WHAT IS FOREIGN EXCHANGE

Foreign exchange can be defined as the science of management of genera on of use and storage of
foreign currency. Also, the process which the currency of one country gets converted into the
currency of another country which is done by the banks who deal in foreign exchange. These banks
maintain stocks of one currencies in the form of balances with banks

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) Dra traveler's cheques, le er of credit or bills of exchange expressed or drawn in Indian currency
but payable in any foreign currency.
(c) Dra s travelers cheques, le er of credit or bills of exchange drawn by banks, ins tu on or
persons outside India, but payable in Indian currency.

FOREIGN EXCHAGE – EXAMPLES FOR BETTER UNDERSTANDING

1. What is Tendering the currency – One currency to another.

What’s so Special about these transac ons if,

1. Goods sold by Italy to France for cash payment.

2. Services rendered by Bri sh resident to Russian Resident in return received the goods of
same value.

3. One side transac on – Gi received by an Indian from Dubai.

FOREIGN EXCHAGE – EXAMPLES FOR BETTER UNDERSTANDING

Jus fica on is

1. Difference of currency

2. Forex reserve of the respec ve country

3. Tendering currency

4. Poli cal stability and capability of country – SriLanka,

5. Balance of Payment

EXCHANGE RATE FOR THE BALANCE OF PAYMENTS AND THE RATE OF INFLATION

This essay describes, reviews and illustrates the consequences & effect of exchange rates for the
balance of payment and the rate of inflation. This also underlying how relationships between inflation
and a country's balance of payments and currency exchange rates. The relationships are illustrated by
clear diagrams. Ways of balancing income and expenditure are described.
There is a discussion of the way in which changes in the centrally determined general interest rate
determine share prices, with examples.
Also discussed are the effects of multinational operations such as devaluation pricing and profits
maximisation, transfer pricing, importing from low-wage countries, transferring work to low-wage
countries.
There are worked examples illustrating the effects of changes in the currency exchange rate on
competitiveness, pricing and profits. The effect of a weakening currency is discussed in detail, taking
into account differing rates of inflation in different countries. The calculations are simple,
straightforward and illuminating. They show, for example, how devaluation (weakening of a country's
currency exchange rate) is used to drive up profits instead of resulting in increasing competitiveness
and exports.
As share values increased, corporations (companies) have withdrawn corresponding 'surpluses' from
their company pension funds and added them, or a substantial part of them, to shareholders' profits.
But as share prices fall, pension funds can become under funded. Companies may then be obliged to
make up the under funding to some extent. The likelihood of this happening may be a factor when
companies change, or advocate changing, established company (corporation) pension schemes.
Causes of inflation are described and discussed. Particular attention is given to inflation in relation to
pay, with worked examples. The calculations are simple and straightforward, with particular reference
to how the burden is shared out between different sections of the community.
As costs increase, bitter confrontation and struggle can develop between those who own and employ,
and those who are employed, about how to share out the burden. The report point to the large cost
of this way of sharing-out the burden among the different sections of the population.
Also discussed are criteria for judging the quality of government in relation to a country's balance of
payments, inflation and the quality of life and living of its inhabitants. As well as objective ways of
comparing different countries worldwide.

And this report is one of a series of seven reports, which cover, and underlie, the field of General
Management, for middle, senior and top management.
DESCRIPTION:

WHAT IS EXCHANGE RATE

 The price of one currency stated in terms of another currency.

 The value of one currency in terms of another.

 The price of one unit of a par cular country's currency in terms of another country's
currency.

 The price of one currency expressed in terms of another, i.e., the number of units of one
currency that may be exchanged for one unit of another currency.

 The price of a country's currency in terms of another country's currency. [FRBM][FRBSF] The
price of one currency in terms of another. [FACS] (see also currency deprecia on, currency
devalua on, currency revalua on, dirty float, fiscal policy, fixed exchange rate system, floa ng
exchange rate system, foreign currency opera ons, purchasing power parity theory, exchange)
(includes fixed exchange rates, floa ng exchange rates, foreign exchange rate)

The EXCHANGE RATE is the price (or rate ) at which two NATIONAL CURRENCIES exchange for each
other, often expressed as the amount of foreign currency, which can be bought using a unit of
domestic currency.
WHAT FACTORS MIGHT CAUSE A CHANGE IN THE EXTERNAL VALUE OF A COUNTRY’S EXCHANGE
RATE

Market value of the exchange rate is determined in the global foreign exchange markets. Markets
move because of shifting forces of demand and supply for a currency. The daily turnover is enormous
(London trades over $500 billion of foreign exchange every working day). Answers should focus on
DEMAND for and SUPPLY of a currency.

Demand for a currency

Exports of goods and services

Inflows of direct and portfolio investments
Pure speculative demand.
Official buying of the currency by the central bank.

Supply of a currency

Imports of goods and services

Outflows of direct and portfolio investments
Speculative selling of the currency
Official selling of the currency by the central bank

Answers should explain important causes of changes in the exchange rate Balance of payments deficit
or surplus (net currency flow from one country to another ). Changing interest rates (relative to those
available elsewhere) and effect this might have on portfolio flows (i.e. international investors seeking
the highest rate of return on their money by shifting it into those currencies that offer attractive risk-
adjusted interest rates. External shocks – e.g. change in international commodity prices .

Other factors driving the exchange rates value.

Purchasing Power Parity (PPP) – If a country has a high relative inflation rate – we expect to see the
exchange rate fail over time to compensate for this
Economic Growth relative to trend – impact on likely interest rate policy of domestic monetary
authorities. Fast growing economies where interest rates are likely to move upwards may see their
exchange rate appreciate as the speculators move in.

Supply – side performance of the economy – those countries with fastest long-term growth and
productivity will do better in trade performance and this impacts on the exchange rate.
FEMA Currency Pairs Chapter II

A currency pair is the quotation of two different currencies, with the value of one currency being
quoted against the other. The first listed currency of a currency pair is called the base currency, and
the second currency is called the quote currency.

Currency pairs compare the value of one currency to another—the base currency (or the first one)
versus the second or the quote currency. It indicates how much of the quote currency is needed to
purchase one unit of the base currency. Currencies are identified by an ISO currency code, or the
three-letter alphabetic code they are associated with on the international market. So, for the U.S.
dollar, the ISO code would be USD.

currency pair is a quotation of two different currencies, where one is quoted against the other. THE
FIRST LISTED CURRECNY IS CALLED THE BASE CURRECY AND THE SECOND CURRENCY IS CALLED THE
QUOTE CURRENCY.

Currency pairs compare the value of one currency to another. IT INDICATES HOW MUCH OF THE
QUOT CURRENCY IS NEEDED TO PURCHASE ONE UNIT OF THE BASE CURRENCY.

Currency pairs are traded in the foreign exchange market, which is open 24 hours a day, five days a
week. All forex trades involves the simultaneous purchase of one currency and the sale of another.

Currency pairs are identified by an ISO currency code, or the three-letter alphabetic code they are
associated with on the international market. For example, USD for U.S. dollar eur for euro jpy for
Japanese yen etc.

