FOREIGN EXCHANGE

MARKETS
PRESENTED BY: GROUP 9
1. KAJOL AWASTHI 01
2. SHIVANI JOSHI 18
3. DHAVAL PAREKH 31
4. YASH PADHIYAR 29
5. YASH VAKHARIYA 56
6. RAHUL VORA 57
INTRODUCTION
• The foreign exchange market provides the physical and
institutional structure through which the money of one
country is exchanged for that of another country, the rate
of exchange between currencies is determined, and foreign
exchange transactions are physically completed.
• A foreign exchange transaction is an agreement between a
buyer and a seller that a given amount of one currency is
to be delivered at a specified rate for some other currency.
SALIENT FEATURES
The foreign exchange market or the Forex market is
characterized by:
• Huge trading volumes
• 24 hour trading
• Geographical Diversity
• Liquidity
• Large variety and number of traders
SALIENT FEATURES (CONTI…)
The Top 5 currencies which are traded in the foreign exchange
market are:
• United States Dollar (USD)
• Eurozone Euro (EUR)
• Japanese Yen (JPY)
• British Pound Sterling (GBP)
• Swiss Franc (CHF)
• Currency rates are always expressed in terms of another, more
popular or stable currency. For example, the exchange rate of the
Indian Rupee is always expressed in comparison with the United
States Dollar.
FACTORS AFFECTING FOREX CURRENCY
MARKET TRADE
• Political Factors: Growth and economic prosperity can positively
affect the currency rates, while political upheaval like civil war can
negatively affect the currency rates of that country.
• Economic Factors: budget deficit or surplus conditions of that
country, the balance of trade situation, levels of inflation and the
general trend of economic growth in that country.
• Market Psychology: susceptibility of the Forex market to rumors,
perceptions of the market regarding the safety of а particular
currency, and the definitive long term trends of а currency in the
market.
All these factors contribute towards the currency rate of а
particular country to rise or fall.
FOREX MARKET COMPONENTS
• Currency Conversion: Companies, investors and governments want to be
able to exchange one currency into another.
• Currency Hedging: This technique refers to the protection against potential
losses that result from adverse changes in exchange rates.
• Currency Arbitrage: This is the simultaneous and instantaneous purchase
and sale of currency for a profit.
• Currency Speculation: This refers to the practise of buying and selling of a
currency with the expectation that the value will result in a profit.
CURRENCY BOARDS
• A currency board is a country's monetary authority which is required to
maintain a fixed exchange rate with a foreign currency,
• Issues notes and coins like a central bank, however it is not the lender of
last resort and a banker to the government,
• It can function alone or work parallel to a central bank,
• It issues local notes and coins in circulation that have to be backed by a
foreign currency (or commodity), also known as the reserve currency,
• Under currency board a country cannot print money unless it is 100%
backed by the anchor currency,
• Has to provide unlimited convertibility to the domestic currency.
CURRENCY BOARDS (CONTI…)
• Interest rates:
• The interest rates cannot be manipulated by the government.
• Since a currency board does not lend to banks or the government, the
government can only borrow or tax to meet its spending
commitments.
• The interest rates are strongly influenced by the reserve currency or
the pegged currency.
CURRENCY BOARDS (CONTI…)

ADVANTAGES
DISADVANTAGES
• Advantageous for small, open • The country no longer has the
economies which would find it ability to set its monetary
difficult to sustain their policy according to other
independent monetary policies. domestic considerations.

• They form a credible • The fixed exchange rate will

commitment to low inflation. influence the country’s terms
of trade irrespective of its
economic differences and
trading partners.
CURRENCY BOARDS IN OPERATION
MODERN DAY CURRENCY BOARDS
• Modern currency boards are not orthodox in practice instead they are currency
board-like systems .
• They use a combination of methods when functioning as the monetary authority.
• Eg: a currency board may not maintain at least 100% reserves of the foreign
currency.
• States such as Lithuania, Estonia and Bosnia have implemented currency board-
like systems .
• Hong Kong, is the most well-known country that employs a currency board
system or a linked exchange rate system.
• Under licence from the HKMA, three commercial banks issue their own
banknotes for general circulation in the region.
CURRENCY BASKET
• A currency basket is a selected group of currencies with different
weights.
• Their weighted average is used to determine the value of the domestic
currency or the currency which is pegged .
• For eg. one may construct a currency basket with
40% euros, 35% U.S. dollars, and 25% British pounds, their
percentages determine the basket's value.
• It is a type of financial derivative in which the underlying assets are
the currencies.
• It is a portfolio where currencies are used instead of shares , bonds or
other securities.
CURRENCY BASKET (CONTI…)
• Eg. of currency baskets are
 The European currency unit (which was replaced by the euro) ,
 the Asian currency unit ,
 The Special drawing rights or SDR etc.
• The SDR is an international reserve asset.
• It was create by IMF in 1969.
EXCHANGE RATES
• Exchange Rate: It is a value of one currency in terms of another. It
compares the purchasing powers of two different currencies.

