Index
Sr. No. 1. 2. 3. 4. 5. 6. 7.
Topics Foreign Exchange Market Foreign Exchange Rate Determinants of Foreign Exchange Rates Exchange Quotation Direct Quotation (Home Currency) Indirect Quotation (Foreign Currency) Conclusion
Page No.s 02 03 04 06 08 09 10
1
Foreign Exchange Market
Introduction: • Today no country is self sufficient in its demand and supply of goods and services and factors of production such as labour and capital are seen moving freely across the national frontiers. • All the countries trade in goods and services, borrow and lend, invest and accept investments with other countries with nominal or full control to govern the currency flow and trade. • Since different countries have their own currencies (with different purchasing power), the settlement of payments cannot be made with the currency of one country. Meaning: • The Foreign Exchange market is a decentralized world-wide market; the participants in the market include central banks, commercial banks, brokers, corporations and individuals. • The central banks monitor both market movements and sentiments and intervene according to government policy and prevailing situation. Functioning: • International economic and commercial relations between countries involve exchange of goods and services and payment for these exchanges. • The payments lead to conversion of one currency into another. • Each country has its financial system and its own currency and financial assets.
2
• Exchanges between the money and financial assets of one country for money or financial assets of another country constitute international financial transactions. • These transactions are put through the foreign exchange market.
Exchange Rate:
• It is the price of one country in terms of another. The rate varies from time to time depending upon the supply of and demands for foreign exchange in the inter-bank, which is based on the transactions in the market segment. • The rate of exchange between two currencies is the amount of one currency that will be exchanged for one unit of another currency. • The exchange rate of a currency appreciates if the general demand for that currency at any moment exceeds the current supplier. • It is worth noting that the exchange rates of active currencies fluctuate every 4 seconds. • You would have come across the data on buying and selling exchange rate in newspapers and T.V. • The selling rate is the rate at which the bank sells a foreign currency against the local currency. • The buying rate is the rate at which the bank buys a foreign currency against the local currency. • The margin between the buying and selling rate constitute the exchange profit for the bank. • Exchange Rates commonly quoted by banks or an authorized dealer as two way rates- the bid price and the offer price.
3
1. The price at which a dealer is buying a foreign currency is called as ‘Bid Price’. 2. The price at which a dealer is selling a given currency is called as ‘Offer Price’. It is also called ‘Ask Price’. 3. The difference between bid price and the offer price is called ‘Spread’. This represents the margin of foreign exchange dealer. • Illustration: The exchange rate of 1 U.S dollar against Rupees in the spot market as follows: 1 U.S Dollar Buying Rs. 42.22 Selling Rs 42.64
• The buying price i.e. Rs. 42.22 is the bid price and selling price of Rs 42.64 is the offer price. • The difference between the bid price and the offer price i.e. Rs. 42.22 - Rs 42.64 = Re 0.42. It is called Spread.
Determinants of Foreign Exchange Rates: 1. Purchasing Power (Inflation):
• The relative inflation rates of different countries will have impact on their currency exchange rates.
2. Interest Rates:
• The relative interest rates and expected changes in interest rates also influence exchange rates.
4
• The domestic economic policies influence domestic interest rates. • The domestic interest rates are an important factor influencing the Foreign Exchange Market.
3. Balance of Payment Position:
• Continuous adverse balance of payment leads to depreciation in home country’s currency exchange rate. • It creates pressure for buying on the foreign currency against its own currency. • Then, the country’s own currency exchange rate will fall.
4. Government Intervention:
• Sometimes the government exerts lot of pressure on exchange rates by involving in direct selling and buying and impose restrictions on currency dealings, currency movements and by their taxation and monetary policies. • All will affect the exchange rates.
5. Market Expectation:
• The market expectations of a country keep on fluctuating which creates an impact on the supply and demand for currencies which influence the rate of exchange.
6. Overseas Investment:
5
• Suppose foreign investment in India from US, increases the supply of US, putting downward pressure on US, investment in India by US individuals or companies will tend to strengthen the rupee.
7. Speculation:
• Speculators, including the treasury managers of international bank influence movement exchange rate by buying and selling in the expectation of making positive return by correctly forecasting movement and exchange rates and by exploiting any market inefficiencies.
Exchange Quotation: Illustration:
• If 1$ can be exchanged for Rs 46/- the rate of exchange between dollars and rupees is 1$ = Rs 46/• When the rate of exchange is quoted as so many rupees per dollar it is know as the ‘dollar rate’. • When it is quoted as dollar as rupees, it is know as ‘rupee rate’.
