2 - Lecture 2 - International Finance FX Markets.pdf

Forex Markets

1. INTERNATIONAL FINANCIAL
MANAGEMENT


Forex Market and
Exchange Rate Arithmetic

2. International Finance
•The foreign exchange market is the market where
the currency of one country is exchanged for the
currency of another country.
•Foreign currency transactions are channelled through
the world-wide interbank market.
Participants
–Speculators
–Arbitrageurs
–Traders
–Hedgers

3. Fx Markets
•Markets where currencies of different
countries are bought and sold
•Wholesale markets and retail markets (also
known as interbank and merchant markets)
•Here we refer only to wholesale markets
•‘Market Makers’ and ‘Market Takers’
•Large number of participants
•Largest volumes

4. Market Makers
•Market Makers announce two way price:
bid/offer or buy / sell
•Typical Rate EUR-USD 1.2350 / 2650
•Market takers can choose the side they want
–Market takers can sell EUR @ 1.2350 USD
–Market takers can buy EUR @ 1.2650 USD

5. Different Rates in the Market
•Rates given by different market makers need not
be same
•Differential rates exist
–ICICI Bank 73.0550 / 1050
–Canara bank 73.0650 / 1100
–Nova scotia bank 73.0450 / 1150
•Rates quoted are as perceived by market makers
•Market takers choose the best rate according to
their availability

6. Why Different Rates?
•Rate given by market maker depends upon
different factors
–Position
–Need
–View
–Sometimes on who is the party?
•For better business interests, market makers
always quote prevailing market rates

7. Exchange Rate
•Exchange Rates would keep changing
continuously affected by various factors
•In a given trading day rate could change
several times, even within hours, minutes
exchange rate could be fluctuating
•Because of exchange rate movements
‘Exchange Rate Risk’ or ‘Currency Risk’ arises

8. Liquidity
•Forex Markets are generally highly liquid
•Liquidity is reflected by number of market
makers and number of trades

9. Where are these Markets?
•No physical place
•Over the Counter Markets
–Mainly telephone
–Rates matching / negotiating screens
•Contacts are all over the Globe

10. 24 hour Market
•Day opens at Tokyo and Sydney
•Day closes at Los Angeles trading
•Before closing at Los Angeles, Sydney opens
up for the next day
•5 days market

11. 24 hour Market
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24
Tokyo
HK
Singapore
Mumbai
Los Angeles
New York
Bahrain
Frankfurt
Zurich
London
Sydney Sydney

12. International Capital
International Money Market:
Place : London, New York, Tokyo, Singapore
Instruments : CP, Bank’s borrowing, Bankers’acceptance
International Payment & Settlement Systems
•Clearing House Interbank Payment System(CHIPS)
•Society for Worldwide International Financial
Transactions(SWIFT)
•Clearing House Automated Payment System (CHAPS)







International Equity Market


FII, GDR, ADR, P-Notes
Long-term Offshore funds in the forms of’
long-term borrowings

13. Exchange Rates Mechanism
Exchange Rate Quotation: Direct
US$1= Rs.73.4525/4550
Bank would sell US$ : Rs.73.4550
(Offer rate)
Bank would purchase US$: Rs.73.4525
(Bid rate)
Offer rate – Bid Rate=Transaction cost+Profit
Two Ways Quotation : Importance
We cannot know the player is a buyer or seller

14. Exchange Rates Mechanism
Exchange Rate Quotation
Interbank market Mumbai
US$1 =Rs.73.4525/4550
Interbank market London
US$1 = FRF 6.0500/0550
At what rate you can buy FRF against Rs.?

15. Exchange Rates Settlement Mechanism

Cash transaction = Same day
Tom Transaction = Next Day
Spot Transaction = 2 days
Forward Transaction = Beyond Spot date

16. Forward and Discount
•Forward Ex Rate= Settlement of Ex beyond spot date.
•Forward Ex. Rate = Spot Rate
+ Forward Premium/Dis
If currency is appreciating = Premium currency
If currency is Depreciating = Discount currency
In case of direct quotation, Premium is added for
depreciation and deduct for appreciation
Forward rate
= ( (Int. Dif)* spot*maturity )/(100*360)

17. Forward Rate.. Example
Forward market is a OTC market.
US$= Rs.72.8325/8650 at Jan 1
st
2021
Forwards : Spot/Feb= 0.1700/1800
Spot/March = 0.3500/3700
Spot/April = 0.5300/5000
Spot/May = 0.7100/7000
Estimate the Forward Rate for March & May

For forward rate quotation Banker may also ask the
fee which is maximum of 0.125%

18. Major Players in Forex Market
–Commercial / Industrial entities
•Corporates – exporters and importers
–Banks
–Investment houses
•Hedge funds, Pension funds, mutual funds,
–Brokers
–Central Banks

19. Instruments
•Spot trades
•Outright forwards
•FX swaps - a buy/sell or a sell/buy
•Currency Swaps
•FX options
•FX derivatives galore…………
•Non-deliverable forwards market

20. Base and Terms
•Exchange Rate: INR/USD



•Quote currency and quoted currency
–INR is quote currency
–USD is quoted currency

USDofnumber
INRofnumber
E =
Base currency
Terms currency

21. Direct and Indirect
•Direct: number of home currency units per
one unit of foreign currency
•Ex: 73.50 number of rupees per one USD

•Indirect: number of foreign currency units per
one unit of home currency
•Ex: 0.01360 number of USD per one INR

22. Direct and Indirect
•In India all foreign currency is quoted in direct
fashion
•In most of the home markets direct quote is
followed
•International market generally, USD is the
base currency
•Exceptions: GBP, EUR, NZD, AUD

23. Inter-bank Forex Market
•Inter-bank market is only among ADs
•Opens at 9.00 am and closes by 5.00 pm
•It is a wholesale market with a certain
minimum lot size
•Banks contact each other to sell or buy forex
•Generally a few market makers and many
market takers would be there

24. Inter-bank Forex Market
•Generally a few well known market makers
and many market takers would be there
•Market makers can sell or buy according to
the request
•Banks contact a market maker over phone or
trading screen

25. Settlement
•Spot Market is the predominant market
•Spot – contract today and settlement on the
second working day
•‘ready transaction’ or ‘cash transaction –
settlement is on the very day
•‘value next day’ is also prevalent in the inter-
bank

26. Inter-bank rate
•Inter-bank market is the most liquid and
therefore works as benchmark rate for other
markets
•Inter-bank rates have the least spread among
all the markets
•Inter-bank rate forms basis on which rates of
other markets are quoted
•Inter-bank rates are also called ‘base’ rates