CHAPTER 1

INTRODUCTION
The market in which participants are able to buy, sell exchange and speculate on
currencies. Foreign exchange markets are made up of banks, commercial
companies, central banks, investment management firms, hedge funds, and retail
forex brokers and investors. The forex market is considered to be the largest
financial market in the world.
Because the currency markets are large and liquid, they are believed to be the most
efficient financial markets. It is important to realize that the foreign exchange
market is not a single exchange, but is constructed of a global network of
computers that connects participants from all parts of the world.
The foreign exchange market (Forex, FX, or currency market) is a global
decentralized market for the trading of currencies. In terms of volume of trading, it
is by far the largest market in the world. The main participants in this market are
the larger international banks. Financial centers around the world function as
anchors of trading between a wide range of multiple types of buyers and sellers
around the clock, with the exception of weekends. The foreign exchange market
determines the relative values of different currencies. The foreign exchange market
works through financial institutions, and it operates on several levels. Behind the
scenes banks turn to a smaller number of financial firms known as dealers, who
are actively involved in large quantities of foreign exchange trading. Most foreign
exchange dealers are banks, so this behind-the-scenes market is sometimes called
the interbank market, although a few insurance companies and other kinds of
financial firms are involved. Trades between foreign exchange dealers can be very
large, involving hundreds of millions of dollars. Because of the sovereignty issue
1

when involving two currencies, Forex has little (if any) supervisory entity
regulating its actions. The foreign exchange market assists international trade and
investments by enabling currency conversion. For example, it permits a business in
the United State to import goods from the European member states,
especially Euro zone members, and pay Euros, even though its income is in United
States dollars. It also supports direct speculation and evaluation relative to the
value of currencies, and the carry trade, speculation based on the interest rate
differential between two currencies. In a typical foreign exchange transaction, a
party purchases some quantity of one currency by paying for some quantity of
another currency. The modern foreign exchange market began forming during the
1970s after three decades of government restrictions on foreign exchange
transactions (the Bretton Woods system of monetary management established the
rules for commercial and financial relations among the world's major industrial
states after World War II), when countries gradually switched to floating exchange
rates from the previous exchange rate regime, which remained fixed as per the
Bretton Woods system.

CHAPTER 2

HISTORY OF FOREIGN EXCHANGE MARKET

The foreign exchange market (FX or Forex) as we know it today originated in
1973. However, money has been around in one form or another since the time of
Pharaohs. The Babylonians are credited with the first use of paper bills and
receipts, but Middle Eastern moneychangers were the first currency traders who
exchanged coins from one culture to another. During the middle ages, the need for
another form of currency besides coins emerged as the method of choice. These
paper bills represented transferable third-party payments of funds, making foreign
currency exchange trading much easier for merchants and traders and causing these
regional economies to flourish. From the infantile stages of Forex during the
middle Ages to WWI, the forex markets were relatively stable and without much
speculative activity. After WWI, the forex markets became very volatile and
speculative activity increased tenfold. Speculation in the forex market was not
looked on as favorable by most institutions and the public in general. The Great
Depression and the removal of the gold standard in 1931 created a serious lull in
forex market activity. From 1931 until 1973, the forex market went through a
series of changes. These changes greatly affected the global economies at the time
and speculation in the forex markets during these times was little, if any.
The Gold exchange period and the Bretton Woods Agreement.
The Bretton Woods Agreement, established in 1944, fixed national currencies
against the dollar, and set the dollar at a rate of 35USD per ounce of gold.This
agreement aimed at establishing international monetary steadiness by preventing
3

money from taking flight across countries, and curbing speculation in the
international currencies. Prior to Bretton Woods, the gold exchange standard dominant between 1876 and World War I - ruled over the international economic
system. Under the gold exchange, currencies experienced a new era of stability
because they were supported by the price of gold.
However, the gold exchange standard had a weakness of boom-bust patterns. As an
economy strengthened, it would import a great deal until it ran down its gold
reserves required to support its currency. As a result, the money supply would
diminish, interest rates escalate and economic activity slowed to the point of
recession. Ultimately, prices of commodities would hit bottom, appearing attractive
to other nations, who would sprint into a buying fury that injected the economy
with gold until it increased its money supply, driving down interest rates and
restoring wealth into the economy. Such boom-bust patterns abounded throughout
the gold standard until World War I temporarily discontinued trade flows and the
free movement of gold.
The Bretton Woods Agreement was founded after World War II, in order to
stabilize and regulate the international Forex market. Participating countries agreed
to try to maintain the value of their currency within a narrow margin against the
dollar and an equivalent rate of gold as needed. The dollar gained a premium
position as a reference currency, reflecting the shift in global economic dominance
from Europe to the USA. Countries were prohibited from devaluing their
currencies to benefit their foreign trade and were only allowed to devalue their
currencies by less than 10%. The great volume of international Forex trade led to
massive movements of capital, which were generated by post-war construction
during the 1950s, and this movement destabilized the foreign exchange rates
established in the Bretton Woods Agreement.
4

