Foreign Exchange Market

WHAT IS FOREIGN EXCHANGE

Foreign exchange is the mechanism by which the currency of one country gets converted into the currency of another country. The conversion of currency is done by the banks who deal in foreign exchange. These banks maintain stocks of one currencies in the form of balances with banks

It also refers to the stock of foreign currencies and other foreign assets. The foreign exchange management ACT 1999 defines Foreign exchange means foreign currency and includes (a) Deposits credits and balances payable in any foreign currency. (b) Draft travelers cheques, letter or credit or bills of exchange expressed or drawn in Indian currency but payable in any foreign currency. (c) Drafts travelers cheques, letter of credit or bills of exchange drawn by banks, institution or persons outside India, but payable in Indian currency

Nature of foreign exchange

Volatile, affected by hedger, arbitrager, speculator. Affected by demand and supply. Affected by rate of interest. Affected by balance of payment surplus and deficit. Affected inflation rate. Spot and forward rates are different. Affected by the economic stability of the country. Affected by the fiscal policy of the government. Affected by the political condition of the country. It can be quoted directly or indirectly

Operation of foreign exchange market:

Foreign exchange market operates either as:Spot Market: (Current Market) Spot market for foreign exchange is that market which handles only spot transaction or current transactions. Principle characteristics: Spot Market is of daily nature. It does not trade in future deliveries. Spot rate of exchange is that rate which happens to prevail at the time when transactions are incurred.

Participants by Market 1. Spot Market a. commercial banks b. brokers c. customers of commercial and central banks

THE SPOT MARKET

Percent Spread Formula (PS):

Ask Bid PS x100 Ask

Forward Market: Forward Market for foreign exchange is that market which handles such transaction of foreign exchange as are meant for future delivery.
Principles Characteristics: It only caters to forward transaction. It determines forward exchange rate at which forward transaction are to be honored.

2. Forward Market a. arbitrageurs b. traders c. hedgers d. speculators

THE FORWARD MARKET

2. Purpose of a Forward: Hedging the act of reducing exchange

rate risk.

THE FORWARD MARKET

B. Forward Rate Quotations 1. Two Methods: a. Outright Rate: quoted to
commercial customers.

b.

Swap Rate: quoted in the

interbank market as a discount or premium.

THE FORWARD MARKET

CALCULATING THE FORWARD PREMIUM OR DISCOUNT

= F-S x 12 x 100 S n
where F = the forward rate of exchange S = the spot rate of exchange n = the number of months in the forward contract

THE FORWARD MARKET

C. Forward Contract Maturities 1. Contract Terms
a. 30-day b. 90-day c. 180-day d. 360-day Longer-term Contracts

2.

Exchange Rate
Fixed

Exchange Rate System Fixed rates provide greater certainty for exporters and importers. Flexible Exchange Rate System Flexible exchange rate or floating exchange rates change freely and are determined by trading in the forex market.

History of Foreign exchange

Foreign exchange history can be viewed as a series of solutions that allowed countries to issue their own currency and to conduct their own monetary policy while also allowing international trade to be conducted by providing a means of exchanging one currency for another according to the exchange rate between them, which was either agreed-upon or set by the market.

Characteristics of foreign exchange

Its huge trading volume representing the largest asset class in the world leading to high liquidity. Its geographical dispersion; Its continuous operation: 24 hours a day except weekends, i.e., trading from 20:15 GMT on Sunday until 22:00 GMT Friday. The use of leverage to enhance profit and loss margins and with respect to account size.

Retail Exchange Market

People

may need to exchange currencies in a number of situations.for Eg

Fluctuations in exchange rates

A market

based exchange rate will change whenever the values of either of the two component currencies change. The higher a country's interest rates, the greater will be the demand for that currency.

Central banks participate in the foreign exchange market to align currencies to their economic needs. Commercial companies . Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rate. Central bank National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies.

Measures Initiated to Develop the Foreign Exchange Market in India

Institutional Framework Foreign Exchange Regulation Act (FERA), 1973 was replaced by the market friendly Foreign Exchange Management Act (FEMA), 1999. Money and Securities Markets set up by the Reserve Bank in 1999 was expanded in 2004 to include foreign exchange markets

Top 10 Currency Traders as on May 2012 are

CURRENCY TRADING RULES

PLAN YOUR TRADE AND TRADE YOUR PLAN. THE TREND IS YOUR FRIEND. FOCUS ON CAPITAL PRESERVATION. KNOW WHEN TO CUT LOSS. TAKE PROFIT WHEN THE TRADE IS GOOD BE EMOTIONLESS. NOT TRADE BASED ON A TIP FROM A FRIEND OR BROKER.