 A currency pair is a quota on of two different currencies, where one is quoted against the
other. The first listed currency is called the base currency, and the second currency is called
the quote currency1
 Currency pairs compare the value of one currency to another. It indicates how much of the
quote currency is needed to purchase one unit of the base currency2
 Currency pairs are traded in the foreign exchange market, which is open 24 hours a day, five
days a week. All forex trades involve the simultaneous purchase of one currency and the sale
of another2
 Currency pairs are iden fied by an ISO currency code, or the three-le er alphabe c code
they are associated with on the interna onal market. For example, USD for U.S. dollar, EUR
for euro, JPY for Japanese yen, etc2
 There are three types of currency pairs: major, minor, and exo c. Major currency pairs are
the most traded ones and include the U.S. dollar as either the base or the quote currency.
Minor currency pairs are less traded and do not include the U.S. dollar. Exo c currency pairs
are the least traded and involve a major currency and a currency from an emerging or
developing country3
 The most ac vely traded currency pair is the euro against the U.S. dollar (EUR/USD). The
second most popular currency pair is the U.S. dollar against the Japanese yen (USD/JPY)2
 Several factors can affect the price of currency pairs, such as interest rates, gross domes c
product (GDP), Federal Reserve ac ons, and other economic and poli cal events

Some examples of currency pairs are:

  EUR/USD: This is the most traded currency pair in the world. It represents the exchange rate
between the euro and the U.S. dollar. The euro is the base currency and the U.S. dollar is the
quote currency1
 USD/JPY: This is the second most popular currency pair in the world. It represents the
exchange rate between the U.S. dollar and the Japanese yen. The U.S. dollar is the base
currency and the Japanese yen is the quote currency 1
 GBP/USD: This is the third most traded currency pair in the world. It represents the exchange
rate between the Bri sh pound and the U.S. dollar. The Bri sh pound is the base currency
and the U.S. dollar is the quote currency. This pair is also known as the cable1
 USD/CHF: This is another major currency pair that involves the U.S. dollar. It represents the
exchange rate between the U.S. dollar and the Swiss franc. The U.S. dollar is the base
currency and the Swiss franc is the quote currency. This pair is also known as the dollar
swissy2
 AUD/USD: This is a commodity currency pair that involves the Australian dollar. It represents
the exchange rate between the Australian dollar and the U.S. dollar. The Australian dollar is
the base currency and the U.S. dollar is the quote currency. This pair is also known as the
Aussie dollar2
 NZD/USD: This is another commodity currency pair that involves the New Zealand dollar. It
represents the exchange rate between the New Zealand dollar and the U.S. dollar. The New
Zealand dollar is the base currency and the U.S. dollar is the quote currency. This pair is also
known as the kiwi dollar2
 USD/CAD: This is a commodity currency pair that involves the Canadian dollar. It represents
the exchange rate between the U.S. dollar and the Canadian dollar. The U.S. dollar is the base
currency and the Canadian dollar is the quote currency. This pair is also known as the dollar
loonie2

These are some of the most common examples of currency pairs, but there are many more that are
traded in the forex market, such as minor and exotic pairs that do not include the U.S. dollar. 34 I
hope this helps you understand what currency pairs are and how they work

The difference between major and minor currency pairs is mainly based on their liquidity, volatility,
and spreads. Liquidity refers to how easily a currency pair can be bought and sold in the market.
Volatility refers to how much the price of a currency pair fluctuates over time. Spreads refer to the
difference between the bid and ask prices of a currency pair, which is the cost of trading.
Major currency pairs are the most traded and liquid currency pairs in the forex market. They include
the US dollar as either the base or the quote currency, and they are paired with other major
currencies such as the euro, the Japanese yen, the British pound, the Swiss franc, the Canadian
dollar, the Australian dollar, and the New Zealand dollar. Some examples of major currency pairs are
EUR/USD, USD/JPY, GBP/USD, USD/CHF, AUD/USD, USD/CAD, and NZD/USD 1
Minor currency pairs are less traded and liquid than major currency pairs. They do not include the
US dollar, but they are paired with other major currencies. Some examples of minor currency pairs
are EUR/GBP, AUD/JPY, GBP/JPY, EUR/CHF, EUR/AUD, GBP/AUD, and GBP/CAD2
Because of their higher liquidity, major currency pairs tend to have lower spreads and volatility than
minor currency pairs. This means that they are more predictable and cheaper to trade. However,
this also means that they offer lower potential returns than minor currency pairs. Minor currency
pairs can offer more opportunities for profit due to their higher volatility and wider spreads, but
they also carry more risk and cost more to trade 34

Therefore, traders should consider their trading style, risk appetite, and market conditions when
choosing between major and minor currency pairs. Major currency pairs are suitable for beginners
and conservative traders who prefer stability and low costs. Minor currency pairs are suitable for
experienced and aggressive traders who seek higher returns and diversification.
FOREIGN EXCHANGE PARTICIPANTS - Chapter III

The forex market is a dynamic and diverse market that offers various opportuni es and challenges
for its par cipants.

The foreign exchange market or Forex market is the pla orm where different currencies are traded. It
is an over-the-counter (OTC) market with no central marketplace to facilitate trading, transac on
ease, and standardiza on during exchange of currencies.

Different countries’ currencies are traded in pairs in exchange for each other. As a result, the value of
one of the currencies will differ from the other.

Different types of Forex markets, such as the spot market, swap market, forward market, op ons
market, futures market, and par cipants, make up the foreign exchange market structure.

Forex par cipants are the people or en es that take part in the foreign exchange market, which is
the global pla orm where different currencies are traded. Forex par cipants have different mo ves,
roles, and resources in the market. Some of the main types of forex par cipants are Banks, Brokers,
Central Banks, Companies, Individual Investors.

FOREIGN EXCHAGE PARTICIPANTS

1. Commercial banks

2. Hedge funds

3. Real money

4. Retail traders

5. Sovereign wealth funds

6. Prime brokers

7. Retail brokers

8. Proprietary trading firms

9. Money transfer/remi ance companies

10. Foreign exchange fixing

11. Commercial companies

12. Governments and central banks

The foreign exchange market is decentralised and there is no organisa on that controls it. However,
commercial banks who act as market makers, and central banks have significant powers and can
influence the market.

Generally, the FX market is too big for one par cular par cipant to control.
Foreign exchange market history tells us that the Foreign exchange market func ons based on the
demand and supply principles of a commodity. Like any commodity, the demand for a par cular
currency pushes its value up; this is called apprecia on of the value of a currency. The supply and
demand of one currency against another determines the values at which exchanges will trade them
against one another. For example, if $1 equals 83 Rupees, it essen ally means that 83 Rupees have
to be spent on purchasing $1 worth of goods.
Apprecia on and Deprecia on Chapter-IV

If you turn on the TV at any given me of the day, the likelihood that you will come across a news
station that is talking about inflation, the dollar is appreciating or depreciating, rising interest rates,
or foreign investments going up or down, is highly likely. But, what does it mean when the dollar is
appreciating or depreciating? What causes a currency to gain or lose value and what effect does it
even have on the economy? Here, we will take a look at all of these things and see some currency
appreciation and depreciation examples along with the appreciation and depreciation formula.

