Foreign Exchange Market

2 Foreign Exchange Markets The market where the commodity traded is Currencies. The market where the commodity traded is Currencies. Price of each currency is determined in term of other currencies. Price of each currency is determined in term of other currencies.

Deals are done over Telephone, REUTERS dealing system etc R E U T E R S Dealing Terminal Dealing Terminal Industry Standard for FX trading. Industry Standard for FX trading. Security guaranteed by Reuters Int. Security guaranteed by Reuters Int. Password Protected. Password Protected. Maintains record of all transactions. Maintains record of all transactions. SBPK (SBP’s REUTERS address) SBPK (SBP’s REUTERS address) News Terminal News Terminal Domestic Market Data/ news available on line. Domestic Market Data/ news available on line. Real Time Exchange Rate quotes of all major Currencies. Real Time Exchange Rate quotes of all major Currencies. Data about Interest Rates (e.g. LIBOR) Data about Interest Rates (e.g. LIBOR) Various SBP pages on REUTERS. Various SBP pages on REUTERS.

SBP’s Role in the Forex Market To manage the exchange rate mechanism. To manage the exchange rate mechanism. Regulate inter-bank forex transactions and monitor the foreign exchange risk of the banks. Regulate inter-bank forex transactions and monitor the foreign exchange risk of the banks. Keep the exchange rate stable. Keep the exchange rate stable. Manage and maintain country's foreign exchange reserves. Manage and maintain country's foreign exchange reserves.

SBP has imposed foreign exchange exposure limits on banks (FE 12 of 1999). The limits are tied with the Paid up capital of the bank. Previously banks had NOP limit, which was based on foreign exchange volume handled by the bank. SBP’s Role in the Forex Market

INTERVENTION To keep exchange rate in line with macro objectives SBP has to intervene from time to time To keep exchange rate in line with macro objectives SBP has to intervene from time to time Intervention is a process where FX is sold or purchased to keep the right amount of liquidity available in the FX market so that demand / supply equilibrium is maintained Intervention is a process where FX is sold or purchased to keep the right amount of liquidity available in the FX market so that demand / supply equilibrium is maintained

Exchange Rate is the price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another. e.g. Rs per USD Major currencies of the World  USD  EURO  YEN  POUND STERLING What is an Exchange Rate ?

What is a Foreign Exchange Transaction ? Any financial transaction that involves more than one currency is a foreign exchange transaction. Any financial transaction that involves more than one currency is a foreign exchange transaction. Most important characteristic of a foreign exchange transaction is that it involves Foreign Exchange Risk. Most important characteristic of a foreign exchange transaction is that it involves Foreign Exchange Risk.

PARTICIPANTS IN THE FOREIGN EXCHANGE MARKET All Commercial Banks All Commercial Banks (Authorized Dealers only). State Bank of Pakistan. State Bank of Pakistan. Corporate Treasuries. Corporate Treasuries. Public Sector/Government. Public Sector/Government. Inter Bank Brokerage Houses. Inter Bank Brokerage Houses. Resident Pakistanis Resident Pakistanis Non Residents Non Residents Exchange Companies Exchange Companies Money Changers Money Changers

Components of a Standard FX Transaction  Base Currency(USD/PKR)  ‘Dealt’ or ‘Variable’ Currency  Exchange Rate  Amount  Deal Date  Value Date  Settlement Instructions

11 Value Date Conventions Currencies are traded both in Ready and forward value dates. 1) Ready: Settlement on the deal date. e.g. Pakistan 2) Value Tom : Settlement on next day. e.g. Canada 3) Spot Transaction : settlement usually in two working days. In international FX transactions, Spot is the Standard value date. In international FX transactions, Spot is the Standard value date.

FX Rate Quotation: In the forex market rates are always quoted ‘two way’. Two way quote gives both ‘Bid’ and ‘Offer’. e.g. USD/PKR= / 50 Bid / Offer Bid / Offer ‘Big Figure’: Term referring to the first digits of an exchange rate. These figures are rarely change in normal market fluctuations and are usually omitted in dealer quotes. ‘Pips (or Point): The smallest incremental move an exchange rate can make. ‘Base Currency’ Vs. ‘Dealt Currency’ Number of variable or dealt currency unit in one unit of base currency. In international quotes base currency comes first. e.g. BC/VC USD/PKR= 63.55/60 USD/PKR= 63.55/60

Price maker Vs. Price Taker The bank quoting the price is ‘price maker’ or ‘market maker’. The bank asking for the price or ‘quote’ is the ‘price taker’ or ‘user’.

14 RATE QUOTATION CONVENTIONS IN-DIRECT QUOTATION: “Price of one Unit of Foreign Currency in terms of Domestic Currency” e.g. USD/PKR = 63.45/50 Buy One USD at Sell One USD at Spread In the international market, almost all currencies are quoted indirectly.

15 RATE QUOTATION CONVENTIONS DIRECT QUOTATION: “Price of one Unit of Domestic Currency in terms of Foreign Currency” e.g. EURO=1.5805/12 Buy One Euro at Sell One Euro at Spread Five Currencies are quoted in Direct Terms 1) Pound Sterling 2) Euro 3) Australian Dollar 4) New Zealand Dollar 5) Irish Punt

In the international market, almost all the currencies are quoted in terms of USD. In the international market, almost all the currencies are quoted in terms of USD.e.g. JPY=117.54/60 A visit to REUTERS ‘EFX=’ Page.

Foreign exchange transactions are settled through Nostro and Vostro accounts. Foreign exchange transactions are settled through Nostro and Vostro accounts. Nostro: our account with banks abroad. SBP maintains various Nostro accounts in a number of countries. Nostro: our account with banks abroad. SBP maintains various Nostro accounts in a number of countries. Vostro: their account with us. Many multilateral agencies (e.g. IMF, World Bank) maintain their Nostro accounts at SBP. Vostro: their account with us. Many multilateral agencies (e.g. IMF, World Bank) maintain their Nostro accounts at SBP. SWIFT (Society for Worldwide Interbank Financial Telecommunications) SWIFT (Society for Worldwide Interbank Financial Telecommunications)

18 Bid - Ask Spread Consider the quote of GBP – for a U.S. investor Consider the quote of GBP – for a U.S. investor What is the quote for a British investor? What is the quote for a British investor? The direct quote is always DC / FC The direct quote is always DC / FC The Quote will become 1/ – 1/ The Quote will become 1/ – 1/ Percentage spread Percentage spread

19 Cross Rates 120 Yen is equivalent to 1 USD 120 Yen is equivalent to 1 USD 140 Yen is equivalent to 1 EUR 140 Yen is equivalent to 1 EUR What is the cross rate of EUR/USD? What is the cross rate of EUR/USD?

20 Bid Ask – Cross Rates A British dealer quotes bid / ask for the U.S. dollar. A British dealer quotes bid / ask for the U.S. dollar. An Australian dealer quotes pound 1.90 / 1.91 An Australian dealer quotes pound 1.90 / 1.91 What is the AUD/$ bid and ask for the Australian dealer What is the AUD/$ bid and ask for the Australian dealer