Description
purpose of forex markets, different terminologies used in forex market, different fore market types and players involved in forex market, different types of participants, determinants of exchange rates, different types of forex market transactions.
Financial Markets
Description of FOREX Markets
Presented by
Saurav Gandhi 09P052 Kanika Narang 09P086 Rahul Kumar 09P106 Sushma T 09P176 Vishal Gupta 09P179 Anubhava Saxena 09P188 Madhurima Guha Roy 09P205 Saurabh Jain 09P229
Agenda
Introduction Functioning of FX Markets Determination of Exchange Rates Types of FOREX Market Transactions Indian FOREX Market Organization of FOREX Markets Purpose of FX Markets
UK FOREX Market
US FOREX Market
Terminology
Factors affecting FOREX
Comparison Between Them
Types of Markets & Market Participants
Foreign Exchange Market
The foreign exchange market is the place where one currency is bought or sold for another currency The foreign exchange market (FOREX, FX, or currency market) is a worldwide decentralized over-the-counter financial market for the trading of currencies
• Huge trading volumes
FX Market Facts
– turnover in traditional FX markets- $3.2 trillion in April 2007 – leads to high liquidity (95% speculative trade)
• Geographical dispersion • Continuous operation
– 24 hours a day except weekends
2004: Turnover $1.88 trillion
107, 6%
Trends
2007: Turnover $3.21 trillion
128, 4%
Spot transactions
621, 33%
1,005, 31%
Outright forwards
944, 50%
1,714, 54%
Foreign exchange swaps
362, 11% Estimated gaps in reporting
208, 11%
Organization of FOREX Markets
FOREX markets are markets on which individuals, firms and banks buy and sell foreign currencies
Trading occurs with the help of the telecommunication net between buyers and sellers of FX that are located all over the world Can actually talk about a single international FX market for every single currency FOREX trading takes place at least in some of the world financial centers at every moment
Purpose of FX Markets
?Clearing of currencies
‡ service of exchanging one currency for another
?Assist international trade and investment ?Supports speculation
‡ facilitates the carry trade ‡ maintains liquidity
?Hedging Risk
‡ minimize exposure to the risks of exchange rate changes
Purpose of FX Markets
?Provision of Credit
?trader that bought a certain good from the manufacturer, needs time to sell this good to the final customer and to pay the manufacturer with the money he received from the customer
?Tourism ?Investments ?Borrowings
Terminology
Cross rate
currency exchange rate between two currencies, where neither of the currencies are of the country in which the exchange rate is given
Eurobonds
bonds denominated in a particular currency and issued simultaneously in the bond markets of several countries
Eurocurrency
money deposited in a financial center outside the home country Eurodollars are dollar deposits held outside the US Euroyen are yen denominated deposits held outside Japan
Foreign bonds
bonds issued in another nation’s capital market by a foreign borrower
Terminology
Arbitrage
? act of buying currency in one market at lower prices and selling it in another at higher price ? helps arbitrageurs in the market to earn profit without risk ? a balancing operations that does not allow the same currency to have varying rates in different FOREX markets
Triangular Arbitrage
? opportunity for riskless profit (when the currency's exchange rates do not exactly match up) by converting one currency to another, converting it again to a third currency and, finally, converting it back to the original currency within a short time span
Terminology
A bank is ready to buy and sell a currency at different prices Buy price- Bid rate Sell price- Ask rate Bid-Ask Spread
difference between Bid and Ask rate is called Bid-Ask spread
It is more in retail market and less in interbank market as there is more volume, greater liquidity and lower counterparty risk in interbank transactions
Terminology
• Quote
† last price at which a security or commodity traded i.e. the most recent price on which a buyer and seller agreed and at which some amount of the asset was transacted
• Merchant quote
† by bank to its retail customers
• Interbank quote
† given by one bank to another bank
Since, both the parties are banks, then whose quote will be considered. The bank requesting the quote will is the customer and the other bank’s quote will be considered
Terminology
Nostro account
? an account maintained by a local bank with a foreign bank that allows the local bank to buy foreign currency
Vostro Account
? an account maintained by an overseas bank with a local bank that allows the overseas bank to purchase local currency
The system of Nostro and Vostro accounts facilitates FX dealings and settlements and allows the settlement of currency transactions between the Country's (Local)Bank and foreign banks
FX Market Types & Players
Retail Market (Client Market) Wholesale Market (Interbank Market)
•Travelers •Tourists
•Commercial Banks •FX Brokers •Central Banks •MNCs •Individuals & SMEs
Graphs
Players- Wholesale Markets
COMMERCIAL BANKS