Appreciation and Depreciation Definition

Appreciation and depreciation of a currency refer to the change in the value of one currency in
comparison to another currency in the freely floating exchange rate regime. Appreciation occurs
when the value of a currency increases in comparison to the value of another
currency. Depreciation of a currency occurs when the value of a currency falls in comparison to the
value of another currency. Forces of demand and supply for currency determine its value in the
freely floating exchange markets.

Appreciation is when a currency experiences an increase in value when it is compared to other

currencies.
Depreciation is when a currency experiences a decrease in value when it is compared to other
currencies.

To learn about the differences between the fixed and floating exchange rate regimes need to learn -
Floating Exchange Rate and Fixed Exchange Rate.
The exchange rate is the price or value of one currency in rela on to another.

What determines a currency's value?

To know if a currency appreciates or depreciates we need to know its value. If we look at it simply, a
currency’s value is determined by the market's demand and supply for the currency just like any
other good or service. Demand for a currency can be influenced by things like a country's interest
rate, its inflation rate, how much money moves in and out of a country, or a country's money supply.
The exchange rate can then help us determine the value of the currency in comparison to other
currencies.

Exchange rate

The exchange rate compares the value of one currency to another and is often the go-to measure for
currency value. The foreign exchange market is where these exchanges of various currencies occur.
Various factors in the economy such as changes in supply, demand, and people's tastes and
preferences can cause the value of a currency to appreciate or depreciate in comparison to another.

Say the United States consumes about 12 billion bushels of domestically produced corn annually. If
there is a drought, and 1/3 of the crop is lost, the United States will have to increase corn imports.
To buy corn imports the USD will need to be exchanged for the foreign currency to pay foreign
suppliers. The value of the USD will depreciate because of the increased supply of USD in the forex
market.
An exchange rate is considered higher when there is a big difference between the values of the two
currencies being compared. The exchange rate of the USD and the Mexican Peso is 1USD to
19.92MXN. This is high because 1 USD gets you many MXN but 1 MXN does not get you very many
USDs.
The exchange rate is lower when two currencies are closer in value. The exchange rate between the
USD and the Euro is 1 Euro to 1.06USD which is a small difference when compared to the difference
between the UDS and MXN.
The exchange rate is the price or value of one currency in relation to another.
To learn more about the exchange rate, click over to our explanation - Exchange Rates

Examples of Currency Appreciation and Depreciation

An example of currency appreciation is when the increased value of the domestic currency,
increases purchasing power in foreign markets. Let's say the USD is the domestic currency, and the
United Kingdom (GBP) will be the foreign market. When a currency appreciates, the currency it is
being compared to depreciates. So foreign, UK goods appear cheaper when the USD appreciates
because the domestic currency, the USD, will be able to purchase more foreign currency, GBP, and
therefore more foreign goods, assuming that foreign prices remained the same.
Imagine currently 1 USD is worth 0.65 GBP. With 1 USD, you can purchase only 65 pence of a GBP.
Over the next 5 years the Federal Reserve decides to increase interest rates to combat rising
inflation, lowering the overall money supply. This helps keep inflation low, which increases the value
of the USD, and improves its purchasing power.
Now, 5 years later, the exchange rate is 1 USD to 0.94 GBP. Where before you could only purchase
0.65 GBP you can now purchase 0.94 GBP, for the same amount of your USD. The value of USD has
increased or appreciated by 44.6% relative to the GBP.
Calculation is as follows:
£0.94-£0.65£0.65=£0.29£0.65=0.446��44.6%
An example of currency depreciation is when the decreased value of the domestic currency
decreases its purchasing power. Currency depreciation makes domestic currency appear cheaper
when compared to foreign currencies. Currency depreciation is when the domestic currency
decreases in value and the amount of foreign currency it can purchase falls.

Your domestic currency is the GBP. For 1 GBP, you can purchase 1.67 USD worth of foreign currency.
Imagine, your country experiences a period of inflation due to a raw material shortage. Inflation
erodes the value of your currency, causing it to depreciate. Now, for 1 GBP, you can only purchase
1.07 USD. The GBP depreciated by 35.9%.
Calculation is as follows:
$1.07-$1.67$1.67=-$0.60$1.67=-0.359��-35.9%
Causes of Appreciation and Depreciation of Currency

An appreciation or depreciation in a currency can be caused by several factors:

 Interest rate
 Trade
 Speculation

Interest rate

Changes in a nation's interest rate can encourage investment by those looking to profit off of a
nation's currency. If the government is offering higher interest rates on products such as treasury
bills, corporate bonds, or certificates of deposits, then those investors that take a fixed income
approach to investment, will want to purchase these products because of the higher investment
yield that they offer. This increases the demand for the currency which appreciates its value.

Capital outflow and inflow can each cause currency depreciation and appreciation, respectively.

Capital outflow occurs when large sums of money are flowing out of a nation's economy.
This can happen if domestic interest rates are low, and investors are looking to foreign markets that
have higher interest rates to increase their returns. Money is flowing out of the domestic economy,
and increasing the supply of the currency in the foreign exchange market. This causes a depreciation
in the value of the currency.

Capital inflow occurs when large sums of money flow into the economy.
When domestic interest rates are high relative to foreign ones, investors will want to purchase
domestic currency which decreases its supply on the foreign exchange market, resulting in
appreciation of the value of the currency.

Trade

The appreciation or depreciation of currency caused by the changes in the interest rate impacts
international trade. The changes in the price of the currency affect the number of imports and
exports. Aggregate demand in the economy partially depends on imports and exports. If the quantity
of exports decreases because of an appreciation of the currency, then there is a loss in capital inflow
and aggregate expenditure and therefore aggregate demand must fall. The rest of the aggregate
demand is comprised of consumption, investment, and government spending.

Aggregate Demand Formula:

��=�+�+�+(�-
�)�ℎ���:�=����������������������������������
�=�����������=�������������������=��������=�
������

To find out more about aggregate demand check out our explanation - Aggregate Demand
If a nation is running a trade surplus, meaning they export more than they import, there will be more
domestic currency demanded as more domestic goods are bought by the foreign buyers. This will
cause an appreciation of the currency.
On the other hand, a trade deficit, meaning imports being higher than exports, can cause a
depreciation of the currency, because a country is having to buy foreign currency to purchase goods
from other countries. This means domestic currency loses its value.

Speculation

Speculation happens when traders in the foreign exchange market buy and sell currencies based on
if they think a currency will appreciate or depreciate. It is partially based on emotion and partially on
opinions and experience. They form their opinions depending on factors like the political climate,
government policies, inflation, and current trends in the market. These speculations can influence
the market because as traders invest where they think they will make a profit, others will follow
which means that as more and more people buy a currency the more it appreciates. Other
currencies will depreciate relative to the currency that has appreciated.

Effect of Currency Appreciation and Depreciation

The effect of currency appreciation and depreciation is felt prominently in international trade. When
a currency’s value changes, a country’s imports, and exports can be affected because trading may
become either relatively cheaper or more expensive depending on the change in the value of the
currency.

Effect of currency appreciation

When a currency appreciates, it will make foreign goods appear relatively cheaper and domestic
goods more expensive. When a currency appreciates its purchasing power in the foreign markets
increases because the same amount of currency can buy more foreign currency. This will encourage
more goods to be imported which is good for the consumer since they will have a more diverse
selection of goods due to lower import prices. On the other hand, the number of exports will
decrease, which is not good for domestic producers, because domestic goods will appear more
expensive in foreign markets. Therefore, when we see an appreciation in the currency, net exports
decrease.

