purchase transactions and /here the foreign currencies are sold by Ban0s to customers are 0no/n as Sale transactions.

Method of quoting rates:

1henever a ban0 2uotes a rate of exchange

it 2uotes a t/o /ay price i.e. its buying rate and the selling rate for the currencies involved in the 2uote. Example of 2uoting rates: 1henever a ban0 2uotes a rate of exchange it 2uotes a t/o /ay price i.e. its buying rate and the selling rate for the currencies involved in the 2uote.

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Example : 1 U"# ! Rs. &-.1%.&-.11 a. U"# is the base currency b. Rupee is the variable currency. c. The first rate3 ie. &-.1% is the price at /hich the 2uoting ban0 is prepared to buy one #ollar i.e. its buying 4BI 5 rate. d. The second number i.e. &-.11 is the price at /hich the 6uoting ban0 is prepared to sell one #ollar i.e. selling 4 FFER 5 rate. e. The median bet/een the bid and offer is 0no/n as middle rate. f. The difference of %.%1 bet/een the buying and selling rate is the 2uoting ban07s spread to cover the cost of bro0erage and communication and a profit margin. . g. The first rate &-.1% is referred as the bid figure and the remaining decimals are 0no/n as pips.points. h. There are t!o "ethods of quoting rates 8by 0eeping the home currency either as the fixed 4base5 unit or as the variable unit. #irect 2uotations 49ome currency 2uotation5: +n this method the Foreign currency as the fixed 4base5 unit and 9ome currency as the variable unit. Example : 1 U"# 8 Rs. &-.1%.&-.1 1. +ndirect 2uotation 4Foreign currency 2uotation5: +n this method the home currency is the fixed.constant unit and the foreign currency is the variable currency. Example : Rs. 1%% ! U"# $.$1:;8 $.$1*) 9ere the cost of a single unit of foreign currency can be obtained only by arithmetical calculation and not straight as in the case of direct 2uotation. ! Rs.1%% devided by U"#.$.$1:; ! 1 U"# ! Rs.&-.1%

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+n U.<.3 =ustralia3 and ,e/ >ealand3 the exchange rates are 2uoted in the indirect form. The home currency is the base currency and U"# is the variable currency. +n +ndia3 /e /ere follo/ing the indirect 2uotation system until recently. From %$.%).1??;3 /e are follo/ing the direct 2uotation method. Ban0s 2uote rates against one unit of foreign currency except for certain currencies specified by Foreign Exchange #ealers7 =ssociation +ndia3 4FE#=+5 for /hich rates are to be 2uoted against 1%% units of foreign currency. Example: @=( AE, 1%% ! Rs. &%.$%

Merchant Rates#

Reserve Ban0 of +ndia has been entrusted /ith the

responsibility of managing forex reserves and maintaining the external value of +ndian Rupees. Earlier the value of Rupee /as lin0ed to a bas0et of currencies /hose value /as 0ept confidential. =fter the introduction of Biberalised Exchange Rate Canagement "ystem 4BERC"5 from %1.%;.1??$3 the rupee has been allo/ed to float freely3 /ith demand and supply for rupee determining its exchange rate. The Reserve Ban0 of +ndia fixes its buying and selling rate for U" #ollar on a day to day basis based on the mar0et determined exchange rate of rupee. These transactions are done on spot basis. Reserve Ban0 of +ndia also has the right to intervene in the mar0et as and /hen necessary.

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Reserve Ban0 of +ndia does not deal /ith the exporters3 importers3 etc3 directly and has authorised certain ban0s to deal /ith these merchants. The ban0s so permitted are called authorised dealers and they deal /ith the merchants. The rates 2uoted by the authorised dealers to merchants are called Cerchant Rates. The e$change rates for "erchant transactions can %e %roadl& classified as follo!s# TT Bu&ing Rate #
15 Dlean +n/ard remittances for /hich cover Funds credited to , "TR $5 Export bills on realisation ;5 Dlean +nstruments payable abroad &5 #elin0ed export bills realised subse2uently. -5 Dancellation of F##.FTT *5 Dancellation of for/ard sales contracts on maturity.

