MODULE 1FOREX MANAGEMENT

Mr. Eldo Geevarghese Zacharia Kayyalath

Asst. Professor/Placement Officer

LEAD College of Management, Palakkad

E-Mail ID: eldo@lead.ac.in / placement@lead.ac.in

Mob: +91 9497713693/ 9400985458

Skype ID: eldo.lead

CONTENT

Important Terms in Forex Management Meaning of the term forex Management Forex Market Introduction to Exchange rate Mechanism SPOT-FORWARD RATE SWAP(s) FUTURES OPTIONS Hedging Arbitrage

IMPORTANT TERMS OF FOREX MANAGEMENT

MEANING OF THE TERM FOREX MANAGEMENT

It is the exchange of currencies in terms of another currency

It refers to a system whereby one currency is exchanged for or converted to another. It is also a system by which commercial nations discharge their debts to each other.

Foreign currencies are collectively referred to as forex

Foreign Exchange also involves:

The method by which the currencies are exchanged

The need for such exchange of currencies

The various forms by which such exchanges takes place

The ratio or equivalent values at which such exchanges are effected

DEFINITION OF FOREIGN EXCHANGE Section 2 FERA, 1973 defines it as:

a. All deposits, credits, balance payable in any foreign currencies

b. Any drafts, travelers cheques, LoC, BoE expressed or drawn in Indian currency and payable in foreign currency

c. Any instrument giving anyone the option of making it payable either partly or fully in a foreign currency

o Hence the term foreign exchange means coins, bank notes, postal notes, postal orders, electronic fund transfer and money orders

o Dr. Paul Einzig:- o a system or a process of converting one

national currency into another and of transferring money from one country to another.

FOREIGN EXCHANGE MARKET It is the market where one currency (foreign

currency) is bought and sold against another currency (domestic or home currency)

It facilitates international trade, foreign investment borrowing from or lending to foreigners.

exchange dealers do the job of the exchange of currencies.

the demand and supply in the foreign exchange markets permits the establishment of the rate of one currency in terms of another.

FOREX MARKET CONT… the transaction in the foreign exchange market can

be either to exchange cash or to buy/sell some other instruments.

The major instruments are: currency forward currency futures currency options currency swaps.

the foreign exchange market is the largest financial market in the world.

is open somewhere or the other in the world all the time such that it is said to be a 24 hours-a-day and 365 days-a-year market.

The market can be divided into three major market segments:

Australasia includes Sydney, Tokyo, Hong kong, Singapore and Bahrain.

Europe includes Zurich, Frankfurt, Paris, Brussels, Amsterdam and London.

North America includes New York, Montreal, Toronto, Chicago, San Francisco and Los Angeles.

FOREX MARKET CONT…

FOREIGN EXCHANGE MARKET (CONT…)

CURRENCY CODE

COMPONENTS OF A FOREX TRANSACTION

Base Currency Dealt/Variable Currency Exchange Rate Amount Deal Date Value Date Settlement Instruction

FOREIGN EXCHANGE RATE QUOTE Quote: when the currency is quoted, it is done in relation to

another currency, so that the value of one is reflected through the value of another

Forex rates are always quoted in two ways:

Indirect Quote: "The expression of an exchange rate in terms of the number of units of a foreign currency corresponding to a single unit of the domestic currency. In EU countries

a direct quote for the US dollar might be [euro]0.63. 1USD = euro 0.63 IUSD = Rs 58.55

Direct Quote: "An exchange rate expressed in terms of the number of units of domestic currency corresponding to one unit of the foreign currency. In EU countries,

an indirect quote for the dollar might be 1 euro =$1.5873 1 INR = USD 0.01707

Oxford University Press Dictionary of Finance and Banking 

FOREX RATE QUOTATION Bid Price: it is the price at which the forex market

is ready to buy a specific currency pair in the forex trading market. This is the price at which the traders of forex market

buys his base currency In a forex quote, the forex price that appears on the lift

side is the bid price For eg: EUR/USD = 1.2342/47

Ask Price: is the price at which the market is ready to sell a certain currency pair in the forex market. This is the price at which the market buys a foreign

currency. It appears on the right side of the forex price quote.