When exports decrease, domestic producers are generating less income, as capital outflows
increase. This means we will see a decrease in the aggregate demand in the economy.

Fig 1. - Increase in demand for U.S. Dollars

Figure 1 shows an increase in the demand for U.S. Dollars. This change in demand can be due to a
decrease in the interest rates in the European markets. This increase in demand is shown by the shift
of the demand curve for U.S. dollars from D 1 to D2. This causes the equilibrium quantity demanded of
U.S. dollars to increase from Q1 to Q2. Since the supply of U.S. dollars has not changed, the
equilibrium number of euros per dollar increases from XR1 to XR2. This indicates an appreciation of
the exchange rate and therefore the price of U.S. dollars compared to euros increases.
An appreciated currency can help control inflation because imports become relatively cheaper and
these relatively lower prices can help keep inflation low. Lower prices on imports force domestic
producers to increase their productive efficiency to keep domestic prices low and competitive with
the foreign goods.

Effect of currency depreciation

When a currency depreciates, it will make foreign goods appear relatively more expensive and
domestic goods cheaper. The purchasing power of the domestic currency in foreign markets falls
too. The benefit of depreciation is that domestic goods now appear cheaper in foreign markets
which will encourage an increase in exports. This will promote a trade surplus and thus result in an
increase in net exports. An increase in exports means domestic producers are generating more
income which will increase capital inflows and encourage domestic producers to increase production
to maximize profits. It also increases aggregate demand.

Fig 2. - Decrease in demand for U.S. Dollars

Figure 2 shows the effect of a decrease in demand for U.S. Dollars. This decrease in demand could
stem from an unstable political climate, for example. The demand curve for U.S. dollars shifts from
D1 to D2, which decreases the equilibrium quantity of dollars demanded from Q 1 to Q2. The supply of
dollars has remained unchanged, so the equilibrium number of euros per dollar falls from XR 1 to XR2.
This indicates a depreciation of the exchange rate and therefore the price of U.S. dollars compared
to euros decreases.

Appreciation and Depreciation Formula

To find out if a currency appreciated or depreciated, and by how much, we need to know the old
value of the currency and the new value of the currency. We then need to apply the following
formula:

%��������=��������-����������������

Appreciation calculation

To calculate appreciation, we will use dollars to euros as an example.

Let the initial exchange rate be: $1.25/1€.

Imagine the dollar appreciates to $1.50/1€.

Now we must find out by how much in percentage terms the dollar appreciated.

We will plug our values into the formula for calculating the percentage change in value:
$1.50-$1.25$1.25=$0.25$1.25=0.2��20%
The dollar has appreciated by 20% relative to the euro.

Depreciation calculation

To calculate depreciation, we will use dollars to euros as an example.

Let the initial exchange rate be: $1.74/1€.

Imagine the dollar depreciates to $1.43/1€.

Now we must find out by how much in percentage terms the dollar depreciated.

$1.43-$1.74$1.74=-$0.31$1.74=-0.178��-17.8%
The dollar has depreciated by 17.8% relative to the euro. Note the negative percentage change that
indicates depreciation.

Appreciation and Depreciation - Key takeaways

 Appreciation is when a currency experiences an increase in value when it is compared to

other currencies. Depreciation is when a currency experiences a decrease in value when it is

compared to other currencies.

 The exchange rate is the price or value of one currency in relation to another.

 When the value of a currency changes, nation's imports and exports can be affected because

trading may become either relatively cheaper or more expensive depending on the change

in the value of the currency.

Frequently Asked Questions about Appreciation and Depreciation

What is appreciation and depreciation of currency?

Appreciation is when a currency experiences an increase in value when it is compared to other currencies.

Depreciation is when a currency experiences a decrease in value when it is compared to other currencies.

What are the effects of currency appreciation and depreciation?

Appreciation causes the value of a currency to go up which decreases exports and increases imports.
Depreciation causes the value of a currency to go down which increases exports and decreases imports.

What are some advantages of appreciation and depreciation of currencies?

An advantage of appreciation is that it makes foreign goods appear cheaper relative to domestic goods
and keeps inflation low. An advantage to depreciation is that domestic prices appear cheaper in foreign
markets which increases exports and promotes a trade surplus.

What causes appreciation and depreciation in currency?

Appreciation and depreciation can be caused by changes in the interest rate, trade, and speculation.

How does appreciation and depreciation affect imports and exports?

Appreciation increases imports and decreases exports because foreign goods appear cheaper.
Depreciation decreases imports and increases exports because domestic goods appear cheaper to foreign
markets.

What is exchange rate appreciation?

Exchange rate appreciation is when the value of your country's currency goes up in relation to the value of
other currencies with which it is in the floating exchange rate regime.

What is exchange rate depreciation?

Exchange rate depreciation is when the value of your country's currency goes down in relation to the value
of other currencies with which it is in the floating exchange rate regime.
Types of FOREX Transac ons Chapter-V

Spot Transac on: The spot transac on is when the buyer and seller of different currencies se le
their payments within the two days of the deal. It is the fastest way to exchange the currencies. Here,
the currencies are exchanged over a two-day period, which means no contract is signed between
the countries. The exchange rate at which the currencies are exchanged is called the Spot Exchange
Rate. This rate is o en the prevailing exchange rate. The market in which the spot sale and purchase
of currencies is facilitated is called as a Spot Market.

Forward Transac on: A forward transac on is a future transac on where the buyer and seller enter
into an agreement of sale and purchase of currency a er 90 days of the deal at a fixed exchange rate
on a definite date in the future. The rate at which the currency is exchanged is called a Forward
Exchange Rate. The market in which the deals for the sale and purchase of currency at some future
date is made is called a Forward Market.

Future Transac on: The future transac ons are also the forward transac ons and deals with the
contracts in the same manner as that of normal forward transac ons. But however, the transac ons
made in a future contract differs from the transac on made in the forward contract on the following
grounds:

The forward contracts can be customized on the client’s request, while the future contracts
are standardized such as the features, date, and the size of the contracts is standardized.

The future contracts can only be traded on the organized exchanges, while the forward contracts
can be traded anywhere depending on the client’s convenience.

No margin is required in case of the forward contracts, while the margins are required of all the
par cipants and an ini al margin is kept as collateral so as to establish the future posi on.

Swap Transac ons: The Swap Transac ons involve a simultaneous borrowing and lending of two
different currencies between two investors. Here one investor borrows the currency and lends
another currency to the second investor. The obliga on to repay the currencies is used as collateral,
and the amount is repaid at a forward rate. The swap contracts allow the investors to u lize the
funds in the currency held by him/her to pay off the obliga ons denominated in a different currency
without suffering a foreign exchange risk.

Op on Transac ons: The foreign exchange op on gives an investor the right, but not the
obliga on to exchange the currency in one denomina on to another at an agreed exchange rate on a
pre-defined date. An op on to buy the currency is called as a Call Op on, while the op on to sell the
currency is called as a Put Op on.

