Foreign Exchange Market

The existence of a number of

currencies gives rise to the need to
transact in these currencies for settling
international payments . This resulted
in the development of a market which
deals specifically in currencies ,called
the foreign exchange market. This is
an OTC MARKET .
• The foreign exchange (currency, forex or FX) market is
where currency trading takes place. FX transactions
typically involve one party purchasing a quantity of one
currency in exchange for paying a quantity of another.
The FX market is one of the largest and most liquid
financial markets in the world, and includes trading
between large banks, central banks, currency
speculators, corporations, governments, and other
institutions. The average daily volume in the global forex
and related markets is continuously growing. Traditional
turnover was reported to be over US$ 3.2 trillion per day
in April 2007 by the Bank for International Settlement.
Since then, the market has continued to grow. According
to Euromoney's annual FX Poll, volumes grew a further
41% between 2007 and 2008
• According to the Bank for International Settlements,[2]
average daily turnover in global foreign exchange
markets is estimated at $3.98 trillion. Trading in the
world's main financial markets accounted for $3.21
trillion of this. Of the $3.98 trillion daily global turnover,
trading in London accounted for around $1.36 trillion, or
34.1% of the total, making London by far the global
center for foreign exchange. In second and third places
respectively, trading in New York accounted for 16.6%,
and Tokyo accounted for 6.0%.[4] In addition to
"traditional" turnover, $2.1 trillion was traded in
derivatives.
 Top 10 currency traders
% of overall volume, May 2008

Top 10 currency traders [5]

% of overall volume, May 2008

Rank Name Volume

1 Deutsche Bank 21.70%
2 UBS AG 15.80%
3 Barclays Capital 9.12%
4 Citi 7.49%
5 Royal Bank of Scotland 7.30%
6 JPMorgan 4.19%
7 HSBC 4.10%
8 Lehman Brothers 3.58%
9 Goldman Sachs 3.47%
10 Morgan Stanley 2.86%
• The participants in the market are linked
together by telephone ,telex, and a
satellite communications network called
the Society for Worldwide International
Financial Telecommunications ( SWIFT )
This computer based communications
system ,based in Brussels ,Belgium, links
banks and brokers in just about every
financial center.
When foreign exchange is trading against the US
Dollar the clearing house that is used is called
CHIPS ( Clearing House interbank Payments
System) .It is located in New York

• Since September 2002 a new settlement

system has been provided to the foreign
exchange markets by New York based
CLS Bank where CLS stands for
Continued Linked Settlement .
 system has been provided ti the
foreign exchange markets by New
York based Bank ehere CLS
• When foreign exchange is trading aginst
stands for Continued Linked
the US Dollar the clearing house that is
Settlememt
used is called .
CHIPS ( Clearing House
interbank Payments System )
• This speed of communications makes the
market the most efficient market and the
efficiency is revealed in the extremely
narrow spread between buying and selling
price and participants of the market can
not can not afford to miss a beat in the
frantic pulse of this dynamic global market
.
 Structure of the market