'( Bill Bu&ing Rate: 1. (urchase.#iscount.,egotiation of Export Bills ) TT Selling Rate#

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out/ard Remittances Remittance to/ards import bills received directly by the importer. Export bill returned unpaid. Dancellation of for/ard purchase contract. #elin0ing purchased. of Export Bills. Dhe2ues

ii5 iii5 iv5 v5

*( Bill Selling Rate#

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Remittance for import bills4 Dollection.BD 5

The Foreign Exchange #ealers7 =ssociation of +ndia 4FE#=+5 has given detailed guidelines for computing rates for various types of foreign exchange transactions. The merchant rates are calculated on the basis of onEgoing mar0et rate /hich is called the FBase Rate7. Ban0s should /or0 out and fix the base rate after giving due consideration to mar0et trend3 its o/n existing position3 etc3 as if may not be possible to cover the transactions immediately. The guidelines for computing merchant rates are given belo/ in a nutshell. a. The base rate should be in line /ith the onEgoing mar0et rate. b. The spread bet/een TT "elling and TT Buying rate should not exceed 1G c. The follo/ing exchange margin can be loaded on the base rates to the merchant transactions. Cinimum
i+ TT Bu&ing ii+ Bill Bu&ing iii+ TT Selling i0+ Bill Selling ,(,'*,(/'*,(/'*,(/1*-

Caximum
,(,.,(/*,(/*,(',- 2

32 on tt selling rate+

The merchant rates so calculated are rounded off to the nearest 2uarter paise and is to be 2uoted upto four decimal places. Cember Ban0s are free to load exchange margins in their discretion for the transactions subHect to compliance of maximum spreads and other provisions relating to calculation of exchange rates.

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Co0er Rate and Base Rate# The rate at /hich the Ban0s can cover the merchant transactions in the interEban0 mar0et /ithout any profit or loss is called the Dover Rate. To elaborate3 the rate at /hich the ban0 can buy the dollars to cover import transactions in U"# and the rate at /hich can sell the #ollars to cover a Export transaction in #ollars is called the Dover rate. The base rate is arrived from the cover rate after allo/ing for some cushion for adverse movement of the rates. +n practice there are instances /here the cover rate and the base rate are the same. Nor"al Transit 4eriod: +n case of export bills3 the foreign exchange is covered based on the approximate date on /hich the bill is expected to be realised and the proceeds credited to ,ostro account. The time ta0en from the date of purchase.negotiation of export bill till the proceeds are credited to ,ostro account is called the ,ormal Transit (eriod 4,T(5. Foreign Exchange #ealers7 =ssociation of +ndia 4FE#=+5 has prescribed the ,ormal Transit (eriod 4,T(5 common for all countries Fixed #ue #ate Dontract : The rates 2uoted are normally on "( T basis. 4"ettlement on the second /or0ing day5. +f the foreign exchange is to be delivered on a fixed.optional D ,TR=DT"J. 5or!ard 6ptional deli0er& Contract # +f the foreign exchange can be delivered /ithin a specified period 8 bet/een the first and the last date of the period 8 it is called an ptional delivery Dontract. The option period maybe specified at the discretion of the customer subHect to the condition future date3 and the exchange rates are 2uoted.fixed for such future deliveries it is called IF R1=R#

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that such option period of delivery shall not extend beyond one month. For example: 1)th @an to 1:th Feb3 ;1st @an to $)th Feb etc. +n the case of an option contract bet/een the customer and the ban0er3 the option of exercising the contract lies /ith the customer. Therefore3 the ban0 /ould presume that the customer /ill exercise the option at the time /hen the rates are more favorable to him and the ban0 /ould cover accordingly. 9ence3 in the case of a sight export bill3 the proceeds of the bill may be received any time during the transit period. 1here the currency is at premium in the for/ard mar0et3 the ban0er /ould presume that the proceeds /ould be received immediately and hence no premium /ould be passed on to the customer and the bill gets realised earlier3 the #ollar has to be disposed off at that point of time /hich /ould be a losing proposition3 in a premium mar0et. 1hen currency is in discount in for/ard mar0et compared to spot mar0et3 the ban0er /ould presume that the proceeds of the export bill /ould be realised at the end of the transit period and hence the discount for the full transit period /ould be loaded to the Bill Buying Rate. Co"putation of S46T E$change Rates# /( TT Buying a. "elect the base rate 4mar0et buying rate5 b. #educt the exchange margin say maximum of %.%) G c. Round off the rate as per FE#=+ guidelines. '( Bill Buying a. "elect the base rate 4mar0et buying rate5 b. =dd the for/ard premium or deduct the for/ard discount for the ,ormal Transit (eriod. c. #educt the exchange marginECaximum of %.1-G