1971 heralded the abandonment of the Bretton Woods in that the US dollar would
no longer be exchangeable into gold. By 1973, the forces of supply and demand
controlled major industrialized nations' currencies, which now floated more freely
across nations. Prices were floated daily, with volumes, speed and price volatility
all increasing throughout the 1970s, and new financial instruments, market
deregulation and trade liberalization emerged.
The onset of computers and technology in the 1980s accelerated the pace of
extending the market continuum for cross-border capital movements through
Asian, European and American time zones. Transactions in foreign exchange
increased intensively from nearly $70 billion a day in the 1980s, to more than $1.5
trillion a day two decades later.
The Beginning of the free-floating system
After the Bretton Woods Accord came the Smithsonian Agreement in
December of 1971. This agreement was similar to the Bretton Woods
Accord, but allowed for a greater fluctuation band for the currencies. In
1972, the European community tried to move away from its dependency on
the dollar. The European Joint Float was established by West
Germany, France, Italy, the Netherlands, Belgium and Luxemburg. The
agreement was similar to the Bretton Woods Accord, but allowed a greater
range of fluctuation in the currency values.
Both agreements made mistakes similar to the Bretton Woods Accord and in 1973
collapsed. The collapse of the Smithsonian agreement and the European Joint Float
in 1973 signified the official switch to the free-floating system. This occurred by
default as there were no new agreements to take their place. Governments were
now free to peg their currencies, semi-peg or allow them to freely float. In 1978,
5

the free-floating system was officially mandated. In a final effort to gain

independence from the dollar, Europe created the European Monetary System in
July of 1978. Like all of the previous agreements, it failed in 1993.The major
currencies today move independently from other currencies. The currencies are
traded by anyone who wishes. This has caused a recent influx of speculation by
banks, hedge funds, brokerage houses and individuals. Central banks intervene on
occasion to move or attempt to move currencies to their desired levels. The
underlying factor that drives today's forex markets, however, is supply and
demand. The free-floating system is ideal for today's forex markets.
TIMELINE OF FOREIGN EXCHANGE
1944 Bretton Woods Accord is established to help stabilize the global economy
after World War II.
1971 Smithsonian Agreement established to allow for greater fluctuation band for
currencies.
1972 European Joint Float established as the European community tried to move
away from its dependency on the U.S. dollar.
1973 Smithsonian Agreement and European Joint Float failed and signified the
official switch to a free-floating system.
1978 The European Monetary System was introduced so other countries could try
to gain independence from the U.S. dollar.
1978 Free-floating system officially mandated by the IMF.
1993 European Monetary System fails making way for a world-wide free-floating
system.

CHAPTER 3

THE SIZE, COMPOSITION AND LOCATION OF THE

FOREIGN-EXCHANGE MARKET

The Bank for International Settlements (BIS) estimated in 2001 that $1.2 trillion in
foreign exchange was traded each day. The substantial decline from earlier years is
thought to be the result of the consolidation of the banking industry (fewer trading
desks) and the introduction of the EURO. The U.S. dollar remains the most
important currency in the foreign-exchange market, comprising one side (buy or
sell) of 90 percent of all foreign currency transactions worldwide in 2001. This is
because the dollar:

is an investment currency in many markets

is held as a reserve currency by many central banks

is a transaction currency in many international commodity markets

serves as an invoice currency in many contracts

is often used as an intervention currency when foreign monetary authorities

wish to influence their own exchange rates.

Nonetheless, the largest foreign exchange market is in the United Kingdom, which
is strategically situated between Asia and the Americas, followed by the United
States, Japan and Singapore.

CHAPTER 4

FEATURES OF FOREIGN EXCHANGE MARKET

Location: OTC Market banks and Brokers at a financial centre.

The Worldwide volume of Foreign Exchange trading is enormous, & it has
ballooned in recent years.
New Technologies, such as internet links are used among the major foreign
exchange centers (London, New York, Tokyo, Frankfurt and Singapore).
Its long trading hours 24 hours a day (except on weekends).
The extreme liquidity of the market.
The integration of financial centers implies that there can be no significance
arbitrage.
It is the network of Banks, Brokers & FE Dealers.
FEM is governed by an unwritten Code of Conduct of all participants.

CHAPTER 5

STRUCTURE OFFOREIGN EXCHANGE MARKET

For most retail traders understanding the structure of the Forex market is
something that is often overlooked. This is a critical element that needs to be
considered when designing and implementing any trading plan. The forex market
differs from other global markets due to the way it is structured. The main factors
affecting the structure of the Forex market are the ways Forex products are traded,
the participants and their motivation, regulation and the sheer size of the market.
Since transactions in the Forex market are done over-the-counter (OTC) and not
through a central exchange like futures or shares, prices behave differently.
5.1 Over The Counter:
9