• participate in FX on behalf of their clients • at retail level enters through inter bank market or through specialized brokers • at bulk level enters through inter-bank wholesale market or international banks and brokers • act as agents who facilitate trading between dealers • provide their client with the information about exchange rates at which banks are willing to buy or sell a particular currency
FOREX BROKERS
CENTRAL BANKS
• Central banks frequently intervene in the foreign exchange market to maintain the exchange rate at desired level • stabilization of the macroeconomic indicators
MNCs
• payment for goods & services • MNCs participate in forward exchange market
Types of Participants
Speculators
• about 70% to 90% of the FX transactions are speculative • speculators think they know what the future exchange rate of a particular currency will be & are willing to accept exchange rate risk with the goal of making profit
Hedgers
• do not want to take risk while participating in the market, they want to insure themselves against the exchange rate changes • every foreign exchange market participant can behave either as a hedger or as a speculator in the context of a particular transaction
Arbitrageurs
• want to earn profits without taking any kind of risk • try to profit from simultaneous exchange rate differences in different markets • making use of the interest rate differences that exist in national financial markets of two countries along with transactions on spot and forward foreign exchange market at the same time
Functioning of FX Markets
Client buys $ with € Local Bank
Brokers
Main Bank’s Interbank Market
Purchases and sales of big MNCs
Local Bank
Client buys € with $
Determinants of Exchange Rate
Supply and demand for any currency depend on combination of several factors
Economic
• economic policies • economic conditions
Political
• internal, regional, and international political conditions and events can have a profound effect on currency markets • all exchange rates are susceptible to political instability and anticipations about the new ruling party
• • • • flights to quality long-term trends "Buy the rumor, sell the fact" economic numbers
Market Psychology
Types of FX Market Transactions
• Spot Foreign Exchange Transactions
¥ almost immediate delivery of foreign exchange
• Outright Forward Transactions
¥ buyer and seller establish the exchange rate at the time of the agreement, payment and delivery are not required until maturity ¥ forward exchange rates:
?1, 3, 6, 9 months, 1 year
• Swap Transactions
Types of FX Market Transactions
€ simultaneous purchase and sale of a given amount of foreign exchange for two different value dates
• Futures Transactions
€ exchange-traded FX futures contracts introduced in 1972 at the Chicago Mercantile Exchange € type of currency quotation & amount of the currency being traded € contract expiration € settlement day € margin requirements
Types of FX Market Transactions
• Options Transactions
Organized Markets Over-the-counter Trading
• standardized contracts with given strike prices, standardized durations (1, 3, 6, 9, 12 months) & expirations • only certain currencies, contract amounts are standardized
Usage of options
• expiration date, strike price and contract amount depend on the individual needs of the client • counterparty risk • retail and interbank market
• when the economic agent expects that the exchange rate trend of a particular currency could change drastically • when the economic agent is unsure of a certain FX flow • advantages • fixed option costs • options do not need to be executed
Factors Affecting FX Transactions
Inflation rate
Interest rates
Balance of payment position
Volume of international reserves Level of activity and employment
Inflation Rate
• If domestic inflation rate >foreign inflation rate
? domestic goods are costlier than foreign goods ? encourages import of foreign goods ? more demand for foreign currencies ? foreign currencies are costlier
• If domestic inflation rate < foreign inflation rate
? domestic goods are cheaper ? encourages export ? foreign exchange inflow increases ? domestic currency appreciates
• If interest rate in home country (India 10%) > foreign country (US 4%)
? US funds likely to be attracted in India as the investor can earn better returns ? more demand for rupees in US causing appreciation for INR
Interest Rates
• Premium/discount of one currency w.r.t. other reflects the interest rate differentials between the two currencies
? forward rate = spot rate x[1 + I(F)]/[1 +I(H)]
• Foreign currency is at a premium when interest rate is higher in foreign country than home
? home currency is at a discount
Balance of Payment (BOP)
• Deficit BOP
© not able to meet the demand of such currency say dollar leads to devaluation of home currency © discourages imports as foreign goods become costlier © encourages exports as domestic goods are cheaper in foreign country
• Favorable BOP
© value of such a country’s currency likely to appreciate
Volume of International Reserves
• The reserve supports or stabilizes whenever currency depreciates • Release or sell FX reserves to meet demand for foreign currency thereby reducing further devaluation • The monetary authority can withstand only to the extent of reserves in hand • Gold also included
