Description
detail on currency market
Subject Topic Prof.Batch Year Institute
: International Finance : Currency Market : Deepa chavan : Master of Finance Management : 2011-2014 : SIMSREE
INDEX
1) History of foreign exchange market 2) Major currencies 3) Overview of international currency market 4) Basics of currency market & peculiarities 5) Market size & liquidity 6) Currency market participant 7) Indian Currency Market & factors affecting INR 8) Trading characteristics 9) Factors affecting determination of exchange rate
Introduction to Currency Markets
1) Brief history of foreign exchange markets
The current currency rate mechanism has evolved over thousands of years of the world community trying with various mechanism of facilitating the trade of goods and services. Initially, the trading of goods and services was by barter system where in goods were exchanged for each other. Such system had its difficulties primarily because of non-divisibility of certain goods, cost in transporting such goods for trading and difficulty in valuing of services.. Therefore the need to have a common medium of exchange resulted in the innovation of money. People tried various commodities as the medium of exchange ranging from food items to metals. Gradually metals became more prominent medium of exchange because of their ease of transportation, divisibility, certainty of quality and universal acceptance. People started using metal coins as medium of exchange. Amongst metals, gold and silver coins were most prominent and finally gold coins became the standard means of exchange. The process of evolution of medium of exchange further progressed into development of paper currency. People would deposit gold/ silver coins with bank and get a paper promising that value of that paper at any point of time would be equal to certain number of gold coins. This system of book entry of coins against paper was the start of paper currency. in each country cost of production of certain goods is cheaper in certain countries than others. resulted in evolution of foreign exchange (FX) i.e., value of one currency of one country versus value of currency of other country. . When money is branded it is called “currency”. Whenever there is a cross-border trade, there is need to exchange one brand of money for another, and this exchange of two currencies is called “foreign exchange” or simply “forex” (FX). The smooth functioning of international trade required a universally accepted foreign currency to settle the internal trade and a way to balance the trade imbalances amongst countries. This led to the question of determining relative value of two currencies? 1870 countries agreed to value their currencies against value of currency of other country using gold as the benchmark for valuation. As per this process, central banks issue paper currency and hold equivalent amount of gold in their reserve. The value of each currency against another currency was derived from gold exchange rate.
Rupees (INR) 10,000 and US dollar (USD) 500 than the exchange rate of INR versus USD would be 1 USD = INR 20. This mechanism of valuing currency was called as gold standard During 1944-1971, countries adopted a system called Bretton Woods System. This system was a blend of gold standard system and floating rate system. As part of the system, all currencies were pegged to USD at a fixed rate and USD value was pegged to gold finally countries adopted system of free floating or managed float method of valuing the currency. Developed countries gradually moved to a market determined exchange rate and developing countries adopted either a system of pegged currency or a system of managed rate. In pegged system, the value of currency is pegged to another currency or a basket of currencies. The benefit of pegged currency is that it creates an environment of stability for foreign investors as they know the value of their investment in the country at any point of time would be fixed. In managed float, countries have controls on flow of capital and central bank intervention is a c0 ommon tool to contain sharp volatility and direction of currency movement. 2) Major currency pairs The most traded currency pairs in the world are called the Majors. The list includes following currencies: Euro (EUR), US Dollar (USD), Japanese Yen (JPY), Pound Sterling (GBP), Australian Dollar (AUD), Canadian Dollar (CAD), and the Swiss Franc (CHF). These currencies follow free floating method of valuation. Amongst these currencies the most active currency pairs are: EURUSD, USDJPY, GBPUSD, AUDUSD, CADUSD and USDCHF. According to Bank for International Settlement (BIS) survey of April 2010, the share of different currency pairs in daily trading volume is as given below.
Currency EURUSD USDJPY GBPUSD AUD/USD USD/CHF USD/CAD USD/others Others/others Total US Dollar (USD)
Share (%) 28 14 9 6 4 5 18 16 100
The US Dollar is by far the most widely traded currency. Dollar reflects its substantial international role as “investment” currency in many capital markets, “reserve” currency held by many central banks, “transaction” currency in many international commodity markets, “invoice” currency in many contracts, and “intervention” currency employed by
monetary authorities in market operations to influence their own exchange rates. use as a “vehicle” currency in foreign exchange transactions, a use that reinforces its international role in trade and finance. The vehicle currency used most often is the US Dollar, although very recently EUR also has become an important vehicle currency. Thus, a trader who wants to shift funds from one currency to another, say from Indian Rupees to Philippine Pesos, will probably sell INR for US Dollars and then sell the US Dollars for Pesos. Use of a vehicle currency greatly reduces the number of exchange rates that must be dealt with in a multilateral system. whereas if no vehicle currency were used, there would be 45 exchange rates to be dealt with. Euro (EUR) Like the US Dollar, the Euro has a strong international presence and over the years has emerged as a premier currency, second only to the US Dollar. Japanese Yen (JPY) The Japanese Yen is the third most traded currency in the world. It has a much smaller international presence than the US Dollar or the Euro. The Yen is very liquid around the world, practically around the clock. British Pound (GBP) Until the end of World War II, the Pound was the currency of reference. The nickname Cable is derived from the telegrams used to update the GBPUSD rates across the Atlantic. The currency is heavily traded against the Euro and the US Dollar, but it has a spotty presence against other currencies. Swiss Franc (CHF) The Swiss Franc is the only currency of a major European country that belongs neither to the European Monetary Union nor to the G-7 countries. Although the Swiss economy is relatively small, the Swiss Franc is one of the major currencies , Typically, it is believed that the Swiss Franc is a stable currency. Actually, from a foreign exchange point of view, the Swiss Franc closely resembles the patterns of the Euro, but lacks its liquidity. 3) Overview of international currency markets For currency market, the concept of a 24-hour market has become a reality. In financial centers around the world, business hours overlap; as some centers close, others open and begin to trade. Given this uneven flow of business around the clock, market participants often will respond less aggressively to an exchange rate development that occurs at a relatively inactive time of day, and will wait to see whether the development is confirmed when the major markets open. Some institutions pay little attention to developments in less active markets.
