Foreign Exchange Market

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

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

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

. 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

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

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

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

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

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

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

FOREX Market Participants Correspondent Banking Relationships

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.

. 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.

The Spot Market Spot Rate Quotations The Bid-Ask Spread Cross Rates

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 (therefore market for purchase or sale of currencies for immediate delivery is called the spot market)

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 is an outright rate between Rs. and $ Quotes=‘buy’ and ‘sell’ OR ‘bid’ and ‘ask’ rates Example:- Buying Rs.35.10/$ Selling 36.35/$

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

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./$)(bid/ask)= Rs / /$

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

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

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

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

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.

Spot Market

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

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.

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.

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

A Forward Contract

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