Level of activity and employment
Higher level of economic activity and full employment have good potential and prospects of appreciation in the value of home currency
Indian FOREX Market
Facts on Indian FX Market
? Regulated by the Reserve Bank of India by the Foreign Exchange Management Act, 1999 or FEMA (replacement of FERA) ? FX Market developed in 1978 when government allowed banks to trade in FX
? Today over 70% of FX trading takes place in inter-bank market ? In 1994 India adopted full account convertibility on current account
? Since 2002 clearing and settlement in interbank market is largely carried out by CCIL
From FERA to FEMA
? FERA was applicable in the period when FOREX was a scarce
commodity ? Regulation vs. Management
? Capital account and current account transactions have been defined and distinguished in FEMA ? Civil Law vs. Criminal Law ? Burden of proof lies with the prosecution under FEMA but the
FERA states otherwise
Market Players in India
?Authorized Dealers ?Foreign exchange brokers-intermediaries ?Customers
?individuals ?corporate
?FEDAI and RBI
Authorized Dealers
? 90 ADs ? AD category I
† commercial banks, who undertake all spheres of FX transactions
? AD category II
† licensed money changers and travel agents, who enjoy limited authorization for encashment of traveler’s check and notes
? AD category III
† IDBI and EXIM Bank etc are permitted handling and hold foreign currencies in a restricted way
FEDAI
This self regulatory body was set up in 1958
Functions
Guidelines and Rules for FX Business
Accreditation of FX Brokers Training of Bank Personnel in the areas of Foreign Exchange Business Advising/Assisting member banks in settling issues/matters in their dealings
Represent member banks on Government/Reserve Bank of India/Other Bodies
Three Tier Architecture
• Bottom tier
? Money changers licensed by RBI
• Second tier
? Cooperative and Commercial Bank licensed to maintain accounts for NRI
• Top tier
? Authorized dealers ? Scheduled Banks ? full-fledged foreign exchange business
FOREX Trading Platforms
• In India FX trading takes place in
? FX CLEAR by CCIL, set up in Aug 2003 ? FX Direct by IBS FOREX (P) Ltd, set up in 2002 ? Two more by Reuters
• FX CLEAR and FX Direct
? offer real time order matching and negotiated modes for dealing
• They cover
? USD-INR ? EUR-USD ? USD-JPY etc
Turnover in FX Market (USD bn)
FOREX Settlement Volumes
London FOREX Market
Facts on London FX Market
• Largest FX market
† † † † historical importance relative lack of regulation proximity to major Eurocurrency markets Time zone: London’s morning overlaps with late trading in the Far East and London’s afternoon overlaps with New York
• Almost one third of the currency trading transactions of the world take place in the UK • Market share of UK is almost twice that of its nearest competitor (US) • Average daily reported turnover was $1,747 billion in April 2010
Turnover
Instrument Oct 2009 Apr 2010
Spot Transactions
Outright Forwards
513
165
612
194
Non-Deliverable Forwards
FX Swaps Total ‘traditional’ foreign exchange turnover Currency swaps Foreign exchange options Total OTC foreign exchange derivatives turnover
26
705 1409 18 95 113
28
756 1620 17 110 127
Currency Distribution
Percentage share of average daily turnover
Instrument US Dollar Oct 2009 85.8 Apr 2010 85.2
Euro
Pound Sterling Japanese Yen Swiss Franc Canadian Dollar Australian Dollar Indian rupee
44.4
17.7 15.8 6.8 3.9 6.0 0.7
44.6
17.6 17.4 6.9 3.9 6.6 0.3
The most intensely traded currency pair is the Dollar/Euro
Regulations
• Regulator
• Financial Services Authority (FSA)
• Principal legislations governing the FX market
• Financial Services and Markets Act 2000 (FSMA) • Non-Investment Products (NIPS) Code
• FX spot transactions and transactions entered for commercial purposes are outside the scope of direct FSA regulation • Foreign Exchange Joint Standing Committee (FX JSC)
• established in 1973 as a forum for banks and brokers to discuss broad market issues
NIPS Code
† Firms should clearly state at the outset, prior to a transaction being executed, any qualifying conditions to which it will be subject † Prices used in mark-to-market calculations should be checked by an area of the principal that is independent of the front office † When an individual currency is experiencing high volatility, intermediaries should pay special attention to the financing of trades in that currency † Oral agreements are considered binding † Brokers should not divulge the names of principals prematurely, and certainly not until satisfied that both sides display a serious intention to transact etc
Products
Spot FX
FX Swaps
Outright Forwards
Products
Non Deliverable Forwards Options Currency Swaps
Products
• Non Deliverable Forwards (NDFs)
? similar to outright forward but there is no physical settlement of two currencies at maturity ? based on the movement of two currencies, a net cash settlement will be made by one party to the other – usually in dollars
• FX Swaps
? A contract that simultaneously agrees to buy (sell) an amount of currency at an agreed rate and to resell (repurchase) the same amount of currency for a later value date to (from) the same counterparty, also at an agreed rate