Nonetheless, the 24-hour market does provide a continuous “real-time”With access to all of the foreign exchange markets generally open to participants from all countries, and with vast amounts of market information transmitted simultaneously and almost instantly to dealers throughout the world, there is an enormous amount of cross-border foreign exchange trading among dealers as well as between dealers and their customers. As per Bank for International Settlements (BIS) survey of April 2010, daily turnover of currencies in the global market is approximately USD 3.9trillion, making it the largest traded asset class. At any moment, the exchange rates of major currencies tend to be virtually identical in all the financial centers where there is active trading. Rarely are there such substantial price differences among major centers as to provide major opportunities for arbitrage. In pricing, the various financial centers that are open for business and active at any one time are effectively integrated into a single market. 4) Basics of currency markets and peculiarities in India Currency pair Unlike any other traded asset class, the most significant part of currency market is the concept of currency pairs. In currency market, while initiating a trade you buy one currency and sell another currency. Therefore same currency will have very different value against every other currency. For example, same USD is valued at say 45 against INR and say 82 against JPY. This peculiarity makes currency market interesting and relatively complex. Base Currency / Quotation Currency Every trade in FX market is a currency pair: one currency is bought with or sold for another currency. We need to identify the two currencies in a trade by giving them a name. The names cannot be “foreign currency” and “domestic currency” because what is foreign currency in one country is the domestic currency in the other. The two currencies are called “base currency” (BC) and “quoting currency” (QC). The BC is the currency that is priced and its amount is fixed at one unit. The other currency is the QC, which prices the BC, and its amount varies as the price of BC varies in the market. What is quoted throughout the FX market anywhere in the world is the price of BC expressed in QC. There is no exception to this rule. For the currency pair, the standard practice is to write the BC code first followed by the QC code. For example, in USDINR (or USDINR), USD is the BC and INR is the quoted currency; and what is quoted in the market is the price of USD expressed in INR. If you want the price of INR expressed in USD, then you must specify the currency pair as INRUSD. Therefore if a dealer quotes a price of USDINR as 45, it means that one unit of USD has a value of 45 INR. Please note that in case of USDINR, USD is base currency and INR is quotation currency. In the interbank market, USD is the universal base currency other than quoted against Euro (EUR), Sterling Pound (GBP), Australian Dollar (AUD), Canadian Dollar (CAD) .
Interbank market and merchant market There are two distinct segment of OTC foreign exchange market. One segment is called as “interbank” market and the other is called as “merchant” market. Interbank market is the market between banks where dealers quote prices at the same time for both buying and selling the currency. The mechanism of quoting price for both buying and selling is called as market making. For example, your close by vegetable vendor will quote prices only for selling and he will not quote prices for buying it. While in a wholesale market, the vegetable wholesaler will quote prices for buying vegetable from farmer and will also quote prices for selling to vegetable retailer. Thus the wholesaler is a market maker as he is quoting two way prices (for both buying and selling). Similarly dealers in interbank market quote prices for both buying and selling i.e., offer two way quotes. In majority of the “merchant” market, merchants are price takers and banks are price givers. Two way quotes In interbank market, currency prices are always quoted with two way price. In a two way quote, the prices quoted for buying is called bid price and the price quoted for selling is called as offer or ask price. For example Suppose a bank quotes USDINR spot price as 45.05/ 45.06 to a merchant. In this quote, 45.05 is the bid price and 45.06 is the offer price or ask price. This quotes means that the bank is willing to buy one unit of USD for a price of INR 45.05 and is willing to sell one unit of USD for INR 45.06. Thus a merchant interested to buy one unit of USD will get it for a price of INR 45.06. Difference between bid and offer price is called as “spread”. A narrow spread indicates a higher liquidity and higher efficiency of the market maker. In USDINR spot market, the spreads are wide at the time of opening and gradually start narrowing as the market discovers the price. There are certain market norms for quoting the two way quotes. Some of the important norms are as follows: 1. The bid price (lower price) is quoted first followed by offer price (higher price) 2. The offer price is generally quoted in abbreviated form. In case the currency pair is quoted upto four decimal places then offer price is quoted in terms of last two decimal places and if the currency pair is quoted in two decimal places then offer price is quoted in terms of two decimal places. Appreciation / Depreciation Exchange rates are constantly changing, Changes in rates are expressed as strengthening or weakening of one currency vis-à-vis the other currency expressed as appreciation or depreciation of one currency in terms of the other currency. Whenever the base currency buys more of the quotation currency, the base currency has strengthened / appreciated and the quotation currency
has weakened / depreciated. For example, if USDINR has moved from 44.00 to 44.25, the USD has appreciated and the INR has depreciated. Market timing In India, OTC market is open from 9:00 AM to 5:00 PM. However, for merchants the market is open from 9:00 AM to 4:30 PM and the last half hour is meant only for interbank dealings for banks to square off excess positions Price benchmarks There are two price benchmarks used in the OTC market to price merchant transactions. Banks price large value merchant transactions from interbank rate (IBR). IBR is the price available to the bank in the interbank market. Therefore IBR could differ from bank to bank. However, the price variation in general seems to be very small, may be in the range of 0.25 paise to 2 paise from bank to bank. Also IBR is the price at a specific point of time and for a specific transaction amount. For small value transactions, banks publish a standard price for the day called as card rate. However on the days of high volatility, banks revise the card rate multiple times during the day. The difference between IBR and card rate is high to cover the risk of price fluctuation. Card rate could vary significantly from bank to bank. Price discovery Indian currency market is increasingly getting aligned to international markets so The opening levels of OTC market are primarily dependent on the development in international markets since closing of domestic market on the previous day. therefore the OTC market is generally not very liquid in the first few minutes of its opening. Gradually, market discovers an equilibrium price at which market clears buy and sell orders. This process of discovering an equilibrium price is called as price discovery. The above is true for transactions where merchants execute the transaction on the interbank prices. However, for small value transactions, banks give a standard price called as card rate for whole day. RBI reference rate RBI reference rate is the rate published daily by RBI for spot rate for various currency pairs. The rates are arrived at by averaging the mean of the bid / offer rates polled from a few select banks during a random five minute window between 1145 AM and 1215 PM and the daily press on RBI reference rate is be issued every week-day (excluding Saturdays) at around 12.30 PM. There is an increasing trend of large value FX transaction being done at RBI reference rate even on OTC market. The reference rate is a transparent price which is publicly available from an authentic source.
