Foreign exchange markets Dr.Guru. Raghavan

Some basic concepts Why we need foreign exchange? What foreign exchange means? Role of exchange rates Payment and settlement systems

Structure of the foreign exchange market It is the world’s largest market It is a twenty four hour market The market is made up of an international network of dealers The market’s most widely traded currency is the Dollar It is an over the counter market with an exchange traded segment

The main participants Foreign exchange dealers Financial and non financial customers Central Banks Classification of exchange rate arrangements Brokers In the over the counter market Voice brokers Automated order making or electronic broking system In the exchange traded market

Main instruments – OTC market Spot There is a buying and a selling price How spot rates quoted: Direct and Indirect quotes European and American Terms There is a base currency and a terms currency Bids and offers are for the base currency Quotes are in basis points Cross rate trading Deriving cross rates from dollar exchange rates

Main instruments – OTC market Outright forwards Relationship of forward to spot – covered interest rate parity Role of the offshore deposit market for euro dollars and other currencies How forward rates are quoted by traders Calculating forward premium / discount points Non deliverable forwards

Main instruments – OTC market FX swaps Why FX swaps are used Pricing FX swap Some uses of FX swaps Calculating FX swap points Currency swaps Purpose of currency swaps

Main instruments – OTC market Over the counter foreign currency options The pricing of currency options Delta hedging Put-Call parity How currency options are traded Options combinations and strategies Foreign exchange options galore

Main instruments – Exchange traded market Exchange traded futures Development of foreign currency futures Quotes for foreign currency futures Exchange traded currency options Linkages Linkages between main foreign exchange instruments in both OTC and exchange traded markets

How dealers conduct foreign exchange operations? Trading room setup The different kinds of trading functions of a dealer institution Trading among major dealers – dealing directly and through brokers mechanics of direct dealing mechanics of trading through brokers : voice brokers and electronic brokering systems Operations of a foreign exchange department Back office payments and settlements

Managing risk in foreign exchange trading Market risk Measuring and managing market risk Value at risk Credit risk Settlement risk – a form of credit risk Arrangements for dealing with settlement risk Sovereign risk – a form of credit risk Other risks

Evolution of the international monetary system The Gold standard The inter war period The Bretton Woods Par value period The floating rate period 1971 to present

Determination of exchange rates Some approaches to exchange rate determination The purchasing power parity approach The balance of payments and the internal-external balance approach The monetary approach The portfolio balance approach Measuring the dollars equilibrium value: a look at some alternatives How good are the various approaches?

Determination of exchange rates Foreign exchange fore casting in practice Assessing factors that may influence exchange rates Official actions to influence exchange rates

What lies ahead? Global financial trends Future of Euro Increased trading in currencies of emerging market countries Shifting structure of the foreign exchange markets Consolidation and concentration Automated order matching system New instruments, New systems

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