Foreign Exchange Market

1. Foreign Exchange Market

2. Chapter Outline • Function and Structure of the FOREX Market • The Spot Market • The Forward Market

3. Chapter Outline • Function and Structure of the FOREX Market • FX Market Participants • The Spot Market • The Forward Market .

4. Chapter Outline • Function and Structure of the FOREX Market • The Spot Market • Spot Rate Quotations • The Bid-Ask Spread • Spot FX Trading • Cross Exchange Rate Quotations • The Forward Market

5. Chapter Outline • Function and Structure of the FOREX Market • The Spot Market • The Forward Market • Forward Rate Quotations • Long and Short Forward Positions • Forward Cross-Exchange Rates .

6. Foreign Exchange Market-Defined • Foreign exchange means the money of a foreign country; that is foreign country bank balances,cheques,drafts and banknotes. • A foreign exchange transaction is an agreement between a buyer and a seller that a fixed amount of currency will be delivered for some other currency at a specified rate. • That is the market where one currency is traded for another. • Huge Market • Foreign exchange market:Avg traded value exceeds $1.9 trillion per day and includes all of the currencies of the world • Competitive and Efficient • Many Participants • Large Commercial Banks • Foreign Exchange Brokers • Multinational Corporations • Central Banks

7. General Features • The Exchange Market • All over the globe • 24 hours a day • Most transactions are channelized through the world-wide interbank market-the market where banks trade with each other(multiples of $1Million US or equivalent in transaction size) • The client or retail market(specific ,small amount) • Individuals and Firms • Speculators and arbitragers • Foreign exchange brokers • Central Bank and treasuries

8. General Features • The Foreign Exchange Market • an electronically linked network of banks, foreign exchange brokers and dealers who bring together buyers and sellers of currencies • Historically • Telephone • Telex • Today • Electronically Brokering

9. Financial Centres • London • New York • Tokyo • Zurich • Frankfurt • Hong Kong • Singapore • Paris • Sydney spanning most time zones

10. Factors For Development • Growth in International Trade • Regulation and control for cross-border capital flows and exchange rates have decreased. • Huge cross-border FDI • International portfolio investments • Arbitrage • Speculation • Hedging

11. Exchange Rate • The rate at which one currency is traded for another currency.

12. FOREX Market Participants • Correspondent Banking Relationships

13. FOREX Market Participants • The FOREX market is a two-tiered market: • Interbank Market (Wholesale) • About 700 banks worldwide stand ready to make a market in Foreign exchange. • Nonbank dealers account for about 20% of the market. • Client Market (Retail) • Market participants include international banks, their customers, nonbank dealers, FOREX brokers, and central banks.

14. Correspondent Banking Relationships • Large commercial banks maintain demand deposit accounts with one another which facilitates the efficient functioning of the forex market. • International commercial banks communicate with one another with: • SWIFT: The Society for Worldwide Interbank Financial Telecommunications. • CHIPS: Clearing House Interbank Payments System • ECHO Exchange Clearing House Limited, the first global clearinghouse for settling interbank FOREX transactions. .

15. The Spot Market • Spot Rate Quotations • The Bid-Ask Spread • Cross Rates

16. Spot market • The spot market or cash market is a commodities or securities market in which foreign exchange are bought and sold and delivered immediately. • Spot Forex • The spot foreign exchange market has a 2 day delivery date(excluding holidays of buyer or seller), originally due to the time it would take to move cash from one bank to another. • Denoted by S(.) where S is the relationship between 2 currencies ,e.g. S(Rs/$)=Rs 48.10/$ means • 1 dollar = Rs.48.10 (therefore market for purchase or sale of currencies for immediate delivery is called the spot market)

17. Quotations at The Foreign Exchange Market • A quotation is the amount of a currency necessary to buy or sell a unit of another currency. • Expressed in currency terms it is called outright rate e.g. S(Rs./$)=Rs. 48.10 is an outright rate between Rs. and $ • Quotes=‘buy’ and ‘sell’ OR ‘bid’ and ‘ask’ rates • Example:- Buying Rs.35.10/$ Selling 36.35/$

18. Direct and Indirect Quotes • Direct Quote: A unit of foreign currency quoted in terms of domestic currency. Example:- At New York exchange market the deutsche mark(DM) is quoted as: Spot(bid) =$2.4000/DM Spot(ask) =$2.4017/DM • Indirect Quote: A unit of domestic currency quoted in terms of foreign currency. Example: London foreign Exchange Market Spot(bid)=$3.0201/BP Spot(Ask)=$3.0180/BP

19. Relationships Between Bid and Ask prices of the currencies • There are two sides of all quotes: • Buy and sell(buy dollars against Rs. Sell dollars for Rs.) • Example: PNB Spot(Rs./$)(bid/ask)= Rs. 48.0010/48.0015 /$

20. Spread • Ask and Bid differential is called Spread. • When quotes are direct: • Example: Spread bid price of dollar at spot S(Rs./bid$)=35.7621 and the ask price is S(Rs./Ask$)=35.8024 Therefore the spread is ? Rs.0.0403 Spread=Ask-bid

21. Spot Rate Quotations The direct quote for British pound is: £1 = $1.688 .

22. Spot Rate Quotations The indirect quote for British pound is: £.5924 = $1

23. Spot Rate Quotations Note that the direct quote is the reciprocal of the indirect quote:

24. The Bid-Ask Spread • The bid price is the price a dealer is willing to pay you for something. • The ask price is the amount the dealer wants you to pay for the thing. • The bid-ask spread is the difference between the bid and ask prices.

25. Spot Market

26. The Forward Market • Forward Rate Quotations • Long and Short Forward Positions • Forward Cross Exchange Rates • Forward Premium .

27. Forward Market • A forward contract between a bank and a customer calls for delivery are a fixed future date of a specified amount of fixed currency against another at an exchange rate fixed at the time of the contract • The contract is binding-both parties must fulfill the contract regardless of what the exchange rate is at the time of the exchange specified in the contract. • Therefore the market where the purchases and sales of currencies are contracted in the present for receipts and delivery in future is called the Forward Market. • Forward Exchange Rates are determined by forward demand and forward supply of various currencies.e.g.

28. Quotations Of Forward Rates • Delivery of the currencies is to take place after some-time(30 days,60 days or 90 days) • Quotations are in the form of bid and ask.

29. Premium and Discount In the Forward Market • Forward Premium: A foreign currency is said to be at a forward premium if its future value exceeds its present value in terms of domestic currency . • Example: Spot(Rs/$)=Rs. 35.70/$ and three month forward is F(Rs/$)=Rs. 36.90 dollar is at premium and Rs is at discount. • Forward Discount: A foreign currency is said to be at a forward discount if its future is lower than its present value in terms of domestic currency . • Example: Spot(Rs/$)=Rs. 35.70/$ and three month forward is F(Rs/$)=Rs. 34.90 dollar is at discount and Rs is at premium.

30. A Forward Contract

31. Spot Rate Quotations Clearly the market participants expect that the yen will be worth MORE in dollars in six months. .