• Major participants – Commercial Banks ,

Fore brokers, Large corporations , Central
bank .
• Central Banks
• The majority of developed market economies have a
central bank, whose role differs from country to country.
Central banks play an important role in the Forex market.
They try to maintain the money supply, interest rates,
inflation, and other market factors. A nation's central
bank also has the fundamental responsibility of
maintaining the market for its national currency. This
entails monitoring and checking the prices dealt in the
Forex market. Participants in the market all tend to
respect the opinions of the central banks because of the
power and control they have over the value of their
national currency.
• Banks
• Both small and large banks, working for themselves and their clients
(institutions, individual investors), participate in the Forex markets.
According to the Bank for International Settlements, approximately
50% of all Forex transactions are strictly interbank trades. Some of
the more active large banks may trade up to one billion dollars daily.
And while some of this trading is done for customers, most of it is for
the bank's own account.
• In the past banks relied on Forex brokers to handle their accounts in
the role of middlemen, but with the emergence of technology in the
Forex arena, they have been replaced by computers and other
devices. Today, transactions are made by telephone with brokers or
by an electronic medium, with the transaction time being between 5
and 10 seconds.
• Market Makers
• Forex market makers are the banks and brokerage
companies that facilitate the 24 hour trading capabilities
of the Forex market. Market makers literally "make the
market" for the currencies. They ensure that the market
is always functional and that the currencies in it will
always obtain the market rate. To achieve this level and
efficiency of trading, Forex market makers update their
prices at least two times per minute allowing the trader to
get the most complete up to date price and information
as possible.
• Corporations
• Small and large companies also play an
important role in the Forex market. These
companies often use foreign exchange to pay for
goods or services. Compared to banks and
hedge funds, corporations trade less amounts of
currency. Although they also do not hold the
influence of banks and hedge funds, they keep
the market strong through international trade
and foreign currency exchange between
multinational companies.
• Fund Managers
• Forex fund manager are similar to money
managers in the investment field. However, fund
managers do business in both the domestic and
international arena for individual investors,
corporate pension funds, governments, and
even central banks. Fund managers usually
have a large pool of investments to oversee for
a wide variety of clients. Dealing with hundreds
of millions of dollars, they invest money across a
range of countries to maximize returns
• Hedge Funds
• Hedge funds have a reputation for aggressive
currency speculation. Their influence in the
market over the past decade has increased
immensely. Hedge funds oversee billions of
dollars of equity, and, due their tremendous
borrowing power, may have rivaled the power
and influence of central banks, if investments
and market rends are in their favor. As opposed
to banks and fund managers, hedge funds are
primarily more concerned with managing the
total risk of their investment pools.
• Investment Management Firms
• Investment management firms typically manage large
accounts on behalf of corporate pension funds, trusts,
charity organization and similar institutions. They use the
Forex market to facilitate transactions in foreign
securities. An example of an investment firm's activity in
the Forex market is given by trading markets.com: an
investment manager in charge of an international equity
portfolio needs to purchase and sell several pairs of
foreign currencies to pay for foreign securities
purchases. Like hedge funds, investment firms are
concerned with limiting risk (while, of course, maximizing
returns).
• Brokers and Electronic Brokers
• The Forex broker is very similar to a stockbroker. One difference,
though, is that Forex brokers only deal with banks. They, in a very
efficient manner, act as the primary agent for bank transactions of
the Forex market. Due to technological innovations in the market,
many traditional brokering duties have been computerized,
decreasing the need for human handling of the orders.
• This technological takeover of the brokerage aspect of the Forex
market, has led to the emergence of 'straight through processing.'
Straight through processing is the automatic processing of an order
as soon as it becomes. This has opened up Forex trading to a new,
wide range of individuals and companies. Some of the most popular
trading platforms include Forex.com, FXconnect, and FX Solutions.
These sights, and others like them, allow Forex market participants,
mostly the larger banks and corporations, to access the market
directly, instead of going through a broker or a middleman,
ultimately cutting costs significantly.
 Forex market is a 24 hour market
•
It has long trading hours: 24 hours a day
except on weekends (from 5pm EST on
Sunday until 4pm EST Friday),
Eastern Time is the Eastern Time Zone of the
United States of America (USA) and Canada.
Eastern Standard Time (EST) is 5 hours behind
Greenwich Mean Time (GMT-5).
The spot foreign exchange market
• The spot exchange rate which is
determined in the spot exchange market is
the number of units of one currency per
unit of another currency ,where both are in
form of bank deposits . The settlement of
trade is completed by transferring of
deposits electronically denominated in
relevant currencies between the parties
involved .
 Some important Aspects
• Nostro Account
• Vostro Acount
• A nostro is our account of our money, held by you
• A vostro is our account of your money, held by us
• Delivery date and procedure for spot exchange :
generally 1+ 2 concept is applicable with some
exceptions.
• Retail versus interbank spot rates : The world over
,about 85% of forex trading arises as a result of
transaction between market makers and speculative
transactions .only 15 % of the transactions being trade or
commerce related .
 Factors Affecting Foreign
Exchange Currency Market
Trade