The first thing to understand about the structure of the forex market is the way in
which products are traded. Forex is for the most part, an over the counter (OTC)
market. This means that there is no central exchange through which instruments
are traded. When we refer to instruments, we are referring to the different forex
products participants use to conduct transactions, whether they be corporate,
speculative or hedging. These products include: Spot forex, outright forwards,
forex swaps, forex options. When a product is traded OTC it is done so through a
market maker. A market maker in forex is effectively a bank or brokers that
facilitates currency trades by providing buy and sell quotes and then taking orders.
Orders can be hedged or passed on so there is no exposure/risk, matched within the
internal order book or held by the market maker, meaning they take the other side
of the order and take a position against the client. Other commonly traded
instruments such as shares and futures are exchange traded products, this means
that any transaction involving these instruments is done through an exchange such
as the New York Stock Exchange (NYSE) and London Stock Exchange (LSE).
The points below highlight some features of OTC and exchange traded
markets.
OTC
Market Made
Trading firm is the counterparty
Heavy price competition
Price and execution quality varies
5.2 Exchange Traded

10

 Exchange is counterparty to all trades

Less price competition
Standardized price and execution
Regulatory oversight from exchange

CHAPTER 6

FUNCTIONS OF FOREIGN EXCHANGE MARKET

Foreign exchange is also referred to as forex market. Participants are
importers, exporters, tourists and investors, traders and speculators, commercial
banks, brokers and central banks.

11

Foreign bill of exchange, telegraphic transfer, bank draft, letter of credit etc.
are the important foreign exchange instruments used in foreign exchange market to
carry out its functions.
The Foreign Exchange Market performs the following functions.
1. Transfer of Purchasing Power I Clearing Function
The basic function of the foreign exchange market is to facilitate the
conversion of one currency into another i.e. payment between exporters and
importers.
For e.g. Indian rupee is converted into U.S. dollar and vice-versa. In performing
the transfer function variety of credit instruments are used such as telegraphic
transfers, bank drafts and foreign bills. Telegraphic transfer is the quickest method
of transferring the purchasing power.
2.

Credit Function
The foreign exchange market also provides credit to both national and

international, to promote foreign trade. It is necessary as sometimes, the

international payments get delayed for 60 days or 90 days. Obviously, when
foreign bills of exchange are used in international payments, a credit for about 3
months, till their maturity, is required.
For e.g. Mr. A can get his bill discounted with a foreign exchange bank in
New York and this bank will transfer the bill to its correspondent in India for
collection of money from Mr. B after the stipulated time.

3. Hedging Function
12

A third function of foreign exchange market is to hedge foreign exchange risks. By

hedging, we mean covering of a foreign exchange risk arising out of the changes in
exchange rates. Under this function the foreign exchange market tries to protect the
interest of the persons dealing in the market from any unforeseen changes in
exchange rate. The exchange rates under free market can go up and down, this can
either bring gains or losses to concerned parties. Hedging guards the interest of
both exporters as well as importers, against any changes in exchange rate.
Hedging can be done either by means of a spot exchange market or a forward
exchange market involving a forward contract.

CHAPTER 7

MARKET PARTICIPANTS FOREIGN EXCHANGE MARKET

The foreign exchange market consists of two tiers:
The interbank or wholesale market (multiples of $1MM US or equivalent in
transaction size) The client or retail market (specific, smaller amounts)

13

Five broad categories of participants operate within these two tiers; bank and
nonbank foreign exchange dealers, individuals and firms, speculators and
arbitragers, central banks and treasuries, and foreign exchange brokers.

Bank and Nonbank Foreign Exchange Dealers :

Banks and a few nonbank foreign exchange dealers operate in both the interbank
and client markets.
The profit from buying foreign exchange at a bid price and reselling it at a
slightly higher offer or ask price.
Dealers in the foreign exchange department of large international banks often
function as market makers.
These dealers stand willing at all times to buy and sell those currencies in which
they specialize and thus maintain an inventory position in those currencies.

Individuals and Firms :

Individuals (such as tourists) and firms (such as importers, exporters and
MNEs) conduct commercial and investment transactions in the foreign
exchange market.
Their use of the foreign exchange market is necessary but nevertheless
incidental to their underlying commercial or investment purpose.
Some of the participants use the market to hedge foreign exchange risk.
14

 Speculators and Arbitragers :

Speculators and arbitragers seek to profit from trading in the market itself.
They operate in their own interest, without a need or obligation to serve clients or
ensure a continuous market.
While dealers seek the bid/ask spread, speculators seek all the profit
from exchange rate changes and arbitragers try to profit from simultaneous
exchange rate differences indifferent markets.

Central Banks and Treasuries :

Central banks and treasuries use the market to acquirer spend their countrys
foreign exchange reserves as well as to influence the price at which their
own currency is traded.
They may act to support the value of their own currency because of policies
adopted at the national level or because of commitments entered into through
membership in joint agreements such as the European Monetary System.
The motive is not to earn a profit as such, but rather to influence the foreign
exchange value of their currency in a manner that will benefit the interests of
their citizens.
As willing loss takers, central banks and treasuries differ in motive from all other
market par.
Foreign Exchange Brokers :
15

Foreign exchange brokers are agents who facilitate trading between dealers
without themselves becoming principals in the transaction.
For this service, they charge a commission.
It is a brokers business to know at any moment exactly which dealers want to buy
or sell any currency.
Dealers use brokers for their speed, and because they want to remain anonymous
since the identity of the participants may influence short term quotes.