Trading Venues
• Predominately an over-the-counter market • In 1990s, dealing systems developed by EBS and Reuters became famous in the interbank market • For Spot FX, many electronic communication networks (ECNs) and electronic intermediaries exist
US FOREX Market
FX Volume in US Market
Source: Federal Reserve Bank of New York
FX Volume in US Market
Source: Federal Reserve Bank of New York
Market Participants
Foreign Exchange Dealers Financial and Non Financial Customers
• financial institutions which buy and sell foreign exchange for their own accounts as well as act as correspondents for other commercial bank • Foreign Exchange Dealers Coalition (FXDC) is an alliance of the largest U.S. foreign exchange market dealers • smaller commercial banks and investment banks that don’t act as major dealers • firms and corporations buying and selling FX • managers of mutual funds, hedge funds, pension funds, high net worth individuals • brokers in OTC market • Voice brokers • Automated Order Matching or Electronic Broking SystemElectronic Brokerage System (EBS) and Reuters 2002 • brokers in Exchange Traded Markets
Brokers
Payment and Settlement Systems
Fedwire
• a system run by the Federal Reserve • Payment via Fedwire • a regional Federal Reserve Bank debits on its books the account of the sending bank and credits the account of the receiving bank • payment is settled when the receiving bank has its deposit account at the Fed credited with the funds or is notified of the payment • it is an RTGS system
CHIPS (Clearing House Interbank Payments System)
• a privately owned system run by the New York Clearing House • Payment via CHIPS • payments processed over CHIPS are finally settled not individually during the day but collectively at the end of the business day after the net debit or credit position of each CHIPS participant has been determined • final settlement occurs by Fedwire Transfer
Major Instruments – OTC Market
Contracts A Outright Contracts
1. Spot
Description Straightforward exchanges with various settlement dates
Settles two business days after deal date (or day 3) except Canada
Cash
Value Tomorrow 2. Outright Forward
Settles on deal date (or day 1)
Settles one business day after deal date (day 2) Settles on any pre-arranged date three or more business days after deal date (day 4 or beyond)
B
FX Swap Contracts
Short-Dated FX Swaps 1. Spot-Next
Exchange of principal with subsequent re-exchange at pre-agreed rate on pre-arranged date
Re-exchange in less than one month Arranged 2 days before spot value date; (or day 1); first leg settles on spot value date (or day 3); second leg settles next business day (or day 4) Arranged 1 day before spot value date; (or day 2); first leg settles on spot date (or day 3) second leg settles following business day (or day 4) Second leg settles same day one week later; (same day two weeks later)
2. Tom-Next
3. Spot-A-Week; (Spot-TwoWeeks)
Major Instruments – OTC Market
Contracts
Forward FX Swaps 1. Spot-Forward
Description
Re-exchange in one month or longer First leg settles on spot date; second leg on a “straight” or standard forward date, e.g. 1, 2, 3, 6, 12 months
2. Odd-Date or Broken Date
3. Forward-Forward 4. Long Dates
First leg settles on spot date; second leg settles on a nonstraight later date First leg usually on a standard forward contract date; second leg a later standard forward contract date
First leg, spot date; second leg, a date beyond one year
C
Currency Swap Contracts
Initial exchange of principal (sometimes omitted), stream of interest payments, with subsequent reexchange of principal on pre-arranged date
D
OTC Currency Option Contracts
Customized options; premium paid upfront; settlement two business days after exercise
Major Instruments – Exchange Traded Market
Contracts A Futures Contracts Description Standardized quarterly or other maturity dates; initial and maintenance margins with daily mark-to-market
B
Exchange-Traded Currency Options Contracts
1. Options on Spot (Philadelphia) On exercise, settlement in currency
2. Options on Futures (Chicago)
On exercise, settlement in futures position in currency
FX Market Activities of the Fed
Conducts all U.S. intervention operations in the foreign exchange market on behalf of the U.S. monetary authorities
Also conducts certain non-intervention business transactions on behalf of various U.S. Government agencies Routinely engaged in FX transactions on behalf of “customers” e.g. foreign central bank
Regulatory Bodies
FX Dealer Members (FDMs) are regulated by
Commodity Futures Trading Commission (CFTC) National Futures Association(NFA) in the United States as well as by national and local regulatory bodies where they conduct business.
All FX dealers
submit financial reports to its regulators are subject to lengthy regulatory audits covering everything from marketing practices to employee training regimens
OTC market is still largely unregulated
Thank you
doc_338527390.pdf
purpose of forex markets, different terminologies used in forex market, different fore market types and players involved in forex market, different types of participants, determinants of exchange rates, different types of forex market transactions.