Settlement date or Value date Unlike currency futures market, the settlement in the OTC spot market happens by actual delivery of currency. The mechanism of settlement where each counterparty exchange the goods traded on the maturity of contract is called as gross settlement and the mechanism where market participants only settle the difference in value of goods is called as net settlement. For example, in currency futures market if an exporter sells one month USDINR futures contract at 45.5. On termination of contract (either on expiry or even before expiry), if the price of USDINR is 45.2 the exporter will receive the difference of 45.5 and 45.2 i.e. Rs 0.3 per USD. In OTC spot market, if an exporter sells one million of USD at a price of 45.5. On the settlement date, he will deliver one million on USD to the bank and receive Rs 45,000,000.0 from the bank. In OTC currency market, settlement date is also called as value date. Please note that value date is different from trade date. On trade date, the two counterparties agree to a transaction with certain terms (currency, price, and amount and value date). The settlement of the transaction, when counterparties actually exchange currency, is called as value date. It is also possible to settle the transaction before spot date. The price at which settlement takes before spot date is a derived price from spot price and is not a traded price. For a currency pair for which spot date is at T+2 and if settlement happens on the trade date, the settlement price is called as “cash” rate and if happens one day after trade date, the price is called as “tom” rate. The foreign exchange market (forex, FX, or currency market) is a global decentralized market for the trading of currencies. The main participants in this market are the larger international banks. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. EBS and Reuters' dealing 3000 are two main interbank FX trading platforms. The foreign exchange market determines the relative values of different currencies. The foreign exchange market assists international trade (import export) and investment by enabling currency conversion. The foreign exchange market is unique because of the following characteristics: Its huge trading volume representing the largest asset class in the world leading to high liquidity; Its geographical dispersion; Its continuous operation: 24 hours a day except weekends, i.e., trading from 20:15 GMT on Sunday until 22:00 GMT Friday;
The variety of factors that affect exchange rates; The low margins of relative profit compared with other markets of fixed income; and The use of leverage to enhance profit and loss margins and with respect to account size. 5) Market Size & Liquidity According to the Bank for International Settlements, as of April 2010, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume as of April 2007. Some firms specializing on foreign exchange market had put the average daily turnover in excess of US$4 trillion. The $3.98 trillion break-down is as follows: $1.490 trillion in spot transactions $475 billion in outright forwards $1.765 trillion in foreign exchange swaps $43 billion currency swaps $207 billion in options and other products
Foreign exchange trading increased by 20% between April 2007 and April 2010 and has more than doubled since 2004. The biggest geographic trading center is the United Kingdom, primarily London, which has its share of global turnover in traditional transactions from 34.6% in April 2007 to 38% in April 2010. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. Currency Futures started in 1972 at CME & they have launched Rupee based Futures contract on 25th Feb. 2013. In India Currency
Futures trading started on 29th August 2008 in Mumbai. One of the largest and most liquid in the world. Daily turnover of $ 4.3 Trillion Main trading centers are London (38%), New York (22%), Tokyo (10%) Singapore (9%) India (0.00000116%) Large transactions involve in 7 major currencies (USD/EUR/JPY/GBP/CHF/AUD/CAD) Market never sleeps and has its own rhythm ( 24/5 ) Rank Name 1 2 3 4 5 6 7 8 9 10 Deutsche Bank Citi Barclays Investment Bank UBS AG HSBC JPMorgan Royal Bank of Scotland Credit Suisse Morgan Stanley Market share 15.18% 14.90% 10.24% 10.11% 6.93% 6.07% 5.62% 3.70% 3.15%
Bank of America Merrill Lynch 3.08%
Foreign exchange fixing
Foreign exchange fixing is the daily monetary exchange rate fixed by the national bank of each country. The idea is that central banks use the fixing time and exchange rate to evaluate behavior of their currency. Fixing exchange rates reflects the real value of equilibrium in the market. but aggressive intervention might be used several times each year in countries with a dirty float currency regime. The combined resources of the market can easily overwhelm any central bank. Several scenarios of this nature were seen in the 1992–93 European Exchange Rate Mechanism collapse.
Hedge funds as speculators
About 70% to 90%[ of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency. Hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor.
6) Currency Market participants
Central banks National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Investment management firms Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases. Some investment management firms also have more speculative specialist currency overlay operations, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. Retail foreign exchange traders Individual Retail speculative traders constitute a growing segment of this market with the advent of retail foreign exchange platforms, both in size and importance. Currently, they participate indirectly through brokers or banks. Retail brokers, while largely controlled and regulated in the USA by the Commodity Futures Trading Commission. There are two main types of retail FX brokers offering the opportunity for speculative currency trading: brokers and dealers or market makers. Brokers serve as an agent of the customer in the broader FX market, by seeking the best price in the market for a retail order and dealing on behalf of the retail customer. They charge a commission or mark-up in addition to the
price obtained in the market. Dealers or market makers, by contrast, typically act as principal in the transaction versus the retail customer, and quote a price they are willing to deal at. Non-bank foreign exchange companies Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as foreign exchange brokers but are distinct in that they do not offer speculative trading but rather currency exchange with payments (i.e., there is usually a physical delivery of currency to a bank account). It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign Exchange Companies. These companies' selling point is usually that they will offer better exchange rates or cheaper payments than the customer's bank. These companies differ from Money Transfer/Remittance Companies in that they generally offer higher-value services. 7) Indian currency market Indian currency market will replicate WEST.. hence tremendous potential USD/INR Pair is traded on 6 International Exchanges thus more avenues to trade FIIs are allowed thus more Volatility and Volume in coming months Traders are considering currency as alternate trading platform to earn USD INR Volatility has ensured that a retail customer too track USD/INR rate Less Cost of transaction i.e: Less Margin (higher leverage) & Less Taxes Continuous Growth in Currency Options volume in India Factors affecting INR Macro economic views Monetary Policy Dollar Liquidity Economical and political scenario Data announcements Micro Economic Views USD sentiment. Performance of Equity markets. Performance of other Asian currencies and Asian Markets. Performance of Commodities like Crude Oil
Policy announcements affecting flows – trade or capital RBI intervention Money transfer/remittance companies and bureaux de change Money transfer companies/remittance companies perform high-volume low-value transfers generally by economic migrants back to their home country. In 2007, the Aite Group estimated that there were $369 billion of remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and the Philippines) receive $95 billion. The largest and best known provider is Western Union with 345,000 agents globally followed by UAE Exchange Bureaux de change or currency transfer companies provide low value foreign exchange services for travelers. They access the foreign exchange markets via banks or non bank foreign exchange companies.
8) Trading Characteristics There is no unified or centrally cleared market for the majority of trades, and there is very little cross-border regulation. Due OTC nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies instruments are traded. This implies that there is not a single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. In practice the rates are quite close due to arbitrage. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. Major trading exchanges include EBS and Reuters, while major banks also offer trading systems. A joint venture of the Chicago Mercantile Exchange and Reuters, called Fx market space opened in 2007 and aspired but failed to the role of a central market clearing mechanism. Tokyo, Hong Kong and Singapore are all important centers as well. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends. Fluctuations in exchange rates are usually caused by actual monetary flows as well as by GDP growth, inflation (ppp theory), interest rates (interest rate parity, Domestic Fisher effect, International Fisher effect), budget and trade deficits or surpluses, large crossborder M&A deals and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. Currencies are traded against one another in pairs. Each currency pair thus constitutes an individual trading product and is traditionally noted XXXYYY or XXX/YYY, where XXX and YYY are the ISO 4217 international three-letter code of the currencies involved. The first currency (XXX) is the base currency that is quoted relative to the second currency (YYY), called the counter currency (or quote currency). For instance, the quotation EURUSD (EUR/USD)
1.5465 is the price of the euro expressed in US dollars, meaning 1 euro = 1.5465 dollars. The market convention is to quote most exchange rates against the USD with the US dollar as the base currency (e.g. USDJPY, USDCAD, USDCHF ). The exceptions are the British pound (GBP), Australian dollar (AUD), the New Zealand dollar (NZD) and the euro (EUR) where the USD is the counter currency (e.g. GBPUSD, AUDUSD, NZDUSD, EURUSD).The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes positive currency correlation between XXXYYY and XXXZZZ.The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes positive currency correlation between XXXYYY and XXXZZZ.
Determination of Exchange Rate The following theories explain the fluctuations in exchange rates in a floating exchange rate regime (In a fixed exchange rate regime, rates are decided by its government): International parity conditions: Relative Purchasing Power Parity, interest rate parity, Domestic Fisher effect, International Fisher effect. Though to some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions [e.g., free flow of goods, services and capital] which seldom hold true in the real world. Balance of payments model (see exchange rate): This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for continuous appreciation of dollar during 1980s and most part of 1990s in face of soaring US current account deficit. Asset market model (see exchange rate): views currencies as an important asset class for constructing investment portfolios. Assets prices are influenced mostly by people's willingness to hold the existing quantities of assets, which in turn depends on their expectations on the future worth of these assets. The asset market model of exchange rate determination states that “the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies.” None of the models developed so far succeed to explain exchange rates and volatility in the longer time frames. For shorter time frames (less than a few days) algorithms can be devised to predict prices. It is understood from the above models that many macroeconomic factors affect the exchange rates and in the end currency prices are a result of dual forces of demand and supply. The world's currency markets can be viewed as a huge melting pot: in a large and everchanging mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distills) as much of what is going on in the world at any given time as foreign exchange.
Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions and market psychology. Economic factors These include: (a) economic policy, disseminated by government agencies and central banks (b) economic conditions, generally revealed through economic reports, and other economic indicators. Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates). Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency. Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency. Inflation levels and trends: Typically a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation. Economic growth and health: Reports such as GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be. Productivity of an economy: Increasing productivity in an economy should positively influence the value of its currency. Political Conditions political stability in the region, country . govt. policies. etc.
Current Article
Rupee Tumbles, Then Rebounds Sharply
( Ref:The Wall Street Journal dated 4th September 2013) India's rupee went on a wild ride Wednesday, falling to within a whisker of its record low against the dollar before rebounding after the central bank intervened, traders said, and continuing to climb after the new central-bank governor announced fresh steps to stabilize the currency. Indonesia's rupiah, meanwhile, slumped to its lowest level in four years on continuing investor concerns over trade imbalances and slowing emerging-market economies. India and Indonesia have taken the brunt of an investor pullback from Asia. Their widening trade deficits and rising inflation leave them especially vulnerable to the impact of global fund managers withdrawing investments from Asia amid signs of accelerating economic growth in the U.S. and Europe. The Reserve Bank of India and Bank Indonesia have pursued a variety of strategies to reverse the downtrend in the currencies, including raising interest rates and intervening in foreign-exchange markets, but the declines have continued. The rupee weakened to 68.60 per dollar during the day—close to a record 68.80 hit on Aug. 28 —before strengthening to 67.07 per dollar late Wednesday in Asia after what traders said was central-bank intervention. That compared with 67.63 late Tuesday, and left the rupee down 19% since May 1. Dealers said India's central bank has sold dollars several times in recent weeks. The RBI says it intervenes in the currency market only to curb volatility and not to target a particular exchange rate. The rupee further strengthened to 66.20 per dollar by midday Wednesday in New York after Raghuram Rajan, who took over as governor of the Reserve Bank of India Wednesday, sought to reassure investors by emphasizing the importance of transparency and consistency in the central bank's actions.
"This is exactly what the market wanted to hear," said Krishnamoorthy Harihar, treasurer at FirstRand Bank in Mumbai. "By announcing a bunch of powerful measures on the first day, the new governor has addressed liquidity constraints of both dollar and rupees." Mr. Rajan said banks that receive dollars from nonresident Indians in certain foreign-currency bank deposits will now be able to swap those dollars for rupees from the RBI. Analysts say this would reduce the hedging cost that banks have to pay on holding the foreign-currency deposits, encouraging banks to attract more foreign-currency deposits from overseas residents. The RBI also doubled the amount of money that Indian banks can raise through overseas bonds, and said the banks would be able to swap these dollars for rupees at a concessional rate with the RBI. Both facilities will be available till Nov. 30, Mr. Rajan said. He added that he was committed to liberalizing Indian markets and reducing restrictions on investments. Toward this end, he said the RBI would introduce derivatives tied to interest rates, and would allow greater flexibility to importers and exporters in dealing with currency-related forward exchange contracts. Meanwhile, Indonesia's rupiah reached 11,125 per dollar in the interbank market late Wednesday in Asia, its weakest level since April 2009. It had been at 11050 late Tuesday in Asia. It is down 14% this year, and the market is expecting the downtrend to continue, with one-month nondeliverable forwards pricing in a further 6% decline. Traders said they believe Indonesia's central bank intervened in the market Wednesday to support the rupiah. For people in Indonesia wanting to buy dollars from money changers and banks, the rupiah is looking even weaker. The difference between the levels that banks use with each other and the posted rates at exchange counters has widened to as high as an extra 900 rupiah per dollar compared with about 200 under normal conditions. Analysts say this is a sign of fear that the supply of U.S. notes is low and is indicative of a large appetite to exchange rupiah for dollars. Investment outflows from Asia, especially Indonesia and India, picked up last week to the most since June, when markets were roiled by the first signs that the Federal Reserve was poised to end its aggressive bond buying sooner than previously anticipated. Global investors withdrew $104 million from Indonesia's bond markets in the week ending Aug. 28, the most of any Asian debt market, according to research from Australia & New Zealand Banking Group Ltd. In India, fund managers have been exiting stock markets, with $213 million leaving the nation's equities over the same period. Signs that the U.S. is moving closer to military action against Syria could make the situation worse for both the rupee and the rupiah.
Although crude-oil prices have slipped since President Barack Obama said over the weekend that he would seek Congress's approval for a strike, support from Republican politicians has increased the likelihood of congressional assent, which could push oil prices higher. That is bad news for both India and Indonesia because it threatens to boost their already-high energy-import bills
Knowing how currency markets work is important ( Business Today dated: September 4, 2013)
How can trading in rupee-dollar currency options benefit investors? Currency markets present a good investment opportunity. However, investors should participate only after a thorough understanding of how they work. In options, the risk is lower because the loss is limited to the premium paid. But investors need to know how puts and calls work and whether the premium being paid for an option is feasible. It's advisable to take a course on forex derivatives offered by currency exchanges and associations What are the factors that affect currency movements? One has to be clued in to global developments, trends in world trade as well as economic indicators of different countries. These include GDP growth, fiscal and monetary policies, inflows and outflows of the currency, local stock market performance and interest rates. What should an investor keep in mind before foraying into this field? The currency derivatives market is highly leveraged. In the stock futures market, a 20% margin gains a five-fold leverage. In forex futures, the margin payable is just 3%, so the leverage is 33 times. This means that even a 1% change can wipe out a third of the investment. However, the Indian currency markets are well-regulated and there is almost no counter-party risk. Investors should start small and gradually invest more. What will be the direction of the US currency over the next 3-6 months? Investors should go long on the dollar due to global growth concerns, including poor performance of Asian giants such as China. They should buy the dollar at every dip. We expect it to touch Rs 48 in the next 2-3 months provided it holds above Rs 46.50 consistently.