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).TD Buying Rate: 1. Ta0e one month for/ard buying rate. $. #educt a commission of maximum 1G ;. Round off to the nearest - paise. 7(Durrency buying Rate: #educt %.-%G from TD Buying rate. *(TD "elling Rate: 1. Ta0e TT "elling rate. $. =dd a margin of %.-%G 5 ;. Round off to the nearest - paise. &. TD Dommission of 1G 4"eparate5 8(Durrency "elling Rate : =dd %.-%G to TD "elling Rate. The rates /or0ed out in the above manner are floor and ceiling rates for buying and selling currency notes and therefore finer rates should be 2uoted /herever possible. Drystallisation of verdue Export Bills and +mport Bills : =s per Foreign Exchange #ealers7 =ssociation of +ndia 4FE#=+5 guidelines3 if an export bill remains unpaid3 then on the ;%th day after the ,ormal Transit (eriod in the case of sight bills3 and on the ;%th day from the ,otional #ue #ate or =ctual #ue #ate in the case of usance bills3 the foreign exchange component has to be delin0ed from the export bill and the liability has to be crystallised in +ndian Rupees. This is done by applying TT "elling Rate or original rate at /hich the bill /as purchased.discounted3 /hichever is higher. +f the crystallised rupee e2uivalent at TT selling rate is less than the rupee e2uivalent of the bill originally purchased3 the resultant surplus in terms of Rupee amount should not be passed on to the exporter3 but surplus

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should be recovered from the exporter to offset the erosion in value of security because of depreciation of the foreign currency. n the other hand3 if the crystallised rupee e2uivalent is more than the rupee e2uivalent of the bill originally purchased3 the resultant shortfall in terms of rupee amount should be recovered from the exporter. 1hen a crystallised bill is realised subse2uently3 TT Buying rate is applied. +n the case of import bills dra/n under letters of credit3 the rupee liability /ill be crystallised on the 1% th day from the date of receipt of documents at the BD opening branch of the ban0 in the case of demand bills and on the due date in the case of usance bills. The delin0ing is made by reporting sale at Bill "elling Rate. D=R# R=TE" 4R=TEK5: The various exchange rates as at the days opening levels /ith full margins for different transactions are advised by +# Cumbai by EECail3 F=K etc toF#Ls M selected branches for information and treated as indicative rates valid for transactions up to U"#.1%3%%%.E or its e2uivalent. . 1E=<BA EKD9=,'E R=TE CEC : = memo containing various exchange rates3 libor rates etc are advised by +# mumbai on a /ee0ly basis as on 1ednesday to all branches for information perpose and valid for small value transactions up to U"#.-%% or its e2uivalent. F+,ER R=TE" : "pecial Exchange Rates 2uoted by dealer by reducing ban0s specified margin as per internal guidelines to corporates.large value business clients. N+( customers3 'ovt #epts.("ULs etc. EEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEE

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S9A4S IN C6NTEXT T6 IN IAN 56REX MAR:ET Introduction # #ay to day foreign exchange cover operations consist of t/o types of transactions. ne /hich affects the position and the other /hich does not affect the position 4position means foreign exchange exposure5. The transactions affect the foreign exchange exposure. The second type of transactions are s/ap transactions and these do not affect the position 4except to the extent of s/ap cost5. efinition # "/aps3 in simple /ords3 are combination of $ outright deals done simultaneously so as not to affect the position. 9ence3 a s/ap is a combination of a purchase and a simultaneous sale for e2ual amount but for different value dates or a combination of a sale and a simultaneous purchase for e2ual amount but different value dates. 5eatures# The necessary things in currency s/aps are: 1. The purchase and sale or sale and purchase should be simultaneous $. =mount of one currency should be the same for both purchase and sale. ;. Nalue dates should be different.