Financial Markets
Description of FOREX Markets
Presented by
Saurav Gandhi 09P052 Kanika Narang 09P086 Rahul Kumar 09P106 Sushma T 09P176 Vishal Gupta 09P179 Anubhava Saxena 09P188 Madhurima Guha Roy 09P205 Saurabh Jain 09P229
Agenda
Introduction Functioning of FX Markets Determination of Exchange Rates Types of FOREX Market Transactions Indian FOREX Market Organization of FOREX Markets Purpose of FX Markets
UK FOREX Market
US FOREX Market
Terminology
Factors affecting FOREX
Comparison Between Them
Types of Markets & Market Participants
Foreign Exchange Market
The foreign exchange market is the place where one currency is bought or sold for another currency The foreign exchange market (FOREX, FX, or currency market) is a worldwide decentralized over-the-counter financial market for the trading of currencies
• Huge trading volumes
FX Market Facts
– turnover in traditional FX markets- $3.2 trillion in April 2007 – leads to high liquidity (95% speculative trade)
• Geographical dispersion • Continuous operation
– 24 hours a day except weekends
2004: Turnover $1.88 trillion
107, 6%
Trends
2007: Turnover $3.21 trillion
128, 4%
Spot transactions
621, 33%
1,005, 31%
Outright forwards
944, 50%
1,714, 54%
Foreign exchange swaps
362, 11% Estimated gaps in reporting
208, 11%
Organization of FOREX Markets
FOREX markets are markets on which individuals, firms and banks buy and sell foreign currencies
Trading occurs with the help of the telecommunication net between buyers and sellers of FX that are located all over the world Can actually talk about a single international FX market for every single currency FOREX trading takes place at least in some of the world financial centers at every moment
Purpose of FX Markets
?Clearing of currencies
‡ service of exchanging one currency for another
?Assist international trade and investment ?Supports speculation
‡ facilitates the carry trade ‡ maintains liquidity
?Hedging Risk
‡ minimize exposure to the risks of exchange rate changes
Purpose of FX Markets
?Provision of Credit
?trader that bought a certain good from the manufacturer, needs time to sell this good to the final customer and to pay the manufacturer with the money he received from the customer
?Tourism ?Investments ?Borrowings
Terminology
Cross rate
currency exchange rate between two currencies, where neither of the currencies are of the country in which the exchange rate is given
Eurobonds
bonds denominated in a particular currency and issued simultaneously in the bond markets of several countries
Eurocurrency
money deposited in a financial center outside the home country Eurodollars are dollar deposits held outside the US Euroyen are yen denominated deposits held outside Japan
Foreign bonds
bonds issued in another nation’s capital market by a foreign borrower
Terminology
Arbitrage
? act of buying currency in one market at lower prices and selling it in another at higher price ? helps arbitrageurs in the market to earn profit without risk ? a balancing operations that does not allow the same currency to have varying rates in different FOREX markets
Triangular Arbitrage
? opportunity for riskless profit (when the currency's exchange rates do not exactly match up) by converting one currency to another, converting it again to a third currency and, finally, converting it back to the original currency within a short time span
Terminology
A bank is ready to buy and sell a currency at different prices Buy price- Bid rate Sell price- Ask rate Bid-Ask Spread
difference between Bid and Ask rate is called Bid-Ask spread
It is more in retail market and less in interbank market as there is more volume, greater liquidity and lower counterparty risk in interbank transactions
Terminology
• Quote
† last price at which a security or commodity traded i.e. the most recent price on which a buyer and seller agreed and at which some amount of the asset was transacted
• Merchant quote
† by bank to its retail customers
• Interbank quote
† given by one bank to another bank
Since, both the parties are banks, then whose quote will be considered. The bank requesting the quote will is the customer and the other bank’s quote will be considered
Terminology
Nostro account
? an account maintained by a local bank with a foreign bank that allows the local bank to buy foreign currency
Vostro Account
? an account maintained by an overseas bank with a local bank that allows the overseas bank to purchase local currency
The system of Nostro and Vostro accounts facilitates FX dealings and settlements and allows the settlement of currency transactions between the Country's (Local)Bank and foreign banks
FX Market Types & Players
Retail Market (Client Market) Wholesale Market (Interbank Market)
•Travelers •Tourists
•Commercial Banks •FX Brokers •Central Banks •MNCs •Individuals & SMEs
Graphs
Players- Wholesale Markets
COMMERCIAL BANKS
• participate in FX on behalf of their clients • at retail level enters through inter bank market or through specialized brokers • at bulk level enters through inter-bank wholesale market or international banks and brokers • act as agents who facilitate trading between dealers • provide their client with the information about exchange rates at which banks are willing to buy or sell a particular currency