Thus, the Foreign exchange transac on involves the conversion of a currency of one country into the
currency of another country for the se lement of payments.
The foreign exchange market or Forex market is the pla orm where different currencies are traded. It
is an over-the-counter (OTC) market with no central marketplace to facilitate trading, transac on
ease, and standardiza on during exchange of currencies.

Different countries’ currencies are traded in pairs in exchange for each other. As a result, the value of
one of the currencies will differ from the other.

Different types of Forex markets, such as the spot market, swap market, forward market, op ons
market, futures market, and par cipants, make up the foreign exchange market structure.

The Foreign Exchange Market is the world’s largest and most liquid currency exchange market. It is
open to any en ty or country regarding the total cash value transacted. Since there is no central
currency, it is an OTC exchange market. Foreign exchange, or foreign currency exchange, is an
important aspect for any company and people func oning in an interna onal context. It facilitates
the exchange of foreign currency into domes c currency and vice versa.

Countries must convert foreign currency into domes c currency for u liza on in the home country. A
na on should deal with all foreign en es on a one-to-one basis, meaning that all imports from a
foreign country needs payment in its currency, and all exports needs payment in the other currency.
However, it is not prac cally possible because it requires keeping track of many currency rates and
the accompanying payment issues. As a result, most countries select a common currency for trading
among themselves.

How Foreign Exchange Market works?

One compares a country’s currency with its common currency for interna onal transac ons. Trades
would take place in this currency, which is the economically dominant currency. As a result, a country
must trade in U.S. dollars or other major currencies such as the Euro, Pound, or Japanese yen. A
balance of payment account helps to keep track of a country’s external trade. This account is credited
with foreign currency receipts while debited with foreign currency payments. Other factors being
constant, a country with a deficit balance of payments will have a weak na onal currency, and vice
versa. Therefore, the demand for foreign currency increases when the country’s balance of payment
account is in deficit. As a result, their value rela ve to the home currency rises.

One trades the currencies of different countries in pairs in exchange for each other. As a result, one
of the currencies will have a different value than the other. This decides how much currency a
country can purchase from another country and vice versa based on supply and demand.
The currency market’s primary job is to establish this price rela onship worldwide. This improves
liquidity in all other financial markets, cri cal for overall stability.

Types of Forex Market

The foreign exchange market features different modes of trading, and they are embodied as follows:

#1 – Spot Market

Transac ons demand quick payments at the prevailing exchange rates. It requires immediate
currency delivery or exchange on the spot- o en within 48 hours. Spot transac ons are those in
which currency exchange occurs two days following the contract date. The spot rate is the effec ve
exchange rate for a spot transac on, and the spot market is the market for such transac ons. When
an increase or decrease in the commodity’s price occurs between the actual agreements and traded
me, traders face uncertainty. Spot market traders are less prone to such uncertain es in the market.

#2 – Forward Market

The forward market involves transac ons in which exchange takes place at a specified date in the
future for a specific price. In other words, the forward currency market entails making a contract
today to purchase or sell foreign currency in the future. Forward rates are similar to spot rates,
except the delivery takes place much later. However, there may be differences between the spot and
forward rates. The difference is the forwarding margin or swap points. In addi on, traders can
customize the period of delivery at their will. This exchange helps exporters and importers avoid the
challenges of rate fluctua ons by using relevant forward exchange contracts.

#3 – Future Market

A futures contract is another version of a forward contract traded publicly on a futures exchange. It
includes the price and the me in the future to buy or sell an asset, just like a forward contract.
Unlike a forward contract, a futures contract has a fixed contract size and maturity date. Futures can
only be exchanged on an organized exchange and they undergo compe ve trading. A forward
contract does not require margins, unlike all players in the futures market. Furthermore, traders
must pay an ini al margin into a collateral account to create a future posi on.

#4 – Swap Market

Swaps allow the exchange of two streams of cash flows in two different currencies. Swaps, or double
transac ons, are opera ons in which a purchase or sale of the same currency for forwarding delivery
follows a simultaneous sale or purchase of spot currency. The spot currency is swapped against the
forward currency. Commercial banks that engage in forwarding exchange ac vity may use a swap
opera on to alter their fund posi on.

#5 – Op ons Market

Op ons are deriva ve instruments that allow a foreign exchange market operator to buy or sell a
foreign currency at a predetermined rate (strike price) on or before a specific date (maturity date).
A call op on allows traders to buy the underlying asset, whereas a put op on allows them to sell it.
Exercising the op on means purchasing or selling the underlying asset through the op on. In the
op ons market, exercising the op on is not an obliga on for traders.
Direct Indirect Quote & Bid Ask Rate Chapter-VI

Direct quota on is where the cost of one unit of foreign currency is given in units of local currency,
whereas indirect quota on is where the cost of one unit of local currency is given in units of foreign
currency.

Your local currency is EUR:

- Direct exchange rate: 1 USD = 0.92819 EUR

- Indirect exchange rate: 1EUR = 1.08238 USD

Your local currency is EUR:

Exchange rate Currency Currency Valid Exchange Translation

type (from) (to) from rate ratio

M USD EUR 1/1/1999 92.81993 100: 1

EURO EUR USD 1/1/1999 1.08238 1: 1

The first line shows a direct exchange rate USD – EUR; the local currency is the to-currency. 100 USD
equals 92.81993 EUR.

The second line shows a indirect exchange rate EUR – USD; the local currency is the from-currency: 1
EUR equals 1.08238 USD.

Exchange rate quotations can be quoted in two ways – Direct quotation and Indirect quotation. Direct
quotation is when the one unit of foreign currency is expressed in terms of domestic currency. Similarly,
the indirect quotation is when one unit of domestic currency us expressed in terms of foreign currency.
Let us learn in more detail about Exchange rate, Direct, and Indirect quotations.

Direct Quote

Let’s now look at it in detail. In financial terms, the exchange rate is the price at which one currency will
be exchanged against another currency. The exchange rate can be quoted directly or indirectly.

The quote is direct when the price of one unit of foreign currency is expressed in terms of the domestic
currency.
Direct Quote is one of the two methods used to define or express the foreign currency conversion
rate with the domestic currency. It explains how many domestic currencies are needed to buy a
single unit of foreign currency.

It describes the number of units of domestic currency required to get a certain amount of foreign
currency. It is used in the foreign exchange market to show the ratio of one currency in relation to
another. If the direct quote has a lower exchange rate, it means the domestic currency is stronger.

Let us look at some examples of citing a direct quote.

An Indian Company ABC Ltd. needed USD 1200 & it was provided that it will require to convert its
INR 84000 for such purpose. Comment on the Direct quote for the company.

As ABC Ltd. is an Indian Company and its place of residence is in India, the direct quote will be in the
form of “Domestic Currency (i.e., INR) needed for conversion of 1 unit of Foreign Currency (i.e.,
USD).

So, as per the formula, the quote would be;

 = Domes c Currency (INR) / Foreign Currency (USD)

 = 84000 / 1200
 = 70

So, this would be; INR 70 per USD at the time of conversion.

Indirect Quote

The quote is indirect when the price of one unit of domestic currency is expressed in terms of Foreign
currency.
Since the US dollar (USD) is the most dominant currency, usually, the exchange rates are expressed
against the US dollar. However, the exchange rates can also be quoted against other countries’ currencies,
which is called as cross currency.