Will the turmoil in Europe pull down the euro further? Medium-to-long-term investors should go short on the euro. The downside pressures have reduced for now, but in 2-3 months, the focus will be back on the dollar. We maintain a bearish stance on the euro against the rupee and expect it to recede to Rs 58-59
doc_254004853.doc
detail on currency market
Subject Topic Prof.Batch Year Institute
: International Finance : Currency Market : Deepa chavan : Master of Finance Management : 2011-2014 : SIMSREE
INDEX
1) History of foreign exchange market 2) Major currencies 3) Overview of international currency market 4) Basics of currency market & peculiarities 5) Market size & liquidity 6) Currency market participant 7) Indian Currency Market & factors affecting INR 8) Trading characteristics 9) Factors affecting determination of exchange rate
Introduction to Currency Markets
1) Brief history of foreign exchange markets
The current currency rate mechanism has evolved over thousands of years of the world community trying with various mechanism of facilitating the trade of goods and services. Initially, the trading of goods and services was by barter system where in goods were exchanged for each other. Such system had its difficulties primarily because of non-divisibility of certain goods, cost in transporting such goods for trading and difficulty in valuing of services.. Therefore the need to have a common medium of exchange resulted in the innovation of money. People tried various commodities as the medium of exchange ranging from food items to metals. Gradually metals became more prominent medium of exchange because of their ease of transportation, divisibility, certainty of quality and universal acceptance. People started using metal coins as medium of exchange. Amongst metals, gold and silver coins were most prominent and finally gold coins became the standard means of exchange. The process of evolution of medium of exchange further progressed into development of paper currency. People would deposit gold/ silver coins with bank and get a paper promising that value of that paper at any point of time would be equal to certain number of gold coins. This system of book entry of coins against paper was the start of paper currency. in each country cost of production of certain goods is cheaper in certain countries than others. resulted in evolution of foreign exchange (FX) i.e., value of one currency of one country versus value of currency of other country. . When money is branded it is called “currency”. Whenever there is a cross-border trade, there is need to exchange one brand of money for another, and this exchange of two currencies is called “foreign exchange” or simply “forex” (FX). The smooth functioning of international trade required a universally accepted foreign currency to settle the internal trade and a way to balance the trade imbalances amongst countries. This led to the question of determining relative value of two currencies? 1870 countries agreed to value their currencies against value of currency of other country using gold as the benchmark for valuation. As per this process, central banks issue paper currency and hold equivalent amount of gold in their reserve. The value of each currency against another currency was derived from gold exchange rate.
Rupees (INR) 10,000 and US dollar (USD) 500 than the exchange rate of INR versus USD would be 1 USD = INR 20. This mechanism of valuing currency was called as gold standard During 1944-1971, countries adopted a system called Bretton Woods System. This system was a blend of gold standard system and floating rate system. As part of the system, all currencies were pegged to USD at a fixed rate and USD value was pegged to gold finally countries adopted system of free floating or managed float method of valuing the currency. Developed countries gradually moved to a market determined exchange rate and developing countries adopted either a system of pegged currency or a system of managed rate. In pegged system, the value of currency is pegged to another currency or a basket of currencies. The benefit of pegged currency is that it creates an environment of stability for foreign investors as they know the value of their investment in the country at any point of time would be fixed. In managed float, countries have controls on flow of capital and central bank intervention is a c0 ommon tool to contain sharp volatility and direction of currency movement. 2) Major currency pairs The most traded currency pairs in the world are called the Majors. The list includes following currencies: Euro (EUR), US Dollar (USD), Japanese Yen (JPY), Pound Sterling (GBP), Australian Dollar (AUD), Canadian Dollar (CAD), and the Swiss Franc (CHF). These currencies follow free floating method of valuation. Amongst these currencies the most active currency pairs are: EURUSD, USDJPY, GBPUSD, AUDUSD, CADUSD and USDCHF. According to Bank for International Settlement (BIS) survey of April 2010, the share of different currency pairs in daily trading volume is as given below.
Currency EURUSD USDJPY GBPUSD AUD/USD USD/CHF USD/CAD USD/others Others/others Total US Dollar (USD)
Share (%) 28 14 9 6 4 5 18 16 100
The US Dollar is by far the most widely traded currency. Dollar reflects its substantial international role as “investment” currency in many capital markets, “reserve” currency held by many central banks, “transaction” currency in many international commodity markets, “invoice” currency in many contracts, and “intervention” currency employed by
monetary authorities in market operations to influence their own exchange rates. use as a “vehicle” currency in foreign exchange transactions, a use that reinforces its international role in trade and finance. The vehicle currency used most often is the US Dollar, although very recently EUR also has become an important vehicle currency. Thus, a trader who wants to shift funds from one currency to another, say from Indian Rupees to Philippine Pesos, will probably sell INR for US Dollars and then sell the US Dollars for Pesos. Use of a vehicle currency greatly reduces the number of exchange rates that must be dealt with in a multilateral system. whereas if no vehicle currency were used, there would be 45 exchange rates to be dealt with. Euro (EUR) Like the US Dollar, the Euro has a strong international presence and over the years has emerged as a premier currency, second only to the US Dollar. Japanese Yen (JPY) The Japanese Yen is the third most traded currency in the world. It has a much smaller international presence than the US Dollar or the Euro. The Yen is very liquid around the world, practically around the clock. British Pound (GBP) Until the end of World War II, the Pound was the currency of reference. The nickname Cable is derived from the telegrams used to update the GBPUSD rates across the Atlantic. The currency is heavily traded against the Euro and the US Dollar, but it has a spotty presence against other currencies. Swiss Franc (CHF) The Swiss Franc is the only currency of a major European country that belongs neither to the European Monetary Union nor to the G-7 countries. Although the Swiss economy is relatively small, the Swiss Franc is one of the major currencies , Typically, it is believed that the Swiss Franc is a stable currency. Actually, from a foreign exchange point of view, the Swiss Franc closely resembles the patterns of the Euro, but lacks its liquidity. 3) Overview of international currency markets For currency market, the concept of a 24-hour market has become a reality. In financial centers around the world, business hours overlap; as some centers close, others open and begin to trade. Given this uneven flow of business around the clock, market participants often will respond less aggressively to an exchange rate development that occurs at a relatively inactive time of day, and will wait to see whether the development is confirmed when the major markets open. Some institutions pay little attention to developments in less active markets.
Nonetheless, the 24-hour market does provide a continuous “real-time”With access to all of the foreign exchange markets generally open to participants from all countries, and with vast amounts of market information transmitted simultaneously and almost instantly to dealers throughout the world, there is an enormous amount of cross-border foreign exchange trading among dealers as well as between dealers and their customers. As per Bank for International Settlements (BIS) survey of April 2010, daily turnover of currencies in the global market is approximately USD 3.9trillion, making it the largest traded asset class. At any moment, the exchange rates of major currencies tend to be virtually identical in all the financial centers where there is active trading. Rarely are there such substantial price differences among major centers as to provide major opportunities for arbitrage. In pricing, the various financial centers that are open for business and active at any one time are effectively integrated into a single market. 4) Basics of currency markets and peculiarities in India Currency pair Unlike any other traded asset class, the most significant part of currency market is the concept of currency pairs. In currency market, while initiating a trade you buy one currency and sell another currency. Therefore same currency will have very different value against every other currency. For example, same USD is valued at say 45 against INR and say 82 against JPY. This peculiarity makes currency market interesting and relatively complex. Base Currency / Quotation Currency Every trade in FX market is a currency pair: one currency is bought with or sold for another currency. We need to identify the two currencies in a trade by giving them a name. The names cannot be “foreign currency” and “domestic currency” because what is foreign currency in one country is the domestic currency in the other. The two currencies are called “base currency” (BC) and “quoting currency” (QC). The BC is the currency that is priced and its amount is fixed at one unit. The other currency is the QC, which prices the BC, and its amount varies as the price of BC varies in the market. What is quoted throughout the FX market anywhere in the world is the price of BC expressed in QC. There is no exception to this rule. For the currency pair, the standard practice is to write the BC code first followed by the QC code. For example, in USDINR (or USDINR), USD is the BC and INR is the quoted currency; and what is quoted in the market is the price of USD expressed in INR. If you want the price of INR expressed in USD, then you must specify the currency pair as INRUSD. Therefore if a dealer quotes a price of USDINR as 45, it means that one unit of USD has a value of 45 INR. Please note that in case of USDINR, USD is base currency and INR is quotation currency. In the interbank market, USD is the universal base currency other than quoted against Euro (EUR), Sterling Pound (GBP), Australian Dollar (AUD), Canadian Dollar (CAD) .