Spread: It is the difference between the Ask and Bid price. It is set by the liquidity of the stock If the stock is highly liquid, it means that the stock is

highly traded in the and the bid/ask spread will be low and V.V..

Pips: The pipe is the smallest amount, a price can move in any currency quote. It is also known as the point.

USD/JPY = 119.50/58

the currency on the left side is called the base currency

The currency on the right side is called the quote/ counter currency

The base currency will always be equal to one unit and the counter currency is what that one base currency unit is equaling to.

Here 1 USD = 119.50 JPY

CROSS RATE The currency exchange rate between two

currencies, both of which are not the official currencies of the country in which the exchange rate quote is given it is called a cross rate.

For Eg:  if an exchange rate between the Euro and the

Japanese Yen was quoted in an American newspaper, this would be considered a cross rate

However, if the exchange rate between the euro and the U.S. dollar were quoted in that same newspaper, it would not be considered a cross rate because the quote involves the U.S. official currency.

This phrase is also sometimes used to refer to currency quotes which do not involve the U.S. dollar, regardless of which country the quote is provided in.

Ie, when a currency quote is given in without the USD as one of its component, it is also referred to as cross currency quote.

The most common cross rate pairs are: EUR/GBP EUR/CHF EUR/JPY

MARKET WATCH

MARKET WATCH

MAJOR CURRENCY PAIR

STRUCTURE OF FOREX MARKET

1. Commercial Banks:2. Forex Brokers 3. Corporates4. Central Banks

FUNCTIONS OF FOREX MARKET

1. Transfer of Purchasing Power

2. Provision of Credit

3. Provision of Hedging facilities

4. Currency Conversion

5. Reducing Forex Risk

SPOT MARKET

SPOT MARKET (CONT…)

The exchange rate determined in sport market is known as spot exchange rate

These rates are determined by the demand and supply of foreign currencies being exchanged in the global foreign exchange market

FORWARD MARKET

In a forward market, the parties enter into foreign exchange contract.

It is an agreement between two parties to exchange one currency for another at some future date, with the exchange date and delivery date and the quantity involved being fixed at the time of the agreement

It is typically traded only on over the counter market

SPOT- FORWARD RELATION

SWAP

OPTION

OPTION TYPES

ARBITRAGE It is recognizing the price differences b/w markets

and simultaneously buying in one market and selling in another market

Forex Arbitrage is a method of trading used by forex traders who attempt to make money on the inefficiencies observed in the pricing b/w a pair/ pares of currencies.

FOREIGN EXCHANGE REGIMES

Fixed Pegged Managed Float Free Float

FIXED EXCHANGE RATE SYSTEM The exchange rate b/w home and foreign

currencies are held constant and are allowed to fluctuate only within a narrow margin

When this exchange rate moves beyond this permitted margin, the monetary authorities of a country intervene

This authority may even devalue the home currency to maintain the stability in the exchange rate.

Eg: Cuba, N.Korea

FREE FLOAT

The exchange rate b/w home and foreign currency is determined purely by the market forces of demand and supply.

There will not be any intervention by the monitory authority in fixing the exchange rate. When demand of home currency exceeds supply, home

currency becomes stronger

When supply of home currency exceeds demand, home currency becomes weaker.

Eg: USA, S. Africa, Peru, Denmark, Paraguay

MANAGED FLOAT

It lies b/w fixed and free float

Forex rate is primarily market forces Monetary authorities do interfere to avoid high

fluctuations

Here it is necessary for the central bank to maintain a certain foreign exchange reserve

It is required coz, the central bank can buy or sell forex reserve to influence exchange rate movement

PEGGED

The value of home currency is pegged or linked to a foreign currency or to a basket of foreign currency.

Here the exchange rate with other currency would be in line with the movement of these currencies with the pegged currencies.

FOREIGN EXCHANGE MECHANISM

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