CAPITAL ACCOUNT CONVERTIBILITY

• Freedom to convert local financial asset to foreign financial asset.

• Free to make investment for all capital needs.• Current account convertibility means free

inflow and outflow of foreign exchange for all purposes other than capital a/c.

• CAC application is debatable.

EXCHANGE RATE REGIME

1. Gold standard Gold Specie Gold Bullion Gold Exchange standard Mint Parity

EXCHANGE RATE REGIME

• 2. Bretton Wood system.• Decisions taken for a new monetary system• a) U.S to convert U.S$ at a fixed parity of $35 per

ounce of gold.• b) Other countries fixed their currency parity with

the $ with 1% variation on either side of the central parity within permissible limits.

• c) “Adjustable peg system” which means on the face of disequilibrium in the forex market 10% variation allowed w/o consent of the IMF.

ROLE OF IMF IN POST BRETTON WOODS SYTEM

1. Continous monitoring analyzing 2. Safeguard assessment of central bank of

countries.3. Helps in reduction of debt and increases the

credit worthiness of the country.

SDR’s

• Special Drawing Rights was a new international fiat money created in 1960’s.

• Initially valued at 35 SDR’s = one ounce of gold .• Between 1975 to 1980 basket of 16 currencies

corresponding to the relative share of each currency’s share in the world’s exports.

• After 1981 it was valued against a basket of 5 currencies($,British pound,Yen,FFrs,Duetsche marks)

• After birth of Euro it is valued against a basket of 4 currencies ($, British pound, Euro,Japanese Yen)

• SDR’s expressed in the terms of U.S. $.

SDR’s

After the breakdown of the Bretton Wood system SDR’s today have a ltd use as a reserve asset . It acts as a potential claim on freely usable currency of IMF members. Holders of SDR’s can obtain these currency in exchange by voluntary exchange between members and by IMF members having strong external position buying SDR’s from members having weak external position.

FOREIGN EXCHANGE MARKET

FOREIGN EXCHANGE MARKET

From the 1970’s after the Bretton wood system collapsed a non system has come into being in the international forex market. This system moves between extreme fixed to extreme fluctuation exchange rate system. Today the forex mkt has completely evolved. The main trading center for forex is London. The most traded currencies are the U.S $, British pound, Euro, Yen etc. India’s forex trade is very small. Forex market is a 24 hours market.

FOREIGN EXCHANGE MARKET

Currencies are expressed as XXX/YYY where YYY is the 3 letter international code into which price of one unit of XXX is expressed.

XXX = Base currency i.e Stronger currency YYY = Counter currency i.e Weaker currency.

SWIFT

Society for world wide International financial telecommunications is a communication system regarding international financial transactions connected by Data transmission lines . The information can be collected from any part of the world 24 hrs a day.

FUNCTIONS OF FOREX MARKET.

Transfer of funds. Minimizing foreign exchange risk.

Participants of forex market

Immediate users or suppliers of forex.Commercial banks acting as clearing houses.Forex brokers thru whom commercial banks

manage and even out inflow and outflow of forex.

Country’s central bank acting as lender or buyer of last resort.

ARBITRAGE

It is a purchase of a currency by a speculator fm a forex market where it is cheaper and sold immediately in another forex market for a higher price. The diff. between the 2 rates is the gain for the speculator. This mechanism acts as a equalizer between 2 forex markets.

What is a forex mkt?

It is the nos. of units of home currency paid to get a certain nos of foreign currency. This market can happen virtually also.

Example : Rs 49 for $1

Forex quotations

Nos of currency that can be bought against 1 unit of another currency. Quotations are expressed generally up to 4th decimal places i.e. 1/10000. Few currencies are relatively small in absolute value they are expressed up to 2 decimal places.

A smallest amount of change in price of a currency is expressed as a ‘pip’.

Forex quotations

• Direct quotation or American style. Nos of units of home currency for one unit of foreign currency. Commonly used by banks while dealing with international banks.

$=Rs 54.37 or 1/54.3700

• Indirect quotation or European style. Nos of units of foreign currency for one unit of home currency. Commonly used for international business by banks.

Re 1 = $0.20252 or Re 1/ 0.20252

Short dated and Broken dated contract

• Forex contracts if settled before spot value date it is short dated. The contract may be settled on the same day or the next day of the spot value date.

• Forex contract if they are placed on non standard dates like 25th day instead of 30 days or 54th day instead of 60 days it is ‘broken dated ‘ contract.

Forex rates

Spot rate is the rate in the spot market, i.e. . Today's mkt. The settlement is done within 2 business days. It is an OTC mkt. dealing are done thru telephones, computer terminals, automated dealing systems. Bloomberg, Reuters are the vendors of the large screen used for this trading.

Forward rate is pre-decided for buying/selling of foreign exchange on a future date. Usually it is 30,60. 90 and 120 days. It is generally done to hedge exposure to fluctuations in exchange rates. Forward rates have to be fulfilled irrespective of the rates on the date of maturity.

Use of forward rates.

• Exporters and Importers use as there is a time gap for settlement They buy forward the currency that needs to be paid and sell forward the currency that is to be received.

• International businesses would like to preserve the value of their asset without speculating against future trends.

Forward Premium and Discount

• FR> SR in the forward market than currency is trading at a premium.

• FR< SR in the forward market than currency is trading at a discount.

Formula for forward premium and discount.

Premium/Discount = FR – SR/SR x n x 100 This prem and dis has to be annualised. If FR given for 90 days n=4 E.g. SR Rs 50.37 = 1$ 6 mths FR Rs 50.65

than Re is selling at a Forward discount of 25 basis points.