FOREX Management

Compiled By: Avneesh Mishra

FOREX
It is a generally accepted form of money including COINS, PAPER
NOTES which is circulated by the Central Govt. (Central Bank)
within an economy.
As a Medium of Exchange for Goods & Services – Basis for Trade.
Mostly traded currency in global foreign exchange market*

ISO 4217 Code % daily share ISO 4217 Code % daily share
Rank Currency Rank Currency
(Symbol) (April 2014) (Symbol) (April 2014)

United States
1 USD ($) 87.00% 11 Swedish Krona SEK (kr) 1.80%
Dollar
2 EURO EUR (€) 33.40% 12 Russian Ruble RUB 1.60%
3 Japanses Yen JPY (¥) 23.00% 13 Hong Kong Dollar HKD ($) 1.40%
4 Pound Sterling GBP (£) 11.80% 14 Norweign krone NOK (kr) 1.40%
Australian
5 AUD ($) 8.60% 15 Singapore Dollar SGD ($) 1.40%
Dollar
6 Swis Franc CHF (Fr) 5.20% 16 Turkish lira TRY 1.30%
Canadian
7 CAD ($) 4.60% 17 South Korean won KRW (W) 1.20%
Dollar
8 Mexican PESO MXN ($) 2.50% 18 South African rand ZAR ( R ) 1.10%
9 Chinese Yuan CNY (¥) 2.20% 19 Brazilian real BRL (R$) 1.10%
New Zealand
10 NZA ($) 2.00% 20 Indian Rupee INR (Rs.) 1.00%
Dollar

*World bank report.

Foreign Exchange Management
Foreign exchange is the exchange of one currency for another or the

conversion of one currency into another currency.

FOREX Management may be defined as the science of management of

generation, use and storage of foreign currencies in the process of

exchange of one currency into other called foreign exchange.

3 Techniques of FOREX Mgmt. viz.

 Planning of FOREX,

 Organization of FOREX, and;

 Control of FOREX.

Strong Analytical Skills, Technical Skills, Conceptual Skills, Legal

Compliances and strong MIS framework.

Foreign Exchange Manager
Development in International Trade created a new entity known as

FOREX MANAGER, to deal with the Management of FOREX

Transactions.

The Key Skills of a FOREX Manager:

 Awareness of International developments affecting forex rates;

 Ability to forecast future trends;

 Comparative analysis skills;

 In-depth knowledge of FOREX Markets (India and Overseas);

 Knowledge of financial markets, interest rates etc;

 Risk Management Skills (Hedging, Speculation etc.)

Foreign Exchange Market
It is largest financial market in the world.

It is a market where currencies are bought and sold against each

other.

It is an Over-the-Counter (OTC) Market, where buyers and sellers

deal with each other directly, without any clearing houses.

Market comprises of very high trading volumes, approx US$ 5.2

Trillion per day (April 2014).

FOREX Market is geographically scattered and has no physical

location. Agents, Telephone, Satellites, Computer, SWIFT (Society
for World-wide International Financial Telecommunication) etc.

Trading Continues 24X7 on WEEKDAYS, due to differential time-

zones.
Foreign Exchange Market Contd..
All transactions of the FOREX Market may be divided into following

categories:

 Transactions between banks and their customers.

 Transactions between different bank in the same country.

 Dealing between banks in a country and their correspondence and

overseas branches.

 Transactions of the Central Bank of one country with Central Bank of

other countries.
Foreign Exchange Market in India
RBI Plays a key role in forex transactions and setting the daily

exchange rates.

Indian Corporate/ Business Houses enter the forex market to cover

their exchange risks arising from international transactions.

Speculative Transactions are not allowed in Indian FOREX Markets.

FEDAI (Foreign Exchange Dealers Association of India) assisted

RBI in controlling the FOREX Market in India.

The Organizations licensed by the RBI are called “Authorized

Dealers” and “Money Changers”. They are governed by FEDAI.

Participants in Foreign Exchange
Markets
1. Central Banks – Control to money supply, inflation, interest rates.
They also use their substantial forex reserves for market stabilization.
2. National Banks – Satisfy the need of Domestic Companies.
3. MN Banks – Forex Dealing for their Local and International Clients.
Involved in transfer of forex funds across the countries.
4. Companies/ Firms – Importers/ Exporters.
5. Regulatory Authority – FEMA & FEDAI.
6. Authorized Dealers – Link between Customer and Bank.
7. Speculators – Speculators are persons or institutions that buys or sell
forex with no intention to actual delivery of Currency. Their motive is
to earn profits from the fluctuations in the forex markets.
SPECULATION IN FOREX IS ILLEGAL IN INDIA.
8. Brokers.
9. Treasuries – Institutions which have plenty of surplus funds with no
immediate need for the same. Mutual Funds, Pension Funds, EPFO,
Universities, NGO‟s etc.
10. Retail Customers – Currently they participate indirectly through
authorised dealers and money changers. Travel, Tourism, Education,
Medical Reasons etc.
Foreign Exchange Rates
Forex Rate is the price of one country‟s money in terms of other
country‟s money.

