Forex Market

Foreign Exchange

WHAT IS MARKETS ?

TYPES OF MARKETS There are 4 types of markets. They are-: •Capital Market It provides long-terms funds with maturities exceeding 1year to make transactions.

•Financial Market It provides financial services in the market

•Foreign Exchange Market Foreign Exchange Market facilitates the foreign exchange trading.

•Money Market It deals with short term funds having maturities of 1year or less.

What is ForEx ? Definition• Foreign exchange is the mechanism by which the currency of one country gets converted into the currency of another country. •

Foreign Exchange is a methods and instruments used to adjust the payment of debts between two nations that employ different currency systems. A nation’s balance of payments has an important effect on the exchange rate of its currency.

History of ForEx •

Barter System

•

value of goods was expressed in terms of other goods.

• Gold & Copper •

Value of goods was expressed in term of other gold & coins.

•

Coins

•

Value of goods was expressed in term other coins

• Currency • •

Gold & coins convertibility into currency Value of goods was expressed in term of other currency

administration of foreign exchange FOREIGN EXCHANGE MANAGEMENT ACT

CENTRAL GOVERNMENT

RESERVE BANK OF INDIA

FEDAI AUTHORISED PEARSONS

AUTHORISED MONEY CHANGER

FULL FLEDGED

AUTHORISED DEALERS

RESTRICTED

DETERMINTION OF FOREIGN EXCHANGE RATE •

• • • • • •

BALANCE OF PAYMENT INFLATION MONEY SUPPLY INTEREST RATE NATIONAL INCOME RESOURCE DISCOVERIES POLITICAL FACTORS

Foreign Currency Accounts FOREIGN CURRENCY ACCOUNT

NOSTRO ACCOUNT

VOSTRO ACCOUNT

LORO ACCOUNT

ForEx A/c’s Continued •

NOSTRO ACCOUNT : OUR ACCOUNT WITH YOU.

• VOSTRO ACCOUNT : YOUR ACCOUNT WITH US. • LORO ACCOUNT : THEIR ACCOUNT WITH YOU.

ForEx Transactions FOREX TRANSACTION

PURCHASE

SALE

BANK

BANK

ACQUIRE FOREIGN PART WITH HOME ACQUIRE HOME CURRENCY CURRENCY CURRENCY

PART WITH FOREIGN CURRENCY

ForEx Transactions EXCHANGE QUOTATION

DIRECT “BUY LOW; SALE HIGH”

INDIRECT “BUY HIGH;SALE LOW”

Foreign Exchange Market

Foreign Exchange Market Features•Market where foreign currencies are traded •Round the clock market •Global market •Large volume of transactions

Participants •Individuals: tourists, migrants •Firms: importers and exporters •Banks: short position, long position, square position •Governments/ monetary authorities: market intervention • International agencies: lending Two tier market: First tier: ultimate customer and banker Second tier: between banks

KINDS OF FOREIGN EXCHANGE MARKETS From the point of view of foreign exchange Market Transactions there are following types of Markets•Spot market •Forward market •Derivatives markets: currency futures and options

SPOT MARKETS •Currencies traded for immediate delivery at rates prevailing at the time of transaction •Actual delivery (electronic transfer) may take two working days •Currency arbitrage: buying a currency at cheaper rate in one market and selling at a higher rate in another market -Two point arbitrage -Triangular (three point) arbitrage – three currencies •Currency speculation: buying and holding a currency for sale at a higher rate in the near future

FORWARD MARKETS •Contract for future delivery •Hedging: -Currencies are bought or sold for forward delivery -Reduces foreign exchange risk •Speculation: -Reap profit from changes in exchange rates in future (difference between forward rates and future spot rates) •Arbitrage: -Reaping profit from disparity between forward differential and interest rate differential

FUTURES MARKETS •It is a derivatives market •Currency futures market is of recent origin (1972) •Currencies can be bought and sold in the futures market •Size and maturity of contracts are standardised •Transactions made with the help of brokers through the clearing house •Margin deposit and daily marking to the market •Hedging: to reduce risk •Futures may not provide a perfect hedge ( mismatch in size and maturity) •Speculation: to reap short term profit

Foreign Currency Exchange Risk Management There are several types of forex risks•Exchange rate risk •Interest rate risk •Credit risk -Replacement risk -Settlement risk •Country Risk

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