II JAI SRIGURUDEV II

Sri Adichunchanagiri Shikshana Trust

SJB INSTITUTE OF TECHNOLOGY

INTERNATIONAL FINANCIAL MANAGEMENT

20MBAFM406
Prepared by

Mrs. Lakshmi Priya M C

Assistant Professor
MBA Department
SJBIT

Department of MBA
BGS Health & Education City
Dr. Vishnuvardhana Road, Kengeri, Bengaluru - 560 060.
Tel.: 080 - 2861 2445 / 46 Fax : 080 - 2861 2651
Web.: www.sjbit.edu.in
 MODULE 2
FOREIGN EXCHANGE MARKETS
 TOPICS TO BE COVERED

• Function and Structure of the Forex markets

• Foreign exchange market participants
• Types of transactions and Settlements Dates
• Exchange rate quotations
• Determination of Exchange rates in Spot markets.
• Exchange rates determinations in Forward markets.
• Exchange rate behaviour
• Cross Rates- Bid – Ask – Spread
 FOREIGN EXCHANGE MARKET

• The Foreign Exchange market is one in which currencies are bought and
sold against each other.
• It is the largest market in the World
• It is an over-the counter market
• It is world wide network of inter-bank traders, consisting primarily of banks,
connected by telephone lines and computers.
 STRUCTURE OF THE FOREIGN EXCHANGE
MARKET
• FOREX Market has two tiers
• Inter-bank Market
• Over-the-counter market
• Inter-bank market is the one where large banks exchange currencies with each
other
• Over-the-counter market is the one where individuals and companies trade.
• It is highly risky in nature as it is not regulated by any regulatory body.
• Spot Market, Forward Market, Future Market, Opting Market, Swap Market are
the types of Foreign Exchange Markets
 STRUCTURE OF THE FOREIGN EXCHANGE
MARKET
• The structure of Foreign Exchange market is composed of
• Commercial Banks
• Central banks
• Immigrants
• Importers
• Exporters
• Tourists and Investors
 FEATURES OF FOREIGN EXCHANGE MARKET

• Highly Liquid
• Market Transparency
• Dynamic market
• Operate 24 hours
• Lower trading cost
• Most widely traded currency is Dollar
 TYPES OF FOREIGN EXCHANGE MARKET

• SPOT
• FORWARD
• FUTURES
• OPTIONS
• SWAPS
 PARTICIPANTS OF FOREIGN EXCHANGE
MARKETS
• Forex Dealers
• Brokers
• Hedgers
• Speculators
• Arbitrageurs
• Central Banks
• Retail Market Participants
FUNCTIONS OF FOREIGN EXCHANGE MARKET

• Transfer Function
• Credit Function
• Hedging Function
 TRADING AND SETTLEMENT IN FOREX

• Settlement of a transaction takes place by transfer of deposits between two

parties.
• The day on which these transfers are carried out is called settlement date.
• Foreign Exchange market practice requires that the settlement date be a valid
business day in both the countries.
• SWIFT-Society for World-wide Inter-bank Financial Telecommunication
• For SPOT transactions, the settlement date is usually two-business days
• Settlement dates of Forward transactions: Settlement date for a spot transaction
between the same currencies done on the same day + one-calendar month
 TRADING AND SETTLEMENT IN FOREX

• A swap transaction in the foreign exchange market is a combination of a spot

and a forward in the opposite direction.
• A spot 60-day dollar euro swap will consist of a spot purchase(sale) of dollars
against the euro coupled with a 60-day forward sale(purchase) of dollar against
euro.
• When both transactions are forward transactions, it becomes forward-forward
swap.
• A 1-3 month dollar-sterling SWAP will consist of purchase(sale) of sterling for
dollars one month forward coupled with sale(purchase) of sterling for 3-months
forward
 EXCHANGE RATE QUOTATIONS

• Exchange rate between currency A and currency B is just price of one in terms
of other.
• It can be stated as number of units of B per unit of A or number of units of A per
unit of B
• The rupee dollar is usually stated as number of rupees per dollar while the
rupee yen rate is stated as number of rupees per 100 yen.
• The International Standards Organization has developed three letter codes of
the currencies which abbreviate the name of the country as well as the currency
 EXCHANGE RATE DETERMINATION

• These codes are carried by SWIFT network which carries out inter-bank fund transfers.
• USD-US dollar EUR-Euro
• GBP-Great Britain Pound IEP-Irish Pound
• JPY-Japanese Yen CHF-Swiss Franc
• CAD-Canadian Dollar AUD-Australian Dollar
• SEK-Swedish Kroner MEP-Mexican Peso
• DKK-Danish Kroner NZD – New Zealand Dollar
• INR-Indian Rupee SAR – Saudi Riyal
 FOREIGN EXCHANGE QUOTATIONS

• Foreign exchange quotations are quoted in terms of currencies

• Foreign exchange currency is the amount of currency that is exchanged for unit of
another currency.
• Ex: an exchange rate of rupee may be quoted in terms of American dollar
• Rs. 75/USD
• A change in price of currency implies, therefore, a change in price of the other currency
that appears in the quote
• For Ex: if the price of rupees against dollar moves from Rs. 75/$ to Rs. 74/$, one can say
that rupee has appreciated relative to $ by Re. 1. It is same as saying that $ has
depreciated relative to the rupee
 TYPES OF FOREIGN EXCHANGE QUOTATIONS