• The quotation in which exchange rate is expressed as the price per unit of foreign currency is known as ‘Home Currency’ or ‘Direct Quotation’. Direct Quotation or Home Currency Indirect Quotation or Foreign Currency
Exchange Quotation
6
• The number of units of foreign currency is kept constant and changing the value in terms of rupees will make any change in the exchange rate. • The quotation in which the unit of home currency is kept constant and the exchange rate is expressed as so many units of foreign currency is known as ‘Foreign Currency Quotation’ or ‘Indirect Quotation’ • Under this system, changing the number of units of foreign currency in exchange will effect any change.
Exchange Quotation
Direct
Indirect
Variable Unit
Variable Unit
Home Currency
Foreign Currency
7
Direct Quotation (Home Currency):
• The prime motive of any trader is to make profit. He earns profit by purchasing the commodity at a lower price and selling it at a higher price. • In foreign exchange too, the banker buys the foreign currency at a lesser price and sells it at a higher price. Example: It may buy US dollar at Rs 45/- and sell at Rs 46/• Thus in Direct Quotation, the principle adopted by the banker is to buy at a lower price and sell at a higher price. This principle is stated in the form of a maxim: “Buy low; Sell high.”
Direct Quotation
Buy Low
Sell High
Pay lesser units of more home currency
For a fixed unit of foreign currency
Receive home currency
8
Indirect Quotation (Foreign Currency):
• This refers to the quantity that a trader purchases and sells instead of the variation in price. For a fixed amount of investment, he would acquire more units of the commodity when he sells.
•
Illustration: When a banana seller gets 50 bananas for Rs 100
from his supplier and for the same amount of Rs 100 if he sells 40 bananas, he would incur a profit. The same principle can be applied to a foreign exchange quotation.
• In Direct Quotation, it is the commodity of the trade, i.e. the foreign currency, which is varying in accordance with the change in exchange rates, • For a fixed unit of home currency, the bank would like to acquire more units of foreign currency while buying and part with lesser units of foreign currency while selling. • The difference between the selling rate and buying rate is the banks profit margin.
Indirect Quotation
Buy High
Sell Low
Acquire more units of foreign currency
For a fixed unit of home currency 9
Part with Lesser units of foreign currency
Conclusion:
• The Central Banking authority in India, that is the Reserve Bank of India, should play a more positive role in developing markets by entering the exchange markets at all centres from time to time. • In the years to come, the foreign exchange market is likely to play a pivotal role in strengthening the Indian financial System and accelerate the process of economic development.
Thank you
10
doc_493702201.doc
Sr. No. 1. 2. 3. 4. 5. 6. 7.
Topics Foreign Exchange Market Foreign Exchange Rate Determinants of Foreign Exchange Rates Exchange Quotation Direct Quotation (Home Currency) Indirect Quotation (Foreign Currency) Conclusion
Page No.s 02 03 04 06 08 09 10
1
Foreign Exchange Market
Introduction: • Today no country is self sufficient in its demand and supply of goods and services and factors of production such as labour and capital are seen moving freely across the national frontiers. • All the countries trade in goods and services, borrow and lend, invest and accept investments with other countries with nominal or full control to govern the currency flow and trade. • Since different countries have their own currencies (with different purchasing power), the settlement of payments cannot be made with the currency of one country. Meaning: • The Foreign Exchange market is a decentralized world-wide market; the participants in the market include central banks, commercial banks, brokers, corporations and individuals. • The central banks monitor both market movements and sentiments and intervene according to government policy and prevailing situation. Functioning: • International economic and commercial relations between countries involve exchange of goods and services and payment for these exchanges. • The payments lead to conversion of one currency into another. • Each country has its financial system and its own currency and financial assets.
2
• Exchanges between the money and financial assets of one country for money or financial assets of another country constitute international financial transactions. • These transactions are put through the foreign exchange market.
Exchange Rate:
• It is the price of one country in terms of another. The rate varies from time to time depending upon the supply of and demands for foreign exchange in the inter-bank, which is based on the transactions in the market segment. • The rate of exchange between two currencies is the amount of one currency that will be exchanged for one unit of another currency. • The exchange rate of a currency appreciates if the general demand for that currency at any moment exceeds the current supplier. • It is worth noting that the exchange rates of active currencies fluctuate every 4 seconds. • You would have come across the data on buying and selling exchange rate in newspapers and T.V. • The selling rate is the rate at which the bank sells a foreign currency against the local currency. • The buying rate is the rate at which the bank buys a foreign currency against the local currency. • The margin between the buying and selling rate constitute the exchange profit for the bank. • Exchange Rates commonly quoted by banks or an authorized dealer as two way rates- the bid price and the offer price.