Factors Affecting
the Equilibrium of
Exchange Rates

Balance of Relative Interest Relative Inflation

Payments Rates Rates
EXCHANGE RATE REGIME
• An exchange-rate regime is the way an authority manages
its currency in relation to other currencies and the foreign exchange
market. It is closely related to monetary policy and the two are
generally dependent on many of the same factors.
• The basic types are a floating exchange rate, where the market
dictates movements in the exchange rate; a pegged float, where a
central bank keeps the rate from deviating too far from a target band
or value; and a fixed exchange rate, which ties the currency to another
currency, mostly reserve currencies such as the U.S. dollar or
the euro or a basket of currencies.
FIXED EXCHANGE RATE REGIME
• A fixed exchange rate is a country's exchange rate regime under
which the government or central bank ties the official exchange
rate to another country's currency or to the price of gold. The purpose
of a fixed exchange rate system is to maintain a country's currency
value within a very narrow band.
• Also called a Hard Peg or Rigid Peg.
• Includes the Crawling Peg System based on the Hard/Rigid Peg.
ADVANTAGES OF FIXED EXCHANGE REGIME
• Price stability: This advantage has been viewed as one of the virtues of the
metallic standard. Price stability implies that changes in prices are small, gradual,
and expected. One of the most important factors that can affect price stability is
monetary policy.
• Economic stability and prosperity: A metallic standard can diminish the short-
run fluctuations in a country’s output, which are also called business cycles. The
reason for decreasing volatility in output may lie in price stability. Price stability,
or the absence of large and unexpected changes in the average price level, may
work as a signal to producers for how much to produce.
• Fixed exchange rates: A metallic standard leads to fixed exchange rates. In a
gold standard, each country determines the gold parity of its currency, which
fixes the exchange rates between countries. In a reserve currency system, the
reserve currency has a gold parity, and all other currencies are pegged to the
reserve currency, which also leads to fixed exchange rates
DISADVANTAGES OF FIXED EXCHANGE REGIME
• Questionable price stability
• Questionable economic stability and prosperity
• Imports of other countries’ unemployment and inflation rates:
• Theoretically, surplus countries were to lend to deficit countries. This
scheme doesn’t work when countries with persistently large current
account deficits also have problems repaying their loans.
FLOATING EXCHANGE RATE REGIME
• It is the one where the value of the currency is not officially fixed but
varies according to the market forces.
• In this system currencies are allowed to: Appreciate and Depreciate .

Features

Every member nation of the IMF member nations need

Exchange rate
IMF is given a choice for the to accept the responsibility
determination on the basis
adoption of their prefered of maintaining stability of
of gold was abolished since.
exchange rate mechanism their exchange rates.
 FOREIGN EXCHANGE CONTRACTS
• Commitment to buy or sell a specified amount of foreign currency on
a fixed date and rate of exchange. Such contracts are used usually by
importers as a hedge against exchange rate fluctuations.
• Types include:
 Spot Contacts
 Forward Contracts
 Future Contracts
SPOT CONTRACTS
• A foreign exchange spot transaction, also known as FX spot, is an
agreement between two parties to buy one currency against selling
another currency at an agreed price for settlement on the spot date.
• The exchange rate at which the transaction is done is called the spot
exchange rate.
• In India, the delivery under a spot transaction can be settled as Cash/
Tom or Spot.
FORWARDS CONTRACTS
• In this contract, the terms of purchase (buy or sell) are agreed up front
(trade execution date) but the actual negotiation takes place on the
maturity date. Upon maturity, both parties exchange the pre-
negotiated rate.
• Types include:
 Fixed Maturity Contract
 Partially Optional Contract
 Fully Optional Contract
 Non Delivery Forward Contract
ADVANTAGES OF FORWARD CONTRACTS
• They can be matched against the time period of exposure as well as
for the cash size of the exposure.
• Forwards are tailor made and can be written for any amount and
term.
• It offers a complete hedge.
• Forwards are over-the-counter products.
• The use of forwards provide price protection.
• They are easy to understand.
DISADVANTAGES OF FORWARD CONTRACTS
• It requires tying up capital. There are no intermediate cash
flows before settlement.
• It is subject to default risk.
• Contracts may be difficult to cancel.
• There may be difficult to find a counter-party.
FUTURE CONTRACTS
• A futures contract is a legal agreement, generally made on the trading
floor of a futures exchange, to buy or sell a particular commodity or
financial instrument at a predetermined price at a specified time in
the future.
• Features:
 Protection against exchange rate fluctuations
 Standardized contracts, hence less or no default risk
 Highly liquid market
 Allows holder to fix prices for import and export purposes
ADVANTAGES AND DISADVANTAGES OF
FUTURES CONTRACTS
ADVANTAGES DISADVANTAGES
1) The commission charges for futures 1) Leverage can make trading in
trading are relatively small as futures contracts highly risky for a
compared to other type of investments. particular strategy.
2) Futures contracts are highly
2) Futures contract is standardized
leveraged financial instruments which
permit achieving greater gains using a
product and written for fixed
limited amount of invested funds. amounts and terms.

3) It is possible to open short as well 3) Lower commission costs

as long positions. Position can be can encourage a trader to
reversed easily. take additional trades and lead to
over-trading.
4) Lead to high liquidity.
THANK YOU!