CHAPTER 8
KINDS OF FOREIGN EXCHANGE MARKETS
Foreign exchange markets are classified on the basis of whether the foreign
exchange transactions are spot or forward accordingly, there are two kinds of
foreign exchange markets:
(i) Spot Market,
(ii) Forward Market.
16

8.1 SPOT MARKET:

Spot market refers to the market in which the receipts and payments are made
immediately. Generally, a time of two business days is permitted to settle the
transaction. Spot market is of daily nature and deals only in spot transactions of
foreign exchange (not in future transactions). The rate of exchange, which prevails
in the spot market, is termed as spot exchange rate or current rate of exchange.
The term spot transaction is a bit misleading. In fact, spot transaction should
mean a transaction, which is carried out on the spot (i.e., immediately). However,
a two day margin is allowed as it takes two days for payments made through
cheques to be cleared.
The spot kinds of foreign exchange market are those in which the commodity is
bought or sold for an immediate delivery or delivery in the very near future. The
trades in the spot markets are settled on the spot. The spot foreign currency market
is among the most popular foreign currency instrument around the globe,
contributing about 37 percent of the total activity happening in all other types of
foreign exchange markets. Spot forex currency markets types are opposite to other
kinds of foreign exchange market such as the future market, in which there is a set
date is mentioned.
The important point to note is that these contracts are settled electronically thus
making forex markets essentially instantaneous. The spot forex currency markets
types are considered to be highly paced markets and volatility and quick profits
and losses are its important features.
A spot deal in foreign exchange market comprises of a bilateral contract between
two parties in which a party transfers a set amount of a particular given currency
against the receipt of a specified amount of another currency from the counterparty,
17

based on an agreed exchange rate, within two business days of the date when the
deal gets finalized. However, there is an exception in case of Canadian dollar. In
Canadian dollar, the Spot delivery happens the very next business day. The name
spot does not mean that the currency exchange happens the same business day on
which the deal is executed. Forex currency transactions which require delivery on
the same day are called as cash transactions. It is interesting to know that the two
day spot delivery has been in place since long before there were any technological
breakthroughs in information processing facilitating the instantaneous transactions.
This time period was required to check all the transactions details among the
participating companies. The most traded currency in spot types of foreign
exchange markets in terms of volume is US dollar. The reason being is that U.S.
dollar is the currency of reference. The other major most common currencies
traded in spot markets are the euro, followed by the Japanese yen, the British
pound, and the Swiss franc.
The exchange rate for immediate delivery is called Spot Exchange Rate is
denoted by S (.)
For e.g. S (Rs. /$) = Rs. 46.85/$
Here immediately means delivery after two business days.
The market where the purchase and sale of currencies is contracted for spot
delivery is called the Spot Market.

8.2 FORWARD MARKET:

Forward market refers to the market in which sale and purchase of foreign
currency is settled on a specified future date at a rate agreed upon today. The
exchange rate quoted in forward transactions is known as the forward exchange
18

rate. Generally, most of the international transactions are signed on one date and
completed on a later date. Forward exchange rate becomes useful for both the
parties involved in the transaction.
The forward Forex currency markets types comprise of two currency trading
instruments- forward outright deals and swaps. The swap currency deal is different
from the other kind of forex instruments in a way that it consists of two deals,
while all other transactions consist of single deals. A swap is a combination of a
spot deal and a forward outright deal. Generally, forward foreign exchange market
deals in cash transactions only. This is the reason why the transactions of the
forward types of foreign exchange markets are separately analyzed. Based on the
data shared by the Bank for International Settlements, the percentage share of the
forward kinds of foreign exchange market was 57% in the year 1998. The forward
markets have no set terms with regard to the settlement dates and this range from 3
days to 3 years. The volume in currency swaps longer than one year tends to be
light but, technically, there is no impediment to making these deals. Any date past
the spot date and within the above range may be a forward settlement, provided
that it is a valid business day for both currencies.
The nature of forward types of foreign exchange markets is decentralized, with
participants from all over the world entering into a different types of forex deals
either on a one on one basis or through forex brokers. In contrast to this, the
currency futures Foreign exchange market is a centralized one and where all the
deals are executed on trading floors provided by different exchanges. Where as in
the futures market only a small number of foreign currencies are traded in
multiples of standardized amounts. The forward types of foreign exchange markets
are open to any currencies in any amount. Future Forex currency markets types are
specific types constitute the forward outright deals which in general take up small
19

part of the foreign exchange currency trading market. Since future contracts are
derivatives of spot price, they are also known as derivative instruments. They are
specific with regard to the expiration date and the size of the trade amount. In
general, the forward outright deals which get mature past the spot delivery date
will mature on any valid date in the two countries whose currencies are being
traded, standardized amounts of foreign currency futures mature only on the third
Wednesday of March, June, September, and December.
Forward Contract is made for two reasons:
(a) To minimize the risk of loss due to adverse changes in the exchange rate
(through hedging);
(b) To make profit (through speculation).