Political Factors
Economic Factors
Market Psychology
 Foreign Exchange Market in India
• The Indian foreign exchange market consists of the
buyers, sellers, market intermediaries and the monetary
authority of India. The main center of foreign exchange
transactions in India is Mumbai, the commercial capital
of the country. There are several other centers for
foreign exchange transactions in the country including
Kolkata, New Delhi, Chennai, Bangalore, Pondicherry
and Cochin. In past, due to lack of communication
facilities all these markets were not linked. But with the
development of technologies, all the foreign exchange
markets of India are working collectively.
• The foreign exchange market India is regulated by the
reserve bank of India through the Exchange Control
Department. At the same time, Foreign Exchange
Dealers Association (voluntary association) also provides
some help in regulating the market. The Authorized
Dealers (Authorized by the RBI) and the accredited
brokers are eligible to participate in the foreign Exchange
market in India. When the foreign exchange trade is
going on between Authorized Dealers and RBI or
between the Authorized Dealers and the Overseas
banks, the brokers have no role to play
• Apart from the Authorized Dealers and brokers,
there are some others who are provided with the
restricted rights to accept the foreign currency or
travelers cheque. Among these, there are the
authorized money changers, travel agents,
certain hotels and government shops. The IDBI
and Exim bank are also permitted conditionally
to hold foreign currency.
• The whole foreign exchange market in India is regulated
by the Foreign Exchange Management Act, 1999 or
FEMA. Before this act was introduced, the market was
regulated by the FERA or Foreign Exchange Regulation
Act ,1947. After independence, FERA was introduced as
a temporary measure to regulate the inflow of the foreign
capital. But with the economic and industrial
development, the need for conservation of foreign
currency was felt and on the recommendation of the
Public Accounts Committee, the Indian government
passed the Foreign Exchange Regulation Act,1973 and
 Exchange Rate quotations
• An exchange rate quotation is the price of
a Currency sated in terms of another
• American Vs European quote: British
pound, Irish pound and South African
Rand are few examples of American
Quotes .
• Direct Vs Indirect quotes
The spot foreign exchange market
• The spot exchange rate which is
determined in the spot exchange market is
the number of units of one currency per
unit of another currency , . The settlement
of trade is completed by transferring of
deposits electronically denominated in
relevant currencies between the parties
involved .
• Bid and ask rate :selling rate are called
ask, offer rate . Buying rate is called bid
rate .
• The difference of the two is the spread .
• Interbank Vs Merchant quotes
• INVERSE Quotes : Arbitrage
• Cross rates :Cross rate and arbitrage
 Types of transaction

• Forward Quotes : A forward contract also called an outright forward

is one where the parties of the transactions agree to bye or sell a
currency at a predetermined future date at particular price . Forward
contracts generally mature after 1,2,3,6,9,12 months.
• The difference of the spot rate and forward rates can be expressed
in terms of swap points . When swap points are low high ,currency B
is at premium and A is at discount .Add the swap points to the spot
rate to get the outright forward rate .If the points are high /low B is at
discount and A is at premium . Deduct the swap points from the spot
rate to arrive at the outright forward rate ,add them to the outright
forward rate to arrive at spot rate.

• Discount and premium :

• Discount and premium :
Calculation of annual premium and
discount
• Forwarded rate vs expected spot rates :
• While the price paid for a forward currency
equals the future spot rate expected by the
market a the time of purchase , when the
forward contract matures its value is determined
by the realized spot rate at that time . The
greater the extent to which the eventually
realized spot rate differs from the spot rate that
was expected at the time of buying the contract
,the larger is the change in the value of the
forward contract vis-à-vis the purchase price.
• Stated differently ,the larger is the
unexpected change in the spot exchange
rate greater is the change in the value of a
forward contract between the purchase
and maturity,
 Outright forward exchange and
swap
• An outright forward exchange contract
consists of an agreement to exchange
currencies at an agreed price at a future
date .
• A swap has two components , usually a
spot transaction plus a forward transaction
in the reverse direction./,although swap
could involve two forward transaction in
opposite directions.
• Swap in : to buy at spot and sell forward
• Swap out : to sell at spot and buy forward
• . Forward forward swap: contract to buy
for 1 month forward and sell 2month
forward .
• When the purchase and sale are
separated by only one day the swap is
called a rollover ,.
• The uses of Swaps : Swaps are valuable to
those who are investing or borrowing in foreign
currency but not for traders .
• Swaps are important for banks . For some dates
and currencies ,a bank will be long in foreign
exchange by having agreed to purchase more of
the foreign exchange than it had agree to sell.
For other dates and currencies a bank will be
short , having agreed to sell more of these
currencies than it had agreed to buy . Swaps
help the bank to economically reduce risk .
• If a bank is long on spot British pound and
short on 30 days pound , it will try to find
another bank ,bank B, in the opposite
situation . Bank A will sell pound spot and
buy pounds forward. –a swap out of
sterling with bank B .