CAIIB BFM Unit 1 - Exchange Rates and Forex Business

1. Foreign Exchange: Conversion of currencies from the currency of invoice to the home currency of the exporters is called as Foreign Exchange.

2. Foreign Exchange Management Act (FEMA),1999 defines Foreign Exchange as o “ All deposits, credits and balances payable in foreign currency and any drafts, traveler’s Cheques, LCs and Bills of Exchange, expressed or drawn in Indian Currency and payable in any foreign currency.”

Any instrument payable at the option of the drawee or holder, thereof or any other party thereto, either in Indian Currency or in foreign currency, or partly in one and partly in the other.

3. A Foreign Exchange transaction is a contract to exchange funds in one currency for funds in another currency at an agreed rate and arranged basis.

4. Exchange Rate means the price or the ratio or the value at which one currency is exchanged for another currency.

5. Foreign Exchange markets participants are
# Central Banks
# Commercial Banks
# Investment Funds/Banks
# Forex Brokers
# Corporations
# Individuals

6. The Forex Markets are highly dynamic, that on an average the exchange rates of major currencies fluctuate every 4 Seconds, which effectively means it registers 21,600 changes in a day (15X60X24)

7. Forex markets usually operate from “Monday to Friday” globally, except for the Middle East or other Islamic Countries which function on Saturday and Sunday with restrictions, to cater to the local needs, but are closed on Friday.

8. The bulk of the Forex markets are OTC (Over the Counter).

9. Factors Determining Exchange Rates:

a) Fundamental Reasons
# Balance of Payment
# Economic Growth rate
# Fiscal policy
# Monetary Policy
# Interest Rates
# Political Issues

b) Technical Reasons
- Government Control can lead to unrealistic value.
- Free flow of Capital from lower interest rate to higher interest rates

c) Speculative - higher the speculation higher the volatility in rates

10. Due to vastness of the market, operating in different time zones, most of the Forex deals in
general are done on SPOT basis.

11. The delivery of FX deals can be settled in one or more of the following ways:
# Ready or Cash
# TOM
# Spot
# Forward
# Spot and Forward

12. Ready or Cash: Settlement of funds takes place on the same day (date of Deal)

13. TOM: Settlement of funds takes place on the next working day of the deal. If the settlement day Is holiday in any of the 2 countries, the settlement date will be next working day in both the countries.

14. Spot : Settlement of funds takes place on the second working day after/following the date of Contract/deal. If the settlement day is holiday in any of the 2 countries, the settlement date will be next working day in both the countries.

15. Forward: Delivery of funds takes place on any day after SPOT date.

16. Spot and Forward Rates: On the other hand, when the delivery of the currencies is to take place at a date beyond the Spot date, it is Forward Transaction and rate applied is called Forward Rate.

17. Forward Rates are derived from Spot Rates and are function of the spot rates and forward premium or discount of the currency, being quoted.

18. Forward Rate = Spot Rte + Premium or – Discount

19. If the value of the currency is more than being quoted for Spot, then it is said to be at a premium.

20. If the currency is cheaper at a later date than Spot, then it is called at a Discount.

21. The forward premium and discount are generally based on the interest rate differentials of the two currencies involved.