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Forex Market

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THE FOREIGN EXCHANGE MARKET

This is over the counter market ( OTC ) i.e. there is no physicalmarket place to make the deals.

Instead it is a net work of banks , brokers and dealers spread

across the various financial centers of the world .

These players trade in different currency through telephones , faxes

, computers and other electronic networks like the SWIFT system

( Society for Worldwide Inter bank Financial Telecommunication) .

These traders generally operate through a trading room .

The deals are finalized orally with written communication

following later .

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THE PLAYERS

The main players in the foreign exchange market are :

large commercial banks,

forex brokers , large corporations and

the central banks

The central banks enter the market tosmoothen outfluctuations in the exchange rates .

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FOREIGN EXCHANGE

As defined in Section 2 of FEMA , 1999 foreign exchange includes :

all deposits ,credits , balance payable in any foreign currency , any drafts , travelers` cheques , letter of credit and bills of

exchange ,

any instrument giving anyone the option of making it payable

either partly or fully in a foreign currency .

Here the term currency includes coins , bank notes , postal notes ,

postal orders and money orders .

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Market Makers :

The large commercial banks which stand ready to buy and sell

various currencies at specific prices at all points of time.

Retail Market :

The market in which the commercial banks deal with the customers

both individuals and corporate .

Inter bank Market / Wholesale Market:

The market in which banks deal with each other.

A 24 Hour Market :

The world wide forex mkt. is a 24 hour market i.e. trading is going

on at least one of the forex market through out the day.

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Authorized Dealers ( A Ds ):

They are generally the commercial banks .They are permitted to dealin all items classified as foreign exchange in FEMA ,1999 . They

have to operate within the rules regulations and guidelines issued by

Foreign Exchange Dealers Association of India ( FEDAI ) .

Money Changers :

They can be either full fledged MC (can both buy and sell) or

restricted MC ( can only buy ) are allowed to deal only in notes ,

coins and travelers` cheque.

Foreign Exchange Brokers:

They do not actually buy and sell any currency . They do the work

of bringing the buyer and seller together .

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EXCHANGE RATE QUOTATIONS

An exchange rate quotation is the price of a currency stated in terms

of anotheri.e. the price of one currency quoted in terms of 1unit of

the other currency .

For e.g. INR / USD : 46.40 / 1USD

American Quote :

The number of dollars expressed per unit of any other currency .

For e.g. USD 1.6689 / 1GBP

European Quote :

The number of units of any other currency expressed per dollar .

For e.g. INR 46.40 / 1USD

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Direct Quote :

The quote where the exchange rate is expressed in terms of number of

units of the domestic currency per unit of foreign currency.

For e.g. INR 46.40 / USD

Indirect Quote :

The quote where the exchange rate is expressed in terms of number of

units of the foreign currency per unit of domestic currency .

For e.g. USD 2.0525 / INR 100 .

Merchant Quote :The quote given by a bank to its retail customers .

Inter Bank Quote :

The quote given by one bank to another bank .

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Variability of exchange rates give rise to :

* foreign exchange risk and* foreign exchange exposure

Foreign Exchange Risk is the variance ofthe domestic

currency value of an asset , liabilityoroperating incomethat is attributable to unanticipated changes in exchangerates.

Foreign Exchange Exposure means the sensitivity of

changes in the real domestic currency value of assets andliabilities or operating incomes to unanticipated changes inexchange rates.

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StrategicOperating

Cash Flow

Accounting

(Translation)

Long TermShort

Term

Currency

Exposure

AnticipatedContractual

(Transaction)

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Transaction Exposure

This is an exposure that arises from foreign currency

denominated transactions which an entity is committed to

complete .In other words , it arises fromcontractual, foreign

currency , cash flows .

E.g. If a firm has entered into a contract to sell computers to a foreign

customer at a fixed price denominated in a foreign currency .The firm will be

exposed exchange rate movements till it receives the payment and converts

the receipts into the domestic currency.

The exposure of a company in a particular currency is

measured in net terms, i.e. after netting off potential cash

inflows with outflows.

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Translation Exposure

This exposure arises from the need to convert values of the

assets and liabilities denominated in a foreign currency , into

the domestic currency.

E.g.a company having foreign currency deposit would need to translate its

value into domestic currency for the purpose of reporting at the time ofpreparation of its financial statements.

It needs to be noted that this exposure is mostly notional , as

there is no real gain orloss due to exchange rate movements

since the asset or liability does not stand liquidated at the time

of reporting. Hence it is also known as Accounting Exposure.

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Operating Exposure

The extent to which the firm's future operating cash flows would

be affected in the longrun due torandom changes in exchange

rates.

This may have a serious impact on the competitive status of

the firm forcing it to restructure its business and redefine its

long-term strategy.

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Management of exposure essentially means:

reduction orelimination of exchange rate risk through

hedging .

it involves taking a position in the forex and / or the money

market which cancels out the outstanding position.

Steps involved in the management of exposure has two significantdimensions :

First, the treasurermust decide whetherand to what extent an exposureshould be explicitly hedged .The nature of the firms operations may providesome natural hedges .Its market position may occasionally permit it toentirely avoid transactions exposure.

Second, at times these hedges may be quite imperfect, or too costlybecause of their adverse effects on sales or profit margins .Having decidedto hedge whole or part of an exposure , the treasurermust evaluatealternative hedging strategies.

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Thank You