FOREX BROKERS
CENTRAL BANKS
• Central banks frequently intervene in the foreign exchange market to maintain the exchange rate at desired level • stabilization of the macroeconomic indicators
MNCs
• payment for goods & services • MNCs participate in forward exchange market
Types of Participants
Speculators
• about 70% to 90% of the FX transactions are speculative • speculators think they know what the future exchange rate of a particular currency will be & are willing to accept exchange rate risk with the goal of making profit
Hedgers
• do not want to take risk while participating in the market, they want to insure themselves against the exchange rate changes • every foreign exchange market participant can behave either as a hedger or as a speculator in the context of a particular transaction
Arbitrageurs
• want to earn profits without taking any kind of risk • try to profit from simultaneous exchange rate differences in different markets • making use of the interest rate differences that exist in national financial markets of two countries along with transactions on spot and forward foreign exchange market at the same time
Functioning of FX Markets
Client buys $ with € Local Bank
Brokers
Main Bank’s Interbank Market
Purchases and sales of big MNCs
Local Bank
Client buys € with $
Determinants of Exchange Rate
Supply and demand for any currency depend on combination of several factors
Economic
• economic policies • economic conditions
Political
• internal, regional, and international political conditions and events can have a profound effect on currency markets • all exchange rates are susceptible to political instability and anticipations about the new ruling party
• • • • flights to quality long-term trends "Buy the rumor, sell the fact" economic numbers
Market Psychology
Types of FX Market Transactions
• Spot Foreign Exchange Transactions
¥ almost immediate delivery of foreign exchange
• Outright Forward Transactions
¥ buyer and seller establish the exchange rate at the time of the agreement, payment and delivery are not required until maturity ¥ forward exchange rates:
?1, 3, 6, 9 months, 1 year
• Swap Transactions
Types of FX Market Transactions
€ simultaneous purchase and sale of a given amount of foreign exchange for two different value dates
• Futures Transactions
€ exchange-traded FX futures contracts introduced in 1972 at the Chicago Mercantile Exchange € type of currency quotation & amount of the currency being traded € contract expiration € settlement day € margin requirements
Types of FX Market Transactions
• Options Transactions
Organized Markets Over-the-counter Trading
• standardized contracts with given strike prices, standardized durations (1, 3, 6, 9, 12 months) & expirations • only certain currencies, contract amounts are standardized
Usage of options
• expiration date, strike price and contract amount depend on the individual needs of the client • counterparty risk • retail and interbank market
• when the economic agent expects that the exchange rate trend of a particular currency could change drastically • when the economic agent is unsure of a certain FX flow • advantages • fixed option costs • options do not need to be executed
Factors Affecting FX Transactions
Inflation rate
Interest rates
Balance of payment position
Volume of international reserves Level of activity and employment
Inflation Rate
• If domestic inflation rate >foreign inflation rate
? domestic goods are costlier than foreign goods ? encourages import of foreign goods ? more demand for foreign currencies ? foreign currencies are costlier
• If domestic inflation rate < foreign inflation rate
? domestic goods are cheaper ? encourages export ? foreign exchange inflow increases ? domestic currency appreciates
• If interest rate in home country (India 10%) > foreign country (US 4%)
? US funds likely to be attracted in India as the investor can earn better returns ? more demand for rupees in US causing appreciation for INR
Interest Rates
• Premium/discount of one currency w.r.t. other reflects the interest rate differentials between the two currencies
? forward rate = spot rate x[1 + I(F)]/[1 +I(H)]
• Foreign currency is at a premium when interest rate is higher in foreign country than home
? home currency is at a discount
Balance of Payment (BOP)
• Deficit BOP
© not able to meet the demand of such currency say dollar leads to devaluation of home currency © discourages imports as foreign goods become costlier © encourages exports as domestic goods are cheaper in foreign country
• Favorable BOP
© value of such a country’s currency likely to appreciate
Volume of International Reserves
• The reserve supports or stabilizes whenever currency depreciates • Release or sell FX reserves to meet demand for foreign currency thereby reducing further devaluation • The monetary authority can withstand only to the extent of reserves in hand • Gold also included
Level of activity and employment