Now, a lower exchange rate in a direct quote implies that the domestic currency is appreciating in value.
Whereas, a lower exchange rate in an indirect quote indicates that the domestic currency is depreciating
in value as it is worth a smaller amount of foreign currency.

Base and Counter Currency

Now that you understand the concept of the direct and indirect quote, let’s look at some other related
concepts. The exchange rate has two components—the base currency and the counter currency.

In a direct quotation, the foreign currency is the base currency and the domestic currency is the counter
currency. In an indirect quotation, it’s the other way around. The domestic currency is the base and the
foreign currency is the counter.

For example, USD to INR is a direct quote and INR to USD is an indirect quote. Most exchange rates list
the USD as the base currency. Exceptions, in this case, include the Euro and the Commonwealth
currencies such as Great Britain Pound (GBP), Australian Dollar (AUD), and the New Zealand Dollar (NZD).

Exchange Rate Types

Floa ng and Fixed Exchange Rate

Exchange rates do not remain constant. They can be floating or fixed. The exchange rate is considered to
be floating when the currency rate is determined by market conditions. Most countries use a floating
exchange rate. On the other hand, some countries prefer to fix their domestic currency as against a
dominant currency, such as the USD.

Spot and Forward Exchange Rate

Exchange rates can also be classified into two types, namely spot, and forward exchange rates. The spot
exchange rate is the current exchange rate at any given point in time. The forward exchange rate refers
to the exchange rate that is stated and traded upon as of today but earmarked for payment and delivery
at a future date.
Bid Ask Rate Chapter-VII

The term "bid" refers to the highest price a buyer will pay to buy a specified number of shares of a
stock at any given time. The term "ask" refers to the lowest price at which a seller will sell the stock.

The bid price will almost always be lower than the ask or “offer,” price. The difference between the
bid price and the ask price is called the "spread.” or the spread, is a key indicator of the liquidity of
the asset. In general, the smaller the spread, the better the liquidity."

Bid-Ask Spreads in the Retail Forex Market

The bid price is what the dealer is willing to pay for a currency, while the ask price is the rate at
which a dealer will sell the same currency.

For example, Ellen is an American traveler visiting Europe. The cost of purchasing euros at the
airport is as follows:

 EUR 1 = USD 1.30 / USD 1.40

The higher price (USD 1.40) is the cost to buy each euro. Ellen wants to buy EUR 5,000, and so
would have to pay the dealer USD 7,000.

Suppose also that the next traveler in line has just returned from their European vacation and
wants to sell the euros that they have left over. Katelyn has EUR 5,000 to sell. They can sell the
euros at the bid price of USD 1.30 (the lower price) and would receive USD 6,500 in exchange for
their euros.

Because of the bid-ask spread, the kiosk dealer is able to make a profit of USD 500 from this
transaction (the difference between USD 7,000 and USD 6,500).

When faced with a standard bid and ask price for a currency, the higher price is what you would
pay to buy the currency and the lower price is what you would receive if you were to sell the
currency.

The bid-ask spread (informally referred to as the buy-sell spread) is the difference between the
price a dealer will buy and sell a currency. However, the spread, or the difference, between the bid
and ask price for a currency in the retail market can be large, and may also vary significantly from
one dealer to the next.
EXCHANGE RATE QUOTATIONS AND ARBITRAGE

Although the term “market rate” is o en used it is not true that all banks will have iden cal quotes
for a given pair
of currencies at a given point of me.
For example if Bank A gives the quote given above:
` /$ : 34.85/34.92
At the same me Bank B quotes
` /$ : 34.75/34.82
Such a situa on will give rise to an arbitrage opportunity. Dollars can be bought at ` 34.82 from Bank
B and sold
at 34.85 to bank A. Thus giving a net profit of ` 0.33 per dollar without any risk or commitment of
capital. This
would lead to a situa on where every dealer would like to buy from Bank B and sell to Bank A.
However, in an
efficient market this would not be allowed to prevail, if at all it does prevail it will be only for a few
moments.

Two Point Arbitrage

If dollars are available in India at ` /$ : 34.60/34.75 and at the same me Rupees are available in
U.S.A at $/` :
0.0285/0.0287.
In such a situa on a trader can buy $ from India at 34.75 and sell it at U.S.A for 34.84 (1/0.287). Thus
making a
net profit of ` 0.09 per dollar. This arbitrage transac on in which the trader buys a currency in one
market and
sells it at a higher price in another market is called “Two Point Arbitrage”.
The bid and risk rate for dollars in terms of ` in U.S.A is computed as follows:
($/` )bid = 1/(` /$)ask
($/` )ask = 1/(` /$)bid
The ask on the rupee being the bid on the dollar and vice-versa.

Problem :
A bank in Canada displays the following spot quota on.
C$/$ : 1.3690/1.4200
At the same me a bank in New York quotes
$/C$ : 0.7100/0.7234
(a) Is there an arbitrage opportunity?
(b) If the Canadian bank lowers its Bid rate to 1.3742, Is there an arbitrage opportunity?
(c) If you buy one million U.S. $ from Canada and sell them in U.S.A a er the Canadian lowers its ask
rate.
What is the riskless profit you will make?
Solu on:

(a) If we buy U.S. dollars from Canada we will pay C$ 1.4200 per U.S. dollar. This can be sold in U.S.A
for
1.4085 only there by leaving us with a loss. Hence there is no arbitrage opportunity.
If 1US$/CAN$ : 0.7100/0.7234

Then if we reverse this rate with 1 Canadian $ to 1 US$ it will become as

: 1.3824/1.4085 (Remember this reversal will make lower Ask & higher Bid Rate as per Rule)

Formula:-
C$/$ : [1/($/C)ask]/[1/($/C$)bid]
: [1/0.7234]/[1/0.7100]
: 1.3824/1.4085

(b) If the Canadian bank lowers its ask rate to 1.3742 we can buy U.S. $ from Canada for C$ 1.3742
and
sell them in U.S.A for C$ 1.4085 per U.S. dollar. Thus making an arbitrage profit of 0.0343 Canadian
dollars on every U.S. dollar.

Problem (c) If you buy one million U.S. $ from Canada and sell them in U.S.A a er the Canadian
lowers its bid rate.
What is the riskless profit you will make?

Solu on (c)
We consider bid rate of Canadian rate $ 1.3690 / 1.3742.
If we buy from Canadian Bank $ @ 1.3742
10,00,000 x 1.3742 = -13,74,200
And sold it in US Bank @ ask rate 0.7100 / 0.7234
That is ask rate effec ve 1.4085
Therefore 10,00,000 x 1.4085 = 14,08,500

Than 34,300 spread / profit possible.

Thus if one million U.S. dollars are bought from Canada and sold in America a er the Canadian bank
lowers its
ask rate, the riskless profit that can be made is C$ 34,300.
Cross Currency Rate Mechanism Chapter-X

Cross-rates

The direct/indirect quote system is related to the domes c currency. The Indian /American quote
system involves the USD.

If a Malaysian trader calls a Hong Kong bank and asks for the JPY/CHF (Swiss franc) quote, the Hong
Kong bank will quote a rate that does not fit under either quote system.