CHAPTER 9

THE FOREIGN EXCHANGE TRANSACTIONS

- The foreign exchange market in India is growing in both volume and
depth. Various kinds of transactions are facilitated by the Banks, both
on a spot and on forward task.
- Any financial transaction that involves more than one currency is a
foreign exchange transaction.
- Most important characteristic of a foreign exchange transaction is that
it involves Foreign Exchange Risk.
20

Value Date Conventions:

- Currencies are traded both in Ready & Forward value dates.
- Ready: Settlement on the deal date.
- Value Tom: settlement on Next day
- Spot Transaction: Settlement usually in two working days.
- In international FX transactions, Spot is the Standard value date.
Forward Transaction: Settlement at some future date ahead of the
spot.
Forex Transactions In The Interbank Market:
The Demand Side of inter-bank market:
- Remittances on account of education abroad.
- Remittances on account medical treatment.
-Repatriation of profit of foreign controlled companies and freight collection etc.
-Disinvestment through SCRA.
-A host of other invisible payments.

The Supply Side of inter-bank market

-Exports regulations governing export receipts.
-Home remittances.

21

-Foreign Direct Investment.

-Capital account receipts.
-Investment through SCRA.
-A host of other invisible receipts.

9.1 SPOT TRANSACTION:

A Spot transaction in the interbank market is the purchase of foreign exchange,
with delivery and payment between banks to take place, normally, on the second
following business day.
The date of settlement is referred to as the value date.
Here immediately means delivery after two business days.
The market where the purchase and sale of currencies is contracted for spot
delivery is called the Spot Market.
The term spot transaction is a bit misleading. In fact, spot transaction
should mean a transaction, which is carried out on the spot (i.e.,
immediately). However, a two day margin is allowed as it takes two days for
payments made through cheques to be cleared.
The exchange rate for immediate delivery is called Spot Exchange Rate is
denoted byS(.)
For e.g. S (Rs. /$) = Rs. 46.85/$

22

9.2FORWARD TRANSACTION:
Outright Sale/ Purchase of A currency against the other for settlement at a
future date at the predetermined exchange rate.
Forward rates are quoted as premium or discount over spot rate.
Forward rates depend upon interest rate differential between the two
currencies.
Currency with higher interest rates is at discount wrt currency having lower
interest rate.

23

 Currency with lower interest rates is at premium wrt currency having higher
interest rate.
For e.g.: 60 days F (Rs./$): Forward rate between rupees & dollar is the rate at
which the foreign exchange dealer can arrange a transaction between rupees &
dollar 60days.
A foreign currency is said to be at a forward premium if its future value in
terms of domestic currency $ it is said to be at discount if the converse is
true.
For e.g.: S (Rs. / $) = Rs. 45.70
F3 (Rs. / $) = Rs. 46.60

9.3 SWAP TRANSACTION:

24

A swap transaction in the interbank market is the simultaneous purchase and sale
of a given amount of foreign exchange for two different value dates.
Both purchase and sale are conducted with the same counterparty.
Some different types of swaps are:
Spot against forward
Forward-Forward
Non deliverable Forwards (NDF)
FX swap is essentially a funding or Money Market transaction and does
not involve exchange risk.

CHAPTER 10
FOREIGN EXCHANGE RATE & QUOTES:

10.1 What is Foreign Exchange Rate Quotes :

- Exchange rate is the price of one countrys currency expressed in
another countrys currency. In other words, the rate at which one
currency can be exchanged for another.
- A foreign exchange quotation (or quote) is a statement of
willingness to buy or sell at an announced rate.
For example:
The exchange rate between US dollars and the Swiss franc is
normally stated:
25

- SF 1.6000/$ (European terms)

- However, this rate can also be stated as:
- $0.6250/SF (American terms)
- Excluding two important exceptions, most interbank quotations
around the world are stated in European terms.
- Major Currencies of the world: USD , EURO , YEN
10.2 Price Maker vs. Price Taker:
The bank quoting the price is price maker or market maker.
The bank asking for the price or quote is the price taker or user.
10.3 FX Rate &FX Rate Quotations:
Foreign exchange quotes are at times described as either:
DIRECT OR INDIRECT QUTES
In the international market, almost all the currencies are quoted
in terms of USD.
I.

IN-DIRECT QUOTATION:
Price of one Unit of Foreign Currency in terms of Domestic
Currency
e.g. USD/INR = 48.50/60
Buy One USD at 48.50
Sell One USD at 48.60
=Spread 00.10

II.

DIRECT QUOTATION:
Price of one Unit of Domestic Currency in terms of Foreign
Currency
e.g. EURO= 1.2805/12
Buy One Euro at 1.2805
Sell One Euro at 1.2812
=Spread 0.0007

In the Forex market rates are always quoted two ways.