E.g: When we say that exchange rate of Indian Rupee is Rs. 65.50 per
US$, we mean that 65.50 Indian Rupee is required to buy 1 US$.

When the Exchange rate becomes Rs. 66.00, it connoted the value of
Indian Rupee has depreciated (Weak) against US$.

If exchange rate becomes Rs. 65.00, it connotes that the value of

Indian Rupee has appreciated (Strong) against US$.

Such Changes in Exchange Rate is primarily due to the demand-

supply forces on both the currencies.

Therefore, when Indian Rupee becomes stronger against the US$, it

indicates the demand of rupee is more than its supply and vice-versa.
Terminologies in Foreign Exchange
Rates
1. Direct Quote: US$1 = Rs 65.00; €1 = Rs 75.00; £1 = Rs. 85.00

DQ denotes the number of units of „DOMESTIC CURRENCY‟ required

to buy 1 unit of foreign currency.

The number of units of foreign currency is kept constant and domestic

currency adjusted/ fluctuate. In India DQ is used to express forex.

2. Indirect Quote: Rs. 1 = US$ 0.0153; Rs. 1 = € 0.0133; Rs. 1 = £ 0.0117

IDQ denotes the number of units of „FOREIGN CURRENCY’ required to

buy 1 unit of domestic Indian currency.

The number of units of domestic currency is kept constant and foreign

currency adjusted/ fluctuate. IDQ is used in LONDON Forex Market.

3. Direct & Indirect Quotes are reciprocals of each other:

DQ = 1 AND IDQ = 1
Indirect Quote Direct Quote
Terminologies in Foreign Exchange Rates
Contd..
4. Bid (Buying) Rate: It is the rate at which the dealer (Bank) is ready to
buy the foreign currency in exchange for the domestic currency.
Therefore, it is the buying rate for the dealer (Bank) and selling rate for
the customer.

5. Offer (Ask) Price: It is the rate at which the dealer (Bank) is ready to
sell the domestic currency in exchange for the foreign currency.
Therefore, it is the selling rate for the dealer (Bank) and buying rate for
the customer.

6. Spread: The difference between the bid price and the offer price is
called spread. Spread is the profit made by the dealers (Bank) due to
the conversion transactions. E.g: Dealers (Bank) Quotes US$1 = Rs.
65.20 – 65.30 that means the Bid Price is Rs 65.20 and the Ask Price is
Rs 65.30 and the Spread (Margin) is Rs. 0.10.
Terminologies in Foreign Exchange Rates
Contd..
4. Thumb Rule:
 Direct Quote: The Quoting Bank will apply – ‘BUY LOW; SELL HIGH’

 Indirect Quote: The Quoting Bank will apply – ‘BUY HIGH; SELL LOW’

5. Spot Rate: A rate at which currencies are being traded for the delivery
on the same day (or Upto 2 days).

6. Indian Exporter: is the seller of Foreign Currency.

7. Indian Importer: is the buyer of Foreign Currency.

8. Forward Rate.

FR at Par.

FR at Premium.

FR at Discount.
Interpretation of Bank Quotations
Market quote for a currency consists of the spot rate and the forward
margins:

Case 1: When the Foreign Margins are given in ascending Order:

Particulars Direct Quote (USD = INR)

Spot Rs. 48.4000 – 4200
Spot /February 2000 – 2100 (Frwrd Margins)
Spot/ March 3500 – 3600 (Frwrd Margins)
It indicates that forward currency is at PREMIUM and forward rates to
be calculated as below:

Buying Rates Selling Rates

Feb March Feb March
Spot 48.4000 48.4000 48.4200 48.4200
(Premium) 0.2000 0.3500 0.2100 0.3600
Frwrd Rate 48.6000 48.7500 48.6300 48.7800
Interpretation of Bank Quotations
Market quote for a currency consists of the spot rate and the forward
margins:

Case 2: When the Foreign Margins are given in decending Order:

Particulars Direct Quote (GBP = INR)

Spot Rs. 73.4000 / 4300
Spot / May 3800 / 3600 (Frwrd Margins)
Spot/ June 5700 / 5400 (Frwrd Margins)
It indicates that forward currency is at DISCOUNT and forward rates to
be calculated as below:

Buying Rates Selling Rates

May June May June
Spot 73.4000 73.4000 73.4300 73.4300
(Discount) 0.3800 0.5700 0.3600 0.5400
Frwrd Rate 73.0200 72.8300 73.0700 72.8900
Cross Rates:
The Cross rate for a currency is the exchange rate based on the
exchange rate of 2 other currencies.

Example:

Spot Rate in India 1 US$ = Rs. 60 (i.e USD/Rs. = 60/1)

Spot Rate in Overseas 1 GBP = US$ 1.6666 (i.e. GBP/USD = 1.6666/1)

Therefore now GBP/ Rupee (Cross Rate):

=US$/ Rs. * GBP/US$

= 60/1 * 1.6666/1 = 60 X 1.6666 = Rs. 100 Per 1 GBP.