Interbank market and merchant market There are two distinct segment of OTC foreign exchange market. One segment is called as “interbank” market and the other is called as “merchant” market. Interbank market is the market between banks where dealers quote prices at the same time for both buying and selling the currency. The mechanism of quoting price for both buying and selling is called as market making. For example, your close by vegetable vendor will quote prices only for selling and he will not quote prices for buying it. While in a wholesale market, the vegetable wholesaler will quote prices for buying vegetable from farmer and will also quote prices for selling to vegetable retailer. Thus the wholesaler is a market maker as he is quoting two way prices (for both buying and selling). Similarly dealers in interbank market quote prices for both buying and selling i.e., offer two way quotes. In majority of the “merchant” market, merchants are price takers and banks are price givers. Two way quotes In interbank market, currency prices are always quoted with two way price. In a two way quote, the prices quoted for buying is called bid price and the price quoted for selling is called as offer or ask price. For example Suppose a bank quotes USDINR spot price as 45.05/ 45.06 to a merchant. In this quote, 45.05 is the bid price and 45.06 is the offer price or ask price. This quotes means that the bank is willing to buy one unit of USD for a price of INR 45.05 and is willing to sell one unit of USD for INR 45.06. Thus a merchant interested to buy one unit of USD will get it for a price of INR 45.06. Difference between bid and offer price is called as “spread”. A narrow spread indicates a higher liquidity and higher efficiency of the market maker. In USDINR spot market, the spreads are wide at the time of opening and gradually start narrowing as the market discovers the price. There are certain market norms for quoting the two way quotes. Some of the important norms are as follows: 1. The bid price (lower price) is quoted first followed by offer price (higher price) 2. The offer price is generally quoted in abbreviated form. In case the currency pair is quoted upto four decimal places then offer price is quoted in terms of last two decimal places and if the currency pair is quoted in two decimal places then offer price is quoted in terms of two decimal places. Appreciation / Depreciation Exchange rates are constantly changing, Changes in rates are expressed as strengthening or weakening of one currency vis-à-vis the other currency expressed as appreciation or depreciation of one currency in terms of the other currency. Whenever the base currency buys more of the quotation currency, the base currency has strengthened / appreciated and the quotation currency
has weakened / depreciated. For example, if USDINR has moved from 44.00 to 44.25, the USD has appreciated and the INR has depreciated. Market timing In India, OTC market is open from 9:00 AM to 5:00 PM. However, for merchants the market is open from 9:00 AM to 4:30 PM and the last half hour is meant only for interbank dealings for banks to square off excess positions Price benchmarks There are two price benchmarks used in the OTC market to price merchant transactions. Banks price large value merchant transactions from interbank rate (IBR). IBR is the price available to the bank in the interbank market. Therefore IBR could differ from bank to bank. However, the price variation in general seems to be very small, may be in the range of 0.25 paise to 2 paise from bank to bank. Also IBR is the price at a specific point of time and for a specific transaction amount. For small value transactions, banks publish a standard price for the day called as card rate. However on the days of high volatility, banks revise the card rate multiple times during the day. The difference between IBR and card rate is high to cover the risk of price fluctuation. Card rate could vary significantly from bank to bank. Price discovery Indian currency market is increasingly getting aligned to international markets so The opening levels of OTC market are primarily dependent on the development in international markets since closing of domestic market on the previous day. therefore the OTC market is generally not very liquid in the first few minutes of its opening. Gradually, market discovers an equilibrium price at which market clears buy and sell orders. This process of discovering an equilibrium price is called as price discovery. The above is true for transactions where merchants execute the transaction on the interbank prices. However, for small value transactions, banks give a standard price called as card rate for whole day. RBI reference rate RBI reference rate is the rate published daily by RBI for spot rate for various currency pairs. The rates are arrived at by averaging the mean of the bid / offer rates polled from a few select banks during a random five minute window between 1145 AM and 1215 PM and the daily press on RBI reference rate is be issued every week-day (excluding Saturdays) at around 12.30 PM. There is an increasing trend of large value FX transaction being done at RBI reference rate even on OTC market. The reference rate is a transparent price which is publicly available from an authentic source.
Settlement date or Value date Unlike currency futures market, the settlement in the OTC spot market happens by actual delivery of currency. The mechanism of settlement where each counterparty exchange the goods traded on the maturity of contract is called as gross settlement and the mechanism where market participants only settle the difference in value of goods is called as net settlement. For example, in currency futures market if an exporter sells one month USDINR futures contract at 45.5. On termination of contract (either on expiry or even before expiry), if the price of USDINR is 45.2 the exporter will receive the difference of 45.5 and 45.2 i.e. Rs 0.3 per USD. In OTC spot market, if an exporter sells one million of USD at a price of 45.5. On the settlement date, he will deliver one million on USD to the bank and receive Rs 45,000,000.0 from the bank. In OTC currency market, settlement date is also called as value date. Please note that value date is different from trade date. On trade date, the two counterparties agree to a transaction with certain terms (currency, price, and amount and value date). The settlement of the transaction, when counterparties actually exchange currency, is called as value date. It is also possible to settle the transaction before spot date. The price at which settlement takes before spot date is a derived price from spot price and is not a traded price. For a currency pair for which spot date is at T+2 and if settlement happens on the trade date, the settlement price is called as “cash” rate and if happens one day after trade date, the price is called as “tom” rate. The foreign exchange market (forex, FX, or currency market) is a global decentralized market for the trading of currencies. The main participants in this market are the larger international banks. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. EBS and Reuters' dealing 3000 are two main interbank FX trading platforms. The foreign exchange market determines the relative values of different currencies. The foreign exchange market assists international trade (import export) and investment by enabling currency conversion. The foreign exchange market is unique because of the following characteristics: Its huge trading volume representing the largest asset class in the world leading to high liquidity; Its geographical dispersion; Its continuous operation: 24 hours a day except weekends, i.e., trading from 20:15 GMT on Sunday until 22:00 GMT Friday;
The variety of factors that affect exchange rates; The low margins of relative profit compared with other markets of fixed income; and The use of leverage to enhance profit and loss margins and with respect to account size. 5) Market Size & Liquidity According to the Bank for International Settlements, as of April 2010, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume as of April 2007. Some firms specializing on foreign exchange market had put the average daily turnover in excess of US$4 trillion. The $3.98 trillion break-down is as follows: $1.490 trillion in spot transactions $475 billion in outright forwards $1.765 trillion in foreign exchange swaps $43 billion currency swaps $207 billion in options and other products
Foreign exchange trading increased by 20% between April 2007 and April 2010 and has more than doubled since 2004. The biggest geographic trading center is the United Kingdom, primarily London, which has its share of global turnover in traditional transactions from 34.6% in April 2007 to 38% in April 2010. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. Currency Futures started in 1972 at CME & they have launched Rupee based Futures contract on 25th Feb. 2013. In India Currency
Futures trading started on 29th August 2008 in Mumbai. One of the largest and most liquid in the world. Daily turnover of $ 4.3 Trillion Main trading centers are London (38%), New York (22%), Tokyo (10%) Singapore (9%) India (0.00000116%) Large transactions involve in 7 major currencies (USD/EUR/JPY/GBP/CHF/AUD/CAD) Market never sleeps and has its own rhythm ( 24/5 ) Rank Name 1 2 3 4 5 6 7 8 9 10 Deutsche Bank Citi Barclays Investment Bank UBS AG HSBC JPMorgan Royal Bank of Scotland Credit Suisse Morgan Stanley Market share 15.18% 14.90% 10.24% 10.11% 6.93% 6.07% 5.62% 3.70% 3.15%
Bank of America Merrill Lynch 3.08%
Foreign exchange fixing
Foreign exchange fixing is the daily monetary exchange rate fixed by the national bank of each country. The idea is that central banks use the fixing time and exchange rate to evaluate behavior of their currency. Fixing exchange rates reflects the real value of equilibrium in the market. but aggressive intervention might be used several times each year in countries with a dirty float currency regime. The combined resources of the market can easily overwhelm any central bank. Several scenarios of this nature were seen in the 1992–93 European Exchange Rate Mechanism collapse.