The Hong Kong bank will quote a cross rate. Most currencies are quoted against the USD, so that
cross-rates are calculated from USD quota ons. For example, the JPY/GBP is calculated using the
USD/JPY and USD/GBP rates. This usually implies a larger bid-ask spread on cross exchange rates.

If bank doesn’t have such currency with them to arbitrate than they will ask same for such
facili es. In such cases the interbank spread will be higher which will make thin margin for buyer
or currency transac ons will be costlier.

The cross-rates are calculated in such a way that arbitrageurs cannot take advantage of the quoted
prices. Otherwise, triangular arbitrage strategies would be possible and banks would soon no ce
imbalances in their buy/sell orders.

What Is a Cross Rate?

A cross rate is a foreign currency exchange transaction between two currencies that are both
valued against a third currency. In the foreign currency exchange markets, the U.S. dollar is the
currency (vehicle currency) that is usually used to establish the values of the pair being exchanged.

As the base currency, the U.S. dollar always has a value of one.

When a cross-currency pair is traded, two transactions are actually involved. The trader first trades
one currency for its equivalent in U.S. dollars. The U.S. dollars are then exchanged for another
currency.

 A cross rate by definition may be any exchange of any two currencies that are not the
official currency of the country in which the quote is published.
 In practice, any currency exchange in which neither of the currencies is the U.S. dollar is
considered a cross rate.
 One of the most common cross currency pairs is the euro and the Japanese yen.

Understanding the Cross Rate

In the transaction described above, the U.S. dollar is used to establish the value of each of the two
currencies being traded.

For example, if you were calculating the cross rate of the British pound versus the euro, you would
first determine that the British pound, as of November 26, 2023, was valued at 1.25 to one U.S.
dollar, while the euro was valued at 1.07 to one U.S. dollar.
As mentioned previously, a cross rate involves the exchange market price made in two currencies
which are then valued to a third currency. During this process, two transactions are being computed.

The first being the individual trading their one specific currency (EUR, JPY, GBP, etc.) for that same
equivalent value in U.S. dollars. Once U.S. dollars have been received, an exchange occurs again
when the U.S. dollars are traded for the second specific currency.

Cross-rates example with exchange rates.

A cross rate is a foreign exchange market quote between two currencies (not involving the U.S.
dollar) that are then both valued against a third currency. If used as a base currency, the U.S. dollar is
always seen to assume the value of one.

When two currencies are being valued against each other, they become a cross-rate pairing. The
pairing is then compared to a base currency (e.g., U.S. dollar), creating a cross rate.

Some of the more popular cross rates not involving USD include the following:

 EUR/JPY = Euro/Japanese Yen FX Cross Rate

 EUR/GBP = Euro/UK Pound Sterling FX Cross Rate
 AUD/NZD = Australian Dollar/New Zealand Dollar FX Cross Rate
 EUR/SEK = Euro/Swedish Krona FX Cross Rate

The Major Currency Pair

Foreign exchange (forex) traders use the term cross rate to refer to price quotes between any pair
of currency in which neither is the U.S. dollar.

Most transactions on the forex are in major currency pairs. That is, one of the currencies being
swapped is the U.S. dollar. For example, if you see on a financial news site that USD/CAD is quoted
at 1.28, it means that one U.S. dollar is currently equal to 1.28 Canadian dollars.

A cross rate also refers to a currency pair or transaction that does not involve the currency of the
party initiating the transaction.

An exchange rate between the euro and the Japanese yen is considered to be a commonly quoted
cross rate because it does not include the U.S. dollar. In the pure sense of the definition, however, it
is considered a cross rate if it is referenced by a speaker or writer who is not in Japan or one of the
countries that use the euro as its official currency. While the pure definition of a cross rate requires
that it be referenced in a place where neither currency is used, the term is primarily used to
reference a trade or quote that does not include the U.S. dollar.

Example I.4: Suppose Housemann Bank gives the following quotes:

St = 0.0104 /0.0108 USD/JPY, and St=1.5670 /1.5675 USD/GBP.

Housemann Bank wants to calculate the JPY/GBP cross-rates.
The JPY/GBP bid rate is the price at which Housemann Bank is willing to buy GBP against JPY, i.e., the
number of JPY units it is willing to pay for one GBP.

This transac on (buy GBP-sell JPY) is equivalent to selling JPY to buy one USD -at Housemann's bid
rate of (1/.0108) JPY/USD- and then reselling that USD to buy GBP-at Housemann's bid rate of
1.5670 USD/GBP.

Formally, the transac on is as follows:

Sbid, JPY/GBP= Sbid,JPY/USD x Sbid,USD/GBP= [(1/.0108) JPY/USD]x[(1.5670) USD/GBP] = 145.0926

JPY/GBP. That is, Housemann Bank will never set the JPY/GBP bid rate below 145.0926 JPY/GBP.
Using a similar argument, Housemann Bank will set the ask JPY/GBP rate (sell GBP-buy JPY) using the
following formula:

Sask,JPY/GBP = Sask,JPY/USDxSask,USD/GBP= [(1/.0104) JPY/USD]x[(1.5675) USD/GBP] = 150.7211

JPY/GBP.
Examples of Major Cross Rates
Any two currencies can be quoted against each other, but the most actively traded cross currency
pairs are the euro versus the British pound, or EUR/GBP, and the euro versus the Japanese yen, or
EUR/JPY.

In fact, these two pairs are the only cross-rate currency pairs that appear in the top 10 most traded
currency pairs at 1

The euro is the base currency for the quote if it is included in the pair. If the British pound is
included but the euro is not, the pound is the base.

These currencies are actively traded in the interbank spot foreign exchange market, and to some
extent in the forward and options markets.

Examples of Minor Cross Rates

Cross rates that are traded in the interbank market but are far less active include the Swiss franc
versus the Japanese yen, or CHF/JPY, and the British pound versus the Swiss franc, or GBP/CHF.

Cross rates involving the Japanese yen are usually quoted as the number of yen versus the other
currency, regardless of the other currency.

Cross quotes in currencies that are similar in value and quoting convention must be posted
carefully in order to prevent mistakes in trading. For example, the New Zealand dollar (NZD) was
quoted at 1.11 per Australian dollar (AUD) in early June of 2022.

Both of these currencies are quoted against the U.S. dollar. That is, the value reflects the number of
U.S. dollars it would take to buy the foreign currency. However, the quote provides no guidance as
to which is the base currency. The market convention is to use the stronger AUD, which is also the
larger economy, as the base. However, the two currencies trade near parity to each other, creating
the potential for a misquote.

Bid-Offer Spread and Cross Rates

The major crosses have bid-offer spreads slightly wider than the major dollar-based pairs, but they
are quoted actively in the interbank market.

Spreads in the minor crosses are generally much wider. Some are not quoted directly at all, so a
quote must be constructed from the bids and offers in the component currencies versus the U.S.
dollar.
Various Foreignn Currency Accounts Chapter-XI

 NRE Savings Account.

 NRO Savings Account.
 NRE FD Account.
 NRO FD Account.
 NRE FD (Without Premature Withdrawal facility)
 NRO FD (Without Premature Withdrawal facility)
 Rupee Plus Plan.
 FCNR FD.
 Non-Resident Ordinary (NRO) Savings Account/ Fixed Deposit Account.
 Non-Resident External (NRE) Savings Account/ Fixed Deposit Account.
 Foreign Currency Non -Resident (FCNR) Fixed Deposit Account.