3
1. The price at which a dealer is buying a foreign currency is called as ‘Bid Price’. 2. The price at which a dealer is selling a given currency is called as ‘Offer Price’. It is also called ‘Ask Price’. 3. The difference between bid price and the offer price is called ‘Spread’. This represents the margin of foreign exchange dealer. • Illustration: The exchange rate of 1 U.S dollar against Rupees in the spot market as follows: 1 U.S Dollar Buying Rs. 42.22 Selling Rs 42.64
• The buying price i.e. Rs. 42.22 is the bid price and selling price of Rs 42.64 is the offer price. • The difference between the bid price and the offer price i.e. Rs. 42.22 - Rs 42.64 = Re 0.42. It is called Spread.
Determinants of Foreign Exchange Rates: 1. Purchasing Power (Inflation):
• The relative inflation rates of different countries will have impact on their currency exchange rates.
2. Interest Rates:
• The relative interest rates and expected changes in interest rates also influence exchange rates.
4
• The domestic economic policies influence domestic interest rates. • The domestic interest rates are an important factor influencing the Foreign Exchange Market.
3. Balance of Payment Position:
• Continuous adverse balance of payment leads to depreciation in home country’s currency exchange rate. • It creates pressure for buying on the foreign currency against its own currency. • Then, the country’s own currency exchange rate will fall.
4. Government Intervention:
• Sometimes the government exerts lot of pressure on exchange rates by involving in direct selling and buying and impose restrictions on currency dealings, currency movements and by their taxation and monetary policies. • All will affect the exchange rates.
5. Market Expectation:
• The market expectations of a country keep on fluctuating which creates an impact on the supply and demand for currencies which influence the rate of exchange.
6. Overseas Investment:
5
• Suppose foreign investment in India from US, increases the supply of US, putting downward pressure on US, investment in India by US individuals or companies will tend to strengthen the rupee.
7. Speculation:
• Speculators, including the treasury managers of international bank influence movement exchange rate by buying and selling in the expectation of making positive return by correctly forecasting movement and exchange rates and by exploiting any market inefficiencies.
Exchange Quotation: Illustration:
• If 1$ can be exchanged for Rs 46/- the rate of exchange between dollars and rupees is 1$ = Rs 46/• When the rate of exchange is quoted as so many rupees per dollar it is know as the ‘dollar rate’. • When it is quoted as dollar as rupees, it is know as ‘rupee rate’.
• The quotation in which exchange rate is expressed as the price per unit of foreign currency is known as ‘Home Currency’ or ‘Direct Quotation’. Direct Quotation or Home Currency Indirect Quotation or Foreign Currency
Exchange Quotation
6
• The number of units of foreign currency is kept constant and changing the value in terms of rupees will make any change in the exchange rate. • The quotation in which the unit of home currency is kept constant and the exchange rate is expressed as so many units of foreign currency is known as ‘Foreign Currency Quotation’ or ‘Indirect Quotation’ • Under this system, changing the number of units of foreign currency in exchange will effect any change.
Exchange Quotation
Direct
Indirect
Variable Unit
Variable Unit
Home Currency
Foreign Currency
7
Direct Quotation (Home Currency):
• The prime motive of any trader is to make profit. He earns profit by purchasing the commodity at a lower price and selling it at a higher price. • In foreign exchange too, the banker buys the foreign currency at a lesser price and sells it at a higher price. Example: It may buy US dollar at Rs 45/- and sell at Rs 46/• Thus in Direct Quotation, the principle adopted by the banker is to buy at a lower price and sell at a higher price. This principle is stated in the form of a maxim: “Buy low; Sell high.”
Direct Quotation
Buy Low
Sell High
Pay lesser units of more home currency
For a fixed unit of foreign currency
Receive home currency
8
Indirect Quotation (Foreign Currency):
• This refers to the quantity that a trader purchases and sells instead of the variation in price. For a fixed amount of investment, he would acquire more units of the commodity when he sells.
•
Illustration: When a banana seller gets 50 bananas for Rs 100
from his supplier and for the same amount of Rs 100 if he sells 40 bananas, he would incur a profit. The same principle can be applied to a foreign exchange quotation.
• In Direct Quotation, it is the commodity of the trade, i.e. the foreign currency, which is varying in accordance with the change in exchange rates, • For a fixed unit of home currency, the bank would like to acquire more units of foreign currency while buying and part with lesser units of foreign currency while selling. • The difference between the selling rate and buying rate is the banks profit margin.
Indirect Quotation
Buy High
Sell Low
Acquire more units of foreign currency
For a fixed unit of home currency 9
Part with Lesser units of foreign currency
Conclusion:
• The Central Banking authority in India, that is the Reserve Bank of India, should play a more positive role in developing markets by entering the exchange markets at all centres from time to time. • In the years to come, the foreign exchange market is likely to play a pivotal role in strengthening the Indian financial System and accelerate the process of economic development.
Thank you
10
doc_493702201.doc