• Direct quotes
• Indirect Quotes
• Cross Currency Rates
• Spot Rates
• Forward Rates
• BID-Ask prices
• Interbank Quotations
• Spread/Cost of Transaction
 DIRECT QUOTES AND INDIRECT QUOTES
• In any country, direct quotes are those units of the currency of that country per unit of a
foreign currency
• Ex: INR 72 per USD is a direct quote in India & USD 1.2950 per EUR in the US.
• Indirect(Inverse or reciprocal)
• Quotes are stated as number of units of foreign currency per unit of home currency
• USD 1.388 per Rs. 100
• The currency pair is denoted by the three-letter SWIFT codes for the two currencies
separated by an oblique or a hyphen
• Ex: USD/CHF, GBP/JPY, USD/INR, USD-SEK
• The first currency in the pair is base currency and the second is quoted currency
• The exchange rate quotation is given as number of units of quoted currency per unit of
base currency
 BID-ASK PRICES

• A quotation consists of two prices:

• The price shown on the left of the oblique or hyphen is the bid price , the one on the
right is the “ask” or “offer” price.
• The bid price is the price at which the dealer giving the quote is prepared to buy
• Is bidding for one unit of base currency against the quoted currency.
• The ask or offer price is the price at which the dealer is willing to sell
• Is offering one unit of base currency
• Ex: USD/CHF Spot: 1.4550/1.4560
• GBP/EUR Spot: 1.3025/1.3035
• The quotations are usually shortened as GBP/EUR: 1.3025/35
 CROSS RATES/CROSS CURRENCY RATES

• Cross Rate or just a cross is a quotation between two-non-dollar currencies.

• An exchange rate between two currencies that is derived from the exchange
rates of those currencies with a third currency is known as a cross exchange
rate.
• A cross rate can be obtained by multiplying two exchange rates by each
other so as to eliminate the third currency that is common to both rates.
• Ex: GBP/CHF; EUR/INR
 SPOT RATE QUOTATIONS

• Spot rate is that exchange rate which applies to those sale/purchase

transactions in foreign exchange for which payments and receipts are to be
effected on the spot(in practice, it normally means a specified short period,
say two working days or so)
• The most common way of stating a foreign exchange quotation is in terms of
the number of units of foreign currency needed to buy one unit of home
currency.
• India quotes its exchange rate in terms of the amount of rupees that can be
exchanged for one unit of foreign currency.
 SPOT RATE QUOTATIONS

• For Ex; If the Indian rupee is the home currency, and the foreign currency is
the French Franc(FFr), then the exchange rate between the rupee and the
French franc might be stated as:
• FFr 0.1462/INR reads 0.1462 FFr per rupee, which means that for one Indian
rupee one can buy0.1462 French Francs.
• This method known as the European terms, the rate is quoted in terms of the
number of units of the foreign currency for one unit of the domestic
currency. This is called as Indirect quote.
 SPOT RATE QUOTATIONS

• The Alternative method called American terms, expresses the home

currency price of one unit of foreign currency.
• For Example: the exchange rate between FFr and rupee can be expressed
as Rs. 6.84/FFr and read as Rs. 6.48 per French franc. This is called as direct
quote.
 FORWARD QUOTES

• A forward rate(or forward exchange rate) is the one which applies to a

foreign exchange transaction to be effected on a specified future date.
• Both the buyer as seller in the forward market agrees that the forward rate
will sell a stated amount of the ‘foreign currency’ at an agreed exchange
rate to the buyer on a specified future date. (e.g, three month hence)
irrespective of the actual exchange rate that may prevail on the said future
date.
• The deal also involves a corresponding payment, in normally domestic
currency by the buyer of foreign currency to the seller of it.
 FORWARD QUOTES

• Forward rate is the rate quoted by foreign exchange traders for the
purchase or sale of foreign exchange in the future.
• There is a difference between the spot rate and the forward rate known as
spread in the forward market.
• With reference to its relationship with the spot rate, the forward rate may be
at par, at a discount or at a premium.
 FORWARD QUOTES

• At Par: If the forward exchange rate quoted is exactly equivalent to the spot
rate at the time of making the contract, forward exchange rate is said to be
at par.
• At Premium: the forward rate for a currency, say US dollar, is said to be at a
premium with respect to the spot rate, when one dollar buys more units of
another currency, say rupee in the forward rather than in the spot market.
• At discount: the forward rate for a currency, for example, the US dollar, is
said to be at a discount with respect to the spot rate when one dollar buys
fewer rupees in the forward than in the spot market.
 FORWARDS QUOTES

•
 CALCULATION OF FORWARD PREMIUM AND
DISCOUNT
•
 PERCENTAGE SPREAD/COST OF
TRANSACTION
•
 CALCULATION OF SPREAD

•
 INTER BANK QUOTATIONS

• The most common way that professional dealers and brokers state foreign
exchange quotations, and the way they appear on all computer trading screens
world wide , is called European terms. European term quote shows the number
of units of foreign currency needed to purchase one unit.
• Ex: CAD 1.5770/USD
• An alternate method is called the American terms: the American term quotes
the number of units of USD needed to purchase one unit of foreign currency.
• Ex: USD 0.6341/CAD