26

 Two ways quote gives both Bid and Offer.

e.g. USD/INR= 48.50 / 60 Bid / Offer
Big Figure: Term referring to the first digits of an exchange rate. These
figures are rarely change in normal market fluctuations and are usually
omitted in dealer quotes.
Pips (or Point): The smallest incremental move an exchange rate can make.
Base Currency Vs. Dealt Currency
Number of variable or dealt currency unit in one unit of base currency.
In international quotes base currency comes first.
e.g. BC/VC USD/INR= 48.50/60
The two most important are quotes for the euro and U.K. pound sterling which are
both normally quoted in American terms.
American terms are also utilized in quoting rates for most foreign currency
options and futures, as well as in retail markets that deal with tourists.
Forward rates are typically quoted in terms of points.
A forward quotation is expressed in points is not a foreign exchange rate as such
Rather, it is the difference between the forward rate and the spot rate.
Forward quotations may also be expressed as the percent-per-annum deviation
from the spot rate.
27

This method of quotation facilitates comparing premiums or discounts in the

forward market with interest rate differentials.
Many currency pairs are only inactively traded, so their exchange rate is
determined through their relationship to a widely traded third currency (cross rate).
Cross rates can be used to check on opportunities for inter -market arbitrage.

CHAPTER 11

SETTLEMENT OF FOREIGN EXCHNGE TRANSACTIONS &

DEALS
11.1 SETTLEMENT OF FOREIGN EXCHNGE
TRANSACTIONS:
Foreign exchange transactions are settled through Nostro and
Vostro accounts.
Nostro: our account with banks abroad. Reserve Bank of India
(RBI) maintains various Nostro accounts in a number of
countries.

28

 Vostro: their account with us. Many multilateral agencies (e.g.

IMF, World Bank) maintain their Nostro accounts at Reserve
Bank of India (RBI).
o SWIFT (Society for Worldwide Interbank Financial
Telecommunications)

11.2SETTLEMENT OF DEALS:
-

Deals are done over Telephone, REUTERS dealing system etc.

REUTERS
DEALING TERMINAL
- Industry Standard for FX trading.
- Security guaranteed by Reuters Int.
- Password Protected.
- Maintains record of all transactions.
NEWS TERMINAL
- Domestic Market Data/ news available on line.
- Real Time Exchange Rate quotes of all major Currencies.
- Data about Interest Rates (e.g. LIBOR)
- Various Reserve Banks of India (RBI) pages on REUTERS.

29

CHAPTER 12

FOREIGN EXCHANGE MARKET FOR THE INDIAN RUPEE

Indian Forex market has also grown in size with an average monthly turnover of
US$ 23 bn in the merchant segment and US$ 90 bn in inter-bank foreign exchange
market.
The US dollar was on one side of 89 per cent of all transactions, followed by the
euro (37 per cent), the yen (20 per cent) and the Pound sterling (17 per cent). In
terms of currency pairs, US dollar/euro continued to be by far the most traded
currency pair in April 2004, accounting for 28 per cent of global turnover, followed
by US dollar/yen with 17 per cent and US dollar/Pound sterling with 14 per cent.

30

 The foreign exchange market spans the globe, with prices moving
and currencies trading somewhere every hour of every business day.
As the next exhibit will illustrate the volume of currency transactions ebbs
and flows across the globe as the major currency trading centers open and
close throughout the day.
With the implementation of the recommendations of the SodhaniCommittee,
money and the foreign exchange markets have been fully integrated.
Against this context, the role of RBI has been to stabilize rupee price and the
monetary policy has been singularly devoted to exchange rate stability rather than
economic growth on a long-range perspective.
With the financial markets in India acquiring greater depth and maturity in
the recent years, the issue of greater integration of various market segments
among themselves, on the one hand, and with the global markets, on the
other, has come to the forefront.
During the post-reform period, the structure of financial market has witnessed a
remarkable change in terms of the types, the number and the spectrum of maturity
of financial instruments traded in various segments of money, gilts and foreign
exchange markets.

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CHAPTER 13

FOREIGN EXCHANGE MARKET TRADING PLATFORM

A variety of trading platforms are used by dealers in the EMEs for

communicating and trading with one another on a bilateral basis. They
conduct bilateral trades through telephones that are later confirmed by fax or
telex. Some dealers also trade on electronic trading platforms that allow for