Hedge funds as speculators
About 70% to 90%[ of the foreign exchange transactions are speculative. In other words, the person or institution that bought or sold the currency has no plan to actually take delivery of the currency in the end; rather, they were solely speculating on the movement of that particular currency. Hedge funds have gained a reputation for aggressive currency speculation since 1996. They control billions of dollars of equity and may borrow billions more, and thus may overwhelm intervention by central banks to support almost any currency, if the economic fundamentals are in the hedge funds' favor.
6) Currency Market participants
Central banks National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Investment management firms Investment management firms (who typically manage large accounts on behalf of customers such as pension funds and endowments) use the foreign exchange market to facilitate transactions in foreign securities. For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases. Some investment management firms also have more speculative specialist currency overlay operations, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. Retail foreign exchange traders Individual Retail speculative traders constitute a growing segment of this market with the advent of retail foreign exchange platforms, both in size and importance. Currently, they participate indirectly through brokers or banks. Retail brokers, while largely controlled and regulated in the USA by the Commodity Futures Trading Commission. There are two main types of retail FX brokers offering the opportunity for speculative currency trading: brokers and dealers or market makers. Brokers serve as an agent of the customer in the broader FX market, by seeking the best price in the market for a retail order and dealing on behalf of the retail customer. They charge a commission or mark-up in addition to the
price obtained in the market. Dealers or market makers, by contrast, typically act as principal in the transaction versus the retail customer, and quote a price they are willing to deal at. Non-bank foreign exchange companies Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as foreign exchange brokers but are distinct in that they do not offer speculative trading but rather currency exchange with payments (i.e., there is usually a physical delivery of currency to a bank account). It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign Exchange Companies. These companies' selling point is usually that they will offer better exchange rates or cheaper payments than the customer's bank. These companies differ from Money Transfer/Remittance Companies in that they generally offer higher-value services. 7) Indian currency market Indian currency market will replicate WEST.. hence tremendous potential USD/INR Pair is traded on 6 International Exchanges thus more avenues to trade FIIs are allowed thus more Volatility and Volume in coming months Traders are considering currency as alternate trading platform to earn USD INR Volatility has ensured that a retail customer too track USD/INR rate Less Cost of transaction i.e: Less Margin (higher leverage) & Less Taxes Continuous Growth in Currency Options volume in India Factors affecting INR Macro economic views Monetary Policy Dollar Liquidity Economical and political scenario Data announcements Micro Economic Views USD sentiment. Performance of Equity markets. Performance of other Asian currencies and Asian Markets. Performance of Commodities like Crude Oil
Policy announcements affecting flows – trade or capital RBI intervention Money transfer/remittance companies and bureaux de change Money transfer companies/remittance companies perform high-volume low-value transfers generally by economic migrants back to their home country. In 2007, the Aite Group estimated that there were $369 billion of remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and the Philippines) receive $95 billion. The largest and best known provider is Western Union with 345,000 agents globally followed by UAE Exchange Bureaux de change or currency transfer companies provide low value foreign exchange services for travelers. They access the foreign exchange markets via banks or non bank foreign exchange companies.
8) Trading Characteristics There is no unified or centrally cleared market for the majority of trades, and there is very little cross-border regulation. Due OTC nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies instruments are traded. This implies that there is not a single exchange rate but rather a number of different rates (prices), depending on what bank or market maker is trading, and where it is. In practice the rates are quite close due to arbitrage. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. Major trading exchanges include EBS and Reuters, while major banks also offer trading systems. A joint venture of the Chicago Mercantile Exchange and Reuters, called Fx market space opened in 2007 and aspired but failed to the role of a central market clearing mechanism. Tokyo, Hong Kong and Singapore are all important centers as well. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends. Fluctuations in exchange rates are usually caused by actual monetary flows as well as by GDP growth, inflation (ppp theory), interest rates (interest rate parity, Domestic Fisher effect, International Fisher effect), budget and trade deficits or surpluses, large crossborder M&A deals and other macroeconomic conditions. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time. Currencies are traded against one another in pairs. Each currency pair thus constitutes an individual trading product and is traditionally noted XXXYYY or XXX/YYY, where XXX and YYY are the ISO 4217 international three-letter code of the currencies involved. The first currency (XXX) is the base currency that is quoted relative to the second currency (YYY), called the counter currency (or quote currency). For instance, the quotation EURUSD (EUR/USD)
1.5465 is the price of the euro expressed in US dollars, meaning 1 euro = 1.5465 dollars. The market convention is to quote most exchange rates against the USD with the US dollar as the base currency (e.g. USDJPY, USDCAD, USDCHF ). The exceptions are the British pound (GBP), Australian dollar (AUD), the New Zealand dollar (NZD) and the euro (EUR) where the USD is the counter currency (e.g. GBPUSD, AUDUSD, NZDUSD, EURUSD).The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes positive currency correlation between XXXYYY and XXXZZZ.The factors affecting XXX will affect both XXXYYY and XXXZZZ. This causes positive currency correlation between XXXYYY and XXXZZZ.