Factors Affecting Foreign Exchange
Rates
1. Economic Strength of Country: GDP Growth, IIP Ratio, per capita
income, forex reserves etc.

2. Political Stability of a Country.

3. Legal rules and regulations: degree of de-licensing, liberal govt.

policies etc.

4. Balance of Payment position.

5. State of capital market in the country (FII Inflows, Bullish v/s Bearish).

6. Speculation.

7. Interest Rates: Differential Interest rates between countries.

8. Inflation Rates: Differential Interest rates between countries.

9. Crude Oil Prices: Demand – Supply for Crude Oil, policy changes by
OPEC nations etc.

10. Gold Prices etc.

Foreign Exchange Risk
1. Transaction Exposure (Risk):

 Arises due to the difference between transaction date and settlement

date of any transaction involving foreign currency.

 Transaction Risk affects the profit of a Company along-with its cash

flow.

 Resulting, an exporter may receive less cash than expected while an

importer ends up paying additional cash than expected.

 Most Important type of Forex Risk from business perspective.

 All fixed value transactions such as receivables, payables, fixed price

sale and purchase contracts etc are subject to transaction exposure.
Foreign Exchange Risk
2. Translation Exposure (Risk):

 Also known as „Accounting Exposure‟.

 Affects the profits of a firm, but does not affect its cash flows. As per
AS-11, all foreign currency transactions outstanding at the end of an
accounting year, shall be disclosed in terms of the Domestic Currency.

 Any change in forex rates alters the values of Assets & Liabilities thus
the P&L account is affected, but the cash flows are not affected since
there is no settlement yet.

 The affect of risk appears in notional (Virtual) terms in P&L Account.

Foreign Exchange Risk
3. Economic Exposure (Risk):

 Refers to the Change in Value of a Firm due to variations in Foreign

Exchange rates.

 The Intrinsic value of a firm is equal to the sum of present value of

future cash flows discounted at an appropriate rate of return.

 If the Future Cash Flow are affected due to the forex rate changes, value
of the firm too shall vary.
Direct Quote – Indirect Quote
1. Direct Quote: E.g. US$ 1 = Rs. 65.0000.

Quoting Bank will Apply „Buy Low; Sell High’

Remark: The Banker buys the Foreign Currency at a lesser price and sells
it at a higher price.

2. Indirect Quote: E.g. Rs. 1 = US$ 0.0153.

Quoting Bank will Apply ‘Buy High; Sell Low’

Remark: The Bank will buy the Home Currency at High and will sell it at
Low.
Foreign Exchange Risk Management
Techniques
Practices could be adopted by the Forex Manager:

1. Denomination in Local Currency.

2. Denomination in Both Currencies – Partially.

3. Denomination in Neutral Currency – Relatively Stable

Currency. E.g. Export from India to Indonesia denoted in US$.

4. Foreign Currency Account.

5. Leads (Hasten/ Fast) & Lags (Postpone).

When traders predict as to whether the currency will weaken or

strengthen in future, they may like to pre-pone (Lead) or post-
pone (Lag) the time of receipt or payment of foreign currency.
Foreign Exchange Risk Management
Techniques
6. Netting & Matching:

Process under which debit balances are netted-off against the

credit balances, so that only the net amounts remain due to
be paid in actual currency flows.

Thus instead of making two-way cash-flows, only net amount

is paid.

Bilateral Netting: Only between 2 parties.

Multilateral Netting: More than 2 firms, it is practiced among

multinational corporations having many subsidiaries in the
same group.

7. Price Variation.
Foreign Exchange Risk Management
Techniques
8 Raising Funds in Foreign Currency:

FCCB, ECB, ADR, GDR etc.

9 Balance Sheet Hedge:

Company may invest as well as borrow in foreign country.

10 Transfer Pricing:

 Profits Are transferred through prices adjustment in intra-firm

transactions.

 Applied between parent and its subsidiaries or between

strong currency and weak currency subsidiaries.

 A Parent charges higher prices to its weak currency

subsidiary, thereby increasing its own profit and reducing that
of the Subsidiary.
Modern Technique – Money Market
Hedging
To optimize interest rate differentials between 2 counties.
A foreign exchange risk is compensated by a contra-transaction, i.e. receivables
against payables.
A Company either borrows/invest in foreign currency to square its position at the
date of settlement.
Hedging Payables (Importer) Hedging Receivables (Exporter)
Borrow funds in foreign currency for the
Borrow Funds in home currency
period after which the receivable is due.
The amount to be borrowed should be
Use them to purchase the foreign currency equal to the amount of the receivables as
reduced by the prevailing rate of interest.
Invest the foreign currency for the period Convert borrowed amount in home
after which the foreign currency payable currency and use it till the receivables
falls due. arrives.
Use the proceeds to make the payments
Invest home currency funds in profitable
Repay the borrowed amount together with areas.
the Interest