Higher level of economic activity and full employment have good potential and prospects of appreciation in the value of home currency
Indian FOREX Market
Facts on Indian FX Market
? Regulated by the Reserve Bank of India by the Foreign Exchange Management Act, 1999 or FEMA (replacement of FERA) ? FX Market developed in 1978 when government allowed banks to trade in FX
? Today over 70% of FX trading takes place in inter-bank market ? In 1994 India adopted full account convertibility on current account
? Since 2002 clearing and settlement in interbank market is largely carried out by CCIL
From FERA to FEMA
? FERA was applicable in the period when FOREX was a scarce
commodity ? Regulation vs. Management
? Capital account and current account transactions have been defined and distinguished in FEMA ? Civil Law vs. Criminal Law ? Burden of proof lies with the prosecution under FEMA but the
FERA states otherwise
Market Players in India
?Authorized Dealers ?Foreign exchange brokers-intermediaries ?Customers
?individuals ?corporate
?FEDAI and RBI
Authorized Dealers
? 90 ADs ? AD category I
† commercial banks, who undertake all spheres of FX transactions
? AD category II
† licensed money changers and travel agents, who enjoy limited authorization for encashment of traveler’s check and notes
? AD category III
† IDBI and EXIM Bank etc are permitted handling and hold foreign currencies in a restricted way
FEDAI
This self regulatory body was set up in 1958
Functions
Guidelines and Rules for FX Business
Accreditation of FX Brokers Training of Bank Personnel in the areas of Foreign Exchange Business Advising/Assisting member banks in settling issues/matters in their dealings
Represent member banks on Government/Reserve Bank of India/Other Bodies
Three Tier Architecture
• Bottom tier
? Money changers licensed by RBI
• Second tier
? Cooperative and Commercial Bank licensed to maintain accounts for NRI
• Top tier
? Authorized dealers ? Scheduled Banks ? full-fledged foreign exchange business
FOREX Trading Platforms
• In India FX trading takes place in
? FX CLEAR by CCIL, set up in Aug 2003 ? FX Direct by IBS FOREX (P) Ltd, set up in 2002 ? Two more by Reuters
• FX CLEAR and FX Direct
? offer real time order matching and negotiated modes for dealing
• They cover
? USD-INR ? EUR-USD ? USD-JPY etc
Turnover in FX Market (USD bn)
FOREX Settlement Volumes
London FOREX Market
Facts on London FX Market
• Largest FX market
† † † † historical importance relative lack of regulation proximity to major Eurocurrency markets Time zone: London’s morning overlaps with late trading in the Far East and London’s afternoon overlaps with New York
• Almost one third of the currency trading transactions of the world take place in the UK • Market share of UK is almost twice that of its nearest competitor (US) • Average daily reported turnover was $1,747 billion in April 2010
Turnover
Instrument Oct 2009 Apr 2010
Spot Transactions
Outright Forwards
513
165
612
194
Non-Deliverable Forwards
FX Swaps Total ‘traditional’ foreign exchange turnover Currency swaps Foreign exchange options Total OTC foreign exchange derivatives turnover
26
705 1409 18 95 113
28
756 1620 17 110 127
Currency Distribution
Percentage share of average daily turnover
Instrument US Dollar Oct 2009 85.8 Apr 2010 85.2
Euro
Pound Sterling Japanese Yen Swiss Franc Canadian Dollar Australian Dollar Indian rupee
44.4
17.7 15.8 6.8 3.9 6.0 0.7
44.6
17.6 17.4 6.9 3.9 6.6 0.3
The most intensely traded currency pair is the Dollar/Euro
Regulations
• Regulator
• Financial Services Authority (FSA)
• Principal legislations governing the FX market
• Financial Services and Markets Act 2000 (FSMA) • Non-Investment Products (NIPS) Code
• FX spot transactions and transactions entered for commercial purposes are outside the scope of direct FSA regulation • Foreign Exchange Joint Standing Committee (FX JSC)
• established in 1973 as a forum for banks and brokers to discuss broad market issues
NIPS Code
† Firms should clearly state at the outset, prior to a transaction being executed, any qualifying conditions to which it will be subject † Prices used in mark-to-market calculations should be checked by an area of the principal that is independent of the front office † When an individual currency is experiencing high volatility, intermediaries should pay special attention to the financing of trades in that currency † Oral agreements are considered binding † Brokers should not divulge the names of principals prematurely, and certainly not until satisfied that both sides display a serious intention to transact etc
Products
Spot FX
FX Swaps
Outright Forwards
Products
Non Deliverable Forwards Options Currency Swaps
Products
• Non Deliverable Forwards (NDFs)
? similar to outright forward but there is no physical settlement of two currencies at maturity ? based on the movement of two currencies, a net cash settlement will be made by one party to the other – usually in dollars
• FX Swaps
? A contract that simultaneously agrees to buy (sell) an amount of currency at an agreed rate and to resell (repurchase) the same amount of currency for a later value date to (from) the same counterparty, also at an agreed rate