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bilateral conversations and dealing such as the Reuters Dealing 2000-1 and
Dealing 3000 Spot systems.
Bilateral conversations may also take place over networks provided by
central banks and over private sector networks (Brazil, Chile, Colombia,
Korea and the Philippines). Reuters Dealing System has been the most
popular trading platform in EMEs.
In the Indian foreign exchange market, spot trading takes place on four
platforms, viz., FX CLEAR Of the CCIL set up in August 2003, FX Direct
that is a foreign exchange trading platform launched by IBS Forex (P) Ltd.
in 2002 in collaboration with Financial Technologies (India) Ltd., and two
other platforms by the Reuters - D2 platform and the Reuters Market Data
System (RMDS) trading platform that have a minimum trading amount limit
of US $ 1 million. FXCLEAR and FX Direct offer both real time orders
matching and negotiation modes for dealing. The Real Time Matching
system enables real time matching of currency pairs for immediate and auto
execution in both the spot and forward segments.
In the Negotiated Dealing System, on the other hand, participant is free to
choose and negotiate with his counter-party on all aspects of the transaction,
thereby offering him flexibility to select the underlying currency as well as
the terms of trade. These trading platforms cover the US dollar-Indian
Rupee (USDINR) transactions and transactions in major cross currencies
(EUR/USD, USD/JPY, GBP/USD etc.),though USD-INR constitutes the
most of the foreign exchange transactions in terms of value.
It is the FXCLEAR of the CCIL that remains the most widely used trading
platform in India. This platform has been given to members free of cost. The
main advantage of this platform is its offer of straight-through processing
(STP) capabilities as it is linked to CCILs settlement platform.

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 In the forward segment of the Indian foreign exchange market, trading takes
place both over the counter (OTC) and in an exchange traded market with
brokers playing an important role. The trading platforms available include
FX CLEAR of the CCIL, RMDS from Reuters and FX Direct of the IBS.
In order to enhance the efficiency and transparency of the foreign exchange
market and make it comparable with the markets of other EMEs, the
Committee on Fuller Capital Account Convertibility (FCAC, 2006) has
proposed the introduction of an electronic trading platform for the conduct
of all foreign exchange transactions. Under such an arrangement, an
authorized dealer will fix certain limits for its clients for trading in foreign
exchange, based on a credit assessment of each client or deposit funds or
designated securities as collateral. A number of small foreign exchange
brokers could also be given access to the foreign exchange trading screen by
the authorized dealers. In the case of electronic transaction, the buy/sell
order for foreign exchange of an authorized dealers client first flows from
the clients terminal to that of the authorized dealers dealing system. If the
clients order is within the exposure limit, the dealing system will
automatically route the order to the central matching system. After the order
gets matched; the relevant details of the matched order would be routed to
the clients terminal through the trading system of the authorized dealer.
Such a system would also have the advantage of the customer having the
choice of trading with the bank quoting the best price and the Reserve
Banks intervention in the foreign exchange market could remain
anonymous. For very large trades, a screen negotiated deal system has been
proposed by the Committee on Fuller Capital Account Convertibility.

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CHAPTER 14

RBIs ROLE IN THE FOREIGN EXCHANGE MARKET

The Indian FOREX market owes its origin to the important step that RBI took in
1978 to allow banks to undertake intra-day trading in foreign exchange. As a
consequence, the stipulation of maintaining Square or near square position was
to be complied with only at the close of business each day. During the period 19751992, the exchange rate of rupee was officially determined by the RBI in terms of a
weighted basket of currencies of Indias major trading partners and there were
significant restrictions on the current account transactions.

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The initiation of economic reforms in July 1991 saw significant two-step

downward adjustment in the exchange rate of the rupee on July 1 and 3, 1991 with
a view to placing it at an appropriate level in line with the inflation differential to
maintain the competitiveness of exports. Subsequently, following the
recommendations of the High Level Committee on Balance of Payments
(Chairman: Dr C. Rangarajan) the Liberalized Exchange Rate Management System
(LERMS) Submitted by: Mayank Agarwal, Sujay Kr. Tiwari, Puneet Chaurasia,
Gopal Saxena Shishir Kumar ,Shobhit Asthana involving dual exchange rate
mechanism was instituted in March 1992 which was followed by the ultimate
convergence of the dual rates effective from March 1, 1993(christened modified
LERMS). The unification of the exchange rate of the rupee marks the beginning of
the era of market determined exchange rate regime of rupee, based on demand and
supply in the forex market. It is also an important step in the progress towards
current account convertibility, which was finally achieved in August 1994 by
accepting Article VIII of the Articles of Agreement of the International
Monetary Fund.
ROLE OF RBI IN FX MARKET:

To manage the exchange rate mechanism.

Regulate Inter- bank Forex Transactions & monitor the foreign

exchange risk of the banks.
Keep the exchange rate stable.
Manage & maintain countrys foreign exchange reserves.
Dealing room catered to the FX market only

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INTERVENTION

To keep exchange rate in line with macro objectives RBI has to intervene
from time to time.
Intervention is a process where FX is sold or purchased to keep the right
amount of liquidity available in the FX market so that demand/ supply
equilibrium is maintained. Intervention can be in READY or FORWARD.