An EEFC Account is a non-interest bearing Current Account, maintained by an Authorised Dealer

Category

It is a facility provided to the foreign exchange earners, including exporters, to credit 100 percent of
their foreign exchange earnings to the account, so that the account holders do not have to convert
foreign exchange into Rupees and vice versa, thereby minimising the transac on cost.

Eligibility
A person residing in India may open, hold and maintain an EEFC Account, subject to the terms and
conditions, as may be specified by the RBI from time to time, including the FEMA Regulations 2000
governing the EEFC Account and the Foreign Exchange Management Act, 1999

Nostro and vostro accounts

Nostro and vostro (from Italian, nostro and vostro; English, 'ours' and 'yours') are accounting terms
used to distinguish an account held for another entity from an account another entity holds. The
entities in question are usually banks.

The terms nostro and vostro are used, mainly by banks, when one bank keeps money at another
bank (in a correspondent account often called a nostro or vostro account). Both banks need to keep
records of how much money is being kept by one bank on behalf of the other. In order to distinguish
between the two sets of records of the same balance and set of transactions, banks refer to the
accounts as nostro and vostro. Speaking from the point of view of the bank whose money is being
held at another bank:

 A nostro is our account of our money (in which country you are staying), held by
the other bank or "Foreign Bank".
 A vostro is our account of other bank / "Foreign Bank's" money, held by us (by your
country's bank)
A vostro account is a record of money held by a bank or owed to a bank by a third party (an
individual, company or bank).
The nostro account is a way of keeping track of how much of the bank’s money is being held by the
other bank. This is similar to an individual keeping a detailed record of every payment in and out of
his or her bank account so that she/he knows the balance at any point in time.

What is an EEFC Account and what are its benefits?

Ans. Exchange Earners' Foreign Currency Account (EEFC) is an account maintained in foreign currency
with an Authorised Dealer Category - I bank i.e. a bank authorized to deal in foreign exchange. It is a
facility provided to the foreign exchange earners, including exporters, to credit 100 per cent of their
foreign exchange earnings to the account, so that the account holders do not have to convert foreign
exchange into Rupees and vice versa, thereby minimizing the transaction costs.

Q 2. Who can open an EEFC account?

Ans. All categories of foreign exchange earners, such as individuals, companies, etc., who are resident
in India, may open EEFC accounts.

Q 3. What are the different types of EEFC accounts? Can interest be paid on these accounts?

Ans. An EEFC account can be held only in the form of a current account. No interest is payable on EEFC
accounts.

Q 4. How much of one’s foreign exchange earnings can be credited into an EEFC account?

Ans. 100% foreign exchange earnings can be credited to the EEFC account subject to the condition
that the sum total of the accruals in the account during a calendar month should be converted into
Rupees on or before the last day of the succeeding calendar month after adjusting for utilization of
the balances for approved purposes or forward commitments.

Q 5. Whether EEFC Account can be opened by Special Economic Zone (SEZ) Units?

Ans. No, SEZ Units cannot open EEFC Accounts. However, a unit located in a Special Economic Zone
can open a Foreign Currency Account with an Authorised Dealer in India subject to conditions
stipulated in Regulation 4 (D) of Foreign Exchange Management (Foreign Currency Accounts by a
person Resident in India) Regulations dated January 21, 2016.

Q 6. Is there any Cheque facility available?

Ans. Yes, Cheque facility is available for operation of the EEFC account.

Q 7. What are the permissible credits into this account?

Ans. i) Inward remittance through normal banking channels, other than remittances received on
account of foreign currency loan or investment received from abroad or received for meeting specific
obligations by the account holder;

ii) Payments received in foreign exchange by a 100 per cent Export Oriented Unit or a unit in (a) Export
Processing Zone or (b) Software Technology Park or (c) Electronic Hardware Technology Park for
supply of goods to similar such units or to a unit in Domestic Tariff Area;
iii) Payments received in foreign exchange by a unit in the Domestic Tariff Area for supply of goods to
a unit in the Special Economic Zone (SEZ);

iv) Payment received by an exporter from an account maintained with an authorised dealer for the
purpose of counter trade. (Counter trade is an arrangement involving adjustment of value of goods
imported into India against value of goods exported from India in terms of the Reserve Bank
guidelines);

v) Advance remittance received by an exporter towards export of goods or services;

vi) Payment received for export of goods and services from India, out of funds representing repayment
of State Credit in U.S. Dollar held in the account of Bank for Foreign Economic Affairs, Moscow, with
an authorised dealer in India;

vii) Professional earnings including directors’ fee, consultancy fee, lecture fee, honorarium and similar
other earnings received by a professional by rendering services in his individual capacity;

viii) Re-credit of unutilised foreign currency earlier withdrawn from the account;

ix) Amount representing repayment by the account holder's importer customer in respect of trade
related loan/advances granted by the exporter (subject to compliance with the extant guidelines)
holding EEFC account; and

x) The disinvestment proceeds received by the resident account holder on conversion of shares held
by him to ADRs/GDRs under the Sponsored ADR/GDR Scheme approved by the Foreign Investment
Promotion Board of the Government of India.

Q 8. Can foreign exchange earnings received through an international credit card be credited to the
EEFC account?

Ans. Yes, foreign exchange earnings received through an international credit card for which
reimbursement has been made in foreign exchange may be regarded as remittance through normal
banking channel and the same can be credited to the EEFC account.

Q 9. What are the permissible debits into this account?

Ans. i) Payment outside India towards a permissible current account transaction [in accordance with
the provisions of the Foreign Exchange Management (Current Account Transactions) Rules, 2000] and
permissible capital account transaction [in accordance with the Foreign Exchange Management
(Permissible Capital Account Transactions) Regulations, 2000].

ii) Payment in foreign exchange towards cost of goods purchased from a 100 percent Export Oriented
Unit or a Unit in (a) Export Processing Zone or (b) Software Technology Park or (c) Electronic Hardware
Technology Park

iii) Payment of customs duty in accordance with the provisions of the Foreign Trade Policy of the
Central Government for the time being in force.

iv) Trade related loans/advances, extended by an exporter holding such account to his importer
customer outside India, subject to compliance with the Foreign Exchange Management (Borrowing
and Lending in Foreign Exchange) Regulations, 2000.
v) Payment in foreign exchange to a person resident in India for supply of goods/services including
payments for airfare and hotel expenditure.

Q 10. Is there any restriction on withdrawal in rupees of funds held in an EEFC account?

Ans. No, there is no restriction on withdrawal in Rupees of funds held in an EEFC account. However,
the amount withdrawn in Rupees shall not be eligible for conversion into foreign currency and for re-
credit to the account.

Q. 11. Whether the EEFC balances can be covered against exchange risk?

Ans. Yes, the EEFC account balances can be hedged. The balances in the account sold forward by the
account holders have to remain earmarked for delivery. However, the contracts can be rolled over.

Q. 12. Whether EEFC Account is permitted to be held jointly with a resident relative?

Ans : Resident individuals are permitted to include resident relative(s) [as defined in section 2(77) of
the Companies Act, 2013] as joint holder(s) in their EEFC account on ‘former or survivor’ basis.