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Example : Buying and "elling of U"# -%%3%%% against +,R value 1;.? against 1;.1%3 or Buying and "elling of 'B( 1-%3%%% against U"# value 1;.? against $%.?. S!ap ifferences# 1hile there is no exchange ris0 involved in s/ap transactions there is a cost involved /hich is 0no/n as the s/ap cost. The s/ap cost depends on the currency being in premium or discount against the other in the for/ard mar0et. = currency is said to be in premium against the other currency if it is costlier in the for/ard mar0et and is said to be in discount against the other if it is cheaper in the for/ard mar0et. Ex. a.. U"#.+,R value 1-.? U"#.+,R value 1;.1% &-.1% .11 &-.1-.1*

U"# is in premium against the +,R in the for/ard. b.. 'B(.U"# value 1-.? 'B(.U"# value 1;.1% Interest Rate ifferential # ,ormally3 in a free mar0et 4as in international mar0et5 the interest rate differential of the t/o currencies determines the premium or the discount. = lo/ interest bearing currency /ill be at a premium against the higher interest being currency. 1.)%*% 1.)%&%

'B( is in discount against U"# in for/ard.

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9o/ever3 in the +ndian mar0et /here Exchange Dontrol Regulations exist and mar0et is restricted3 the premium or discount of dollar is determined by demand and supply of for/ard dollars for various deliveries.

"/ap cost /hen the currency is in premium: 1hen a currency is in premium against the other3 then the currency is costlier in the for/ards. "o /hen a buying and a selling transaction is underta0en then the s/ap cost /ill be in favour 4receive the s/ap cost5. +,TER B=,< 6U TE +" =" U,#ER: U"#.+,R Nalue 1;.? at &-.1%.11 U"#.+,R value 1;.1% at &-.1-.1* 4explanation : Buy at &-.11 and sell at &-.1-5 8Buying the currency at a cheaper price and selling at the costlier price. =lternatively /hen selling and buying transactions ta0es place then the s/ap cost has to be paid. 4Explanation: "ell at &-.1% and Buy at &-.1*5 4"elling the currency at a cheaper price and buying it at a costlier price5. S!ap Cost !hen the currenc& is in discount( 1hen a currency is in discount against the other3 then the currency is cheaper in the for/ards. "o /hen buying and selling transactions ta0e place3 then the s/ap cost has to be paid 8Buying the currency at a costlier price and selling at a cheaper price. Thus3 the s/ap cost could be determined by the follo/ing:

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T&pes of Transactions 4re"iu" Buying M "elling "elling M Buying T&pes of S!aps # "/aps can be t/o types: 1. Fixed date delivery s/ap $. ption delivery s/ap Fixed #ate #elivery "/ap: Receive 4For 5 (ay 4=gainst5

If Currenc& is at iscount (ay 4=gainst5 Receive 4For5

The value dates for the s/aps both purchase and sale have to be fixed at the time of underta0ing the s/ap. +n the international mar0et normally fixed date s/aps are underta0en. 6ption eli0er& S!ap# ption delivery s/aps are those for /hich the delivery of the contract can be done over a number of days. ,ormally3 option period in the +ndian mar0et covers a month or part of the month. The right to exercise the option lies /ith the buyer. =n example of option s/ap is: Buy =ug delivery U"# 1 Cio "ell "ept delivery U"# 1 Cio Need for S!aps# 1hile any foreign exchange exposure can be covered by underta0ing outright deals3 there are many circumstances /hich necessitate doing s/aps. 5unds Manage"ent# a. funding overdra/n account. b. Bi2uidating excess balances.
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c. Utilisation of various deposit funds. 5or!ard Contracts # a. early delivery of contracts b. cancellation and reboo0ing of contracts. U"E" of "1=(":: 1. "etting right of mismatches due to cover operation $. Trading a. interest arbitrage b. trading in s/aps ;. Funds Canagement: a. 1hen the account is overdra/n due to B.D debits b. 1hen early payments come for exports. EEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEEE

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