CHPAPTER 15
ADVANTAGES AND DISADVANTAGES OF FOREX TRADING
The foreign exchange market can be best described as the Wild West of the
online trading world. Because it is so new and grew so rapidly, the brokers could
really do whatever they wanted and have set things up to be more like a casino that
a legitimate, trasparent market.
Some of the Advantages of trading the forex market include:
Leverage : Foreign exchange markets give investors a lot of leverage when
trading. In other words, a small amount of capital can go a long way. In fact,
some markets allow a leverage ratio of up to 50:1 or 100:1. In other words, a
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single dollar can be worth up to $50 or $100 when trading. This means that
you can earn a lot of money with a relatively small investment.
Round-the-clock trading - Another advantage of forex trading is that the
markets are open 24 hours a day, five days a week. The markets are only
closed on weekends based on a standard time. This means that you can trade
at any time of day or night that is comfortable for you.
Lower fees - One of the biggest advantages of the forex market is that there
are fewer fees involved, in comparison to other markets like the stock
exchange. In forex trading, fees are normally limited to the spread (the
difference in value between the two currencies being traded) of the
transaction. Lower fees means that you have more money to save, invest, or
spend on other things.
Online services and tools - Another main advantage when it comes to forex
trading is that you can trade from the comfort of your own home. Online
services and tools have made it easy for even beginners to understand,
monitor, and analyze the market. Furthermore, the Internet allows you to
start trading within a few clicks. Make use of all of the tools and services
available to you. This will put you in the best position to make income in the
forex market.
Automated trading software - Another advantage of forex trading is that
you can use automated trading software that can make transactions for you
depending on how you programmed the software. This makes it easier to
make trades at the right time and in the right situations.

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 Low barriers to entry (i.e: low account margins, free real-time

price quotes, free and sophisticated charting programs)
Not a lot off choices to trade allowing traders to focus on several instruments
instead of 1000s
Very liquid market allowing for good fills and not a lot of manipulation.

Some disadvantages of trading the forex market include:

One of the biggest disadvantages of the forex market is that it is fast and
volatile. Although this means that you can make money fast, the downside is
that you can lose money just as fast as well. Currency values can change
without warning, making it difficult to accurately predict where to invest
your money.

Leverage can work against you.

Although good leverage can help you make bigger investments with smaller
capital, it can also lead to losses that are greater than what you initially
invested. Just as you can make $100 for every $1 of capital, you can also
lose that same amount.
Online connections may fail.
Another downside of forex trading is that your Internet connection may fail,
causing you more problems. Some of the problems that you may encounter
if your Internet connection goes out include incomplete transactions and
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inability to monitor the market. In such cases, you will be held solely
responsible for the effects of disrupted Internet connection.
Other disadvantages include:
Scammers - Perhaps the most dangerous downside of forex trading is that
there are many scammers out there looking to steal your identity, your
money, or your financial information. Scams range from phishing scams and
hacking scams to fraudulent companies and fake software. It's important to
be very careful when dealing with others on the Internet. Only deal with well
known, reputable, and high rated companies, brokers, and markets.
24-hour market changes - Although a 24-hour trade market can be
convenient, it can also work against you. The fact that the market works
around the clock means that prices and values can change at any time of the
day. The market continues to move even when you are asleep or too busy to
manage your forex investments. This is where the automated software comes
in handy. Still, it can be dangerous to rely too much on automated software.
No centralized market allowing some unprofessional brokers to essentially
trade against their clients
Largely unregulated compared to stock and futures markets allowing some
brokers to manipulate data and client trades
Not a lot of choices of instruments to trade from vs. stocks which have
1000sVery complicated fundamentals which must be studied on a global
scale vs. stocks which are specific to one company in one industry

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CHAPTER 16

CONCLUSION
The market in which participants are able to buy, sell exchange and speculate on
currencies. Foreign exchange markets are made up of banks, commercial
companies, central banks, investment management firms, hedge funds, and retail
forex brokers and investors. The forex market is considered to be the largest
financial market in the world.
The foreign exchange market (Forex, FX, or currency market) is a global
decentralized market for the trading of currencies. In terms of volume of trading, it
is by far the largest market in the world. The main participants in this market are
the larger international banks. Financial centers around the world function as
anchors of trading between a wide range of multiple types of buyers and sellers
around the clock, with the exception of weekends. The foreign exchange market
41

determines the relative values of different currencies. The foreign exchange market
works through financial institutions, and it operates on several levels. Behind the
scenes banks turn to a smaller number of financial firms known as dealers, who
are actively involved in large quantities of foreign exchange trading. Most foreign
exchange dealers are banks, so this behind-the-scenes market is sometimes called
the interbank market, although a few insurance companies and other kinds of
financial firms are involved. Trades between foreign exchange dealers can be very
large, involving hundreds of millions of dollars. Because of the sovereignty issue
when involving two currencies, Forex has little (if any) supervisory entity
regulating its actions. The foreign exchange market assists international trade and
investments by enabling currency conversion.

BIBILIOGRAPHY

en.wikipedia.org/wiki/ Foreign_exchange_market
www.slideshare.net/manoharprasad/foreign-exchange-marketwww.investopedia.com/terms/forex/f/foreign-exchange-markets.asp
bookboon.com/en/foreign-exchange-market-an-introduction-ebook
https://www.scribd.com/doc/3928782/The-Foreign-Exchange-Market
www.slideshare.net/jineshshah123/foreign-exchange

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