Trading Venues
• Predominately an over-the-counter market • In 1990s, dealing systems developed by EBS and Reuters became famous in the interbank market • For Spot FX, many electronic communication networks (ECNs) and electronic intermediaries exist
US FOREX Market
FX Volume in US Market
Source: Federal Reserve Bank of New York
FX Volume in US Market
Source: Federal Reserve Bank of New York
Market Participants
Foreign Exchange Dealers Financial and Non Financial Customers
• financial institutions which buy and sell foreign exchange for their own accounts as well as act as correspondents for other commercial bank • Foreign Exchange Dealers Coalition (FXDC) is an alliance of the largest U.S. foreign exchange market dealers • smaller commercial banks and investment banks that don’t act as major dealers • firms and corporations buying and selling FX • managers of mutual funds, hedge funds, pension funds, high net worth individuals • brokers in OTC market • Voice brokers • Automated Order Matching or Electronic Broking SystemElectronic Brokerage System (EBS) and Reuters 2002 • brokers in Exchange Traded Markets
Brokers
Payment and Settlement Systems
Fedwire
• a system run by the Federal Reserve • Payment via Fedwire • a regional Federal Reserve Bank debits on its books the account of the sending bank and credits the account of the receiving bank • payment is settled when the receiving bank has its deposit account at the Fed credited with the funds or is notified of the payment • it is an RTGS system
CHIPS (Clearing House Interbank Payments System)
• a privately owned system run by the New York Clearing House • Payment via CHIPS • payments processed over CHIPS are finally settled not individually during the day but collectively at the end of the business day after the net debit or credit position of each CHIPS participant has been determined • final settlement occurs by Fedwire Transfer
Major Instruments – OTC Market
Contracts A Outright Contracts
1. Spot
Description Straightforward exchanges with various settlement dates
Settles two business days after deal date (or day 3) except Canada
Cash
Value Tomorrow 2. Outright Forward
Settles on deal date (or day 1)
Settles one business day after deal date (day 2) Settles on any pre-arranged date three or more business days after deal date (day 4 or beyond)
B
FX Swap Contracts
Short-Dated FX Swaps 1. Spot-Next
Exchange of principal with subsequent re-exchange at pre-agreed rate on pre-arranged date
Re-exchange in less than one month Arranged 2 days before spot value date; (or day 1); first leg settles on spot value date (or day 3); second leg settles next business day (or day 4) Arranged 1 day before spot value date; (or day 2); first leg settles on spot date (or day 3) second leg settles following business day (or day 4) Second leg settles same day one week later; (same day two weeks later)
2. Tom-Next
3. Spot-A-Week; (Spot-TwoWeeks)
Major Instruments – OTC Market
Contracts
Forward FX Swaps 1. Spot-Forward
Description
Re-exchange in one month or longer First leg settles on spot date; second leg on a “straight” or standard forward date, e.g. 1, 2, 3, 6, 12 months
2. Odd-Date or Broken Date
3. Forward-Forward 4. Long Dates
First leg settles on spot date; second leg settles on a nonstraight later date First leg usually on a standard forward contract date; second leg a later standard forward contract date
First leg, spot date; second leg, a date beyond one year
C
Currency Swap Contracts
Initial exchange of principal (sometimes omitted), stream of interest payments, with subsequent reexchange of principal on pre-arranged date
D
OTC Currency Option Contracts
Customized options; premium paid upfront; settlement two business days after exercise
Major Instruments – Exchange Traded Market
Contracts A Futures Contracts Description Standardized quarterly or other maturity dates; initial and maintenance margins with daily mark-to-market
B
Exchange-Traded Currency Options Contracts
1. Options on Spot (Philadelphia) On exercise, settlement in currency
2. Options on Futures (Chicago)
On exercise, settlement in futures position in currency
FX Market Activities of the Fed
Conducts all U.S. intervention operations in the foreign exchange market on behalf of the U.S. monetary authorities
Also conducts certain non-intervention business transactions on behalf of various U.S. Government agencies Routinely engaged in FX transactions on behalf of “customers” e.g. foreign central bank
Regulatory Bodies
FX Dealer Members (FDMs) are regulated by
Commodity Futures Trading Commission (CFTC) National Futures Association(NFA) in the United States as well as by national and local regulatory bodies where they conduct business.
All FX dealers
submit financial reports to its regulators are subject to lengthy regulatory audits covering everything from marketing practices to employee training regimens
OTC market is still largely unregulated
Thank you
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