Determination of Exchange Rate The following theories explain the fluctuations in exchange rates in a floating exchange rate regime (In a fixed exchange rate regime, rates are decided by its government): International parity conditions: Relative Purchasing Power Parity, interest rate parity, Domestic Fisher effect, International Fisher effect. Though to some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions [e.g., free flow of goods, services and capital] which seldom hold true in the real world. Balance of payments model (see exchange rate): This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for continuous appreciation of dollar during 1980s and most part of 1990s in face of soaring US current account deficit. Asset market model (see exchange rate): views currencies as an important asset class for constructing investment portfolios. Assets prices are influenced mostly by people's willingness to hold the existing quantities of assets, which in turn depends on their expectations on the future worth of these assets. The asset market model of exchange rate determination states that “the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies.” None of the models developed so far succeed to explain exchange rates and volatility in the longer time frames. For shorter time frames (less than a few days) algorithms can be devised to predict prices. It is understood from the above models that many macroeconomic factors affect the exchange rates and in the end currency prices are a result of dual forces of demand and supply. The world's currency markets can be viewed as a huge melting pot: in a large and everchanging mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses (and distills) as much of what is going on in the world at any given time as foreign exchange.
Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: economic factors, political conditions and market psychology. Economic factors These include: (a) economic policy, disseminated by government agencies and central banks (b) economic conditions, generally revealed through economic reports, and other economic indicators. Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy (the means by which a government's central bank influences the supply and "cost" of money, which is reflected by the level of interest rates). Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits, and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency. Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy. For example, trade deficits may have a negative impact on a nation's currency. Inflation levels and trends: Typically a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power, thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation. Economic growth and health: Reports such as GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be. Productivity of an economy: Increasing productivity in an economy should positively influence the value of its currency. Political Conditions political stability in the region, country . govt. policies. etc.
Current Article
Rupee Tumbles, Then Rebounds Sharply
( Ref:The Wall Street Journal dated 4th September 2013) India's rupee went on a wild ride Wednesday, falling to within a whisker of its record low against the dollar before rebounding after the central bank intervened, traders said, and continuing to climb after the new central-bank governor announced fresh steps to stabilize the currency. Indonesia's rupiah, meanwhile, slumped to its lowest level in four years on continuing investor concerns over trade imbalances and slowing emerging-market economies. India and Indonesia have taken the brunt of an investor pullback from Asia. Their widening trade deficits and rising inflation leave them especially vulnerable to the impact of global fund managers withdrawing investments from Asia amid signs of accelerating economic growth in the U.S. and Europe. The Reserve Bank of India and Bank Indonesia have pursued a variety of strategies to reverse the downtrend in the currencies, including raising interest rates and intervening in foreign-exchange markets, but the declines have continued. The rupee weakened to 68.60 per dollar during the day—close to a record 68.80 hit on Aug. 28 —before strengthening to 67.07 per dollar late Wednesday in Asia after what traders said was central-bank intervention. That compared with 67.63 late Tuesday, and left the rupee down 19% since May 1. Dealers said India's central bank has sold dollars several times in recent weeks. The RBI says it intervenes in the currency market only to curb volatility and not to target a particular exchange rate. The rupee further strengthened to 66.20 per dollar by midday Wednesday in New York after Raghuram Rajan, who took over as governor of the Reserve Bank of India Wednesday, sought to reassure investors by emphasizing the importance of transparency and consistency in the central bank's actions.
"This is exactly what the market wanted to hear," said Krishnamoorthy Harihar, treasurer at FirstRand Bank in Mumbai. "By announcing a bunch of powerful measures on the first day, the new governor has addressed liquidity constraints of both dollar and rupees." Mr. Rajan said banks that receive dollars from nonresident Indians in certain foreign-currency bank deposits will now be able to swap those dollars for rupees from the RBI. Analysts say this would reduce the hedging cost that banks have to pay on holding the foreign-currency deposits, encouraging banks to attract more foreign-currency deposits from overseas residents. The RBI also doubled the amount of money that Indian banks can raise through overseas bonds, and said the banks would be able to swap these dollars for rupees at a concessional rate with the RBI. Both facilities will be available till Nov. 30, Mr. Rajan said. He added that he was committed to liberalizing Indian markets and reducing restrictions on investments. Toward this end, he said the RBI would introduce derivatives tied to interest rates, and would allow greater flexibility to importers and exporters in dealing with currency-related forward exchange contracts. Meanwhile, Indonesia's rupiah reached 11,125 per dollar in the interbank market late Wednesday in Asia, its weakest level since April 2009. It had been at 11050 late Tuesday in Asia. It is down 14% this year, and the market is expecting the downtrend to continue, with one-month nondeliverable forwards pricing in a further 6% decline. Traders said they believe Indonesia's central bank intervened in the market Wednesday to support the rupiah. For people in Indonesia wanting to buy dollars from money changers and banks, the rupiah is looking even weaker. The difference between the levels that banks use with each other and the posted rates at exchange counters has widened to as high as an extra 900 rupiah per dollar compared with about 200 under normal conditions. Analysts say this is a sign of fear that the supply of U.S. notes is low and is indicative of a large appetite to exchange rupiah for dollars. Investment outflows from Asia, especially Indonesia and India, picked up last week to the most since June, when markets were roiled by the first signs that the Federal Reserve was poised to end its aggressive bond buying sooner than previously anticipated. Global investors withdrew $104 million from Indonesia's bond markets in the week ending Aug. 28, the most of any Asian debt market, according to research from Australia & New Zealand Banking Group Ltd. In India, fund managers have been exiting stock markets, with $213 million leaving the nation's equities over the same period. Signs that the U.S. is moving closer to military action against Syria could make the situation worse for both the rupee and the rupiah.
Although crude-oil prices have slipped since President Barack Obama said over the weekend that he would seek Congress's approval for a strike, support from Republican politicians has increased the likelihood of congressional assent, which could push oil prices higher. That is bad news for both India and Indonesia because it threatens to boost their already-high energy-import bills
Knowing how currency markets work is important ( Business Today dated: September 4, 2013)
How can trading in rupee-dollar currency options benefit investors? Currency markets present a good investment opportunity. However, investors should participate only after a thorough understanding of how they work. In options, the risk is lower because the loss is limited to the premium paid. But investors need to know how puts and calls work and whether the premium being paid for an option is feasible. It's advisable to take a course on forex derivatives offered by currency exchanges and associations What are the factors that affect currency movements? One has to be clued in to global developments, trends in world trade as well as economic indicators of different countries. These include GDP growth, fiscal and monetary policies, inflows and outflows of the currency, local stock market performance and interest rates. What should an investor keep in mind before foraying into this field? The currency derivatives market is highly leveraged. In the stock futures market, a 20% margin gains a five-fold leverage. In forex futures, the margin payable is just 3%, so the leverage is 33 times. This means that even a 1% change can wipe out a third of the investment. However, the Indian currency markets are well-regulated and there is almost no counter-party risk. Investors should start small and gradually invest more. What will be the direction of the US currency over the next 3-6 months? Investors should go long on the dollar due to global growth concerns, including poor performance of Asian giants such as China. They should buy the dollar at every dip. We expect it to touch Rs 48 in the next 2-3 months provided it holds above Rs 46.50 consistently.
Will the turmoil in Europe pull down the euro further? Medium-to-long-term investors should go short on the euro. The downside pressures have reduced for now, but in 2-3 months, the focus will be back on the dollar. We maintain a bearish stance on the euro against the rupee and expect it to recede to Rs 58-59
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