UNIT 1 - INTRODUCTION TO FOREX MANAGEMENT.pptx

Introduction to the forex management and its concepts.

1. UNIT 1 INTRODUCTION TO FOREX MANAGEMENT

2. INTRODUCTION The New Economic policy of liberalisation, privatisation and globalisation have infused the operational growth of the following components of financial system in India: Financial Institutions Financial Markets Financial Instruments Financial Services

3. CONTD… Financial institutions are the major players in the financial market. Financial markets facilitate buying and selling of financial claims, assets, services and securities Money market and capital market are the two important segments of the financial market. Another segment in the financial market emerged in the form of DERIVATIVE MARKET. Financial claims, assets and securities dealt in financial market are known as financial instruments

4. Financial System Financial System Financial Institutions Financial Markets Financial Instruments Financial Services

5. Financial Market - Types bashbdfhg Financial Market Capital Market Money Market Derivative Market Call Money Market Treasury Bill Market Commercial Paper Certificate of deposits Government or gilt –edged securities Primary Market Secondary Market

6. Common Derivatives Derivatives Futures Swaps Forwards Options

7. Structural concept of Derivatives Derivatives in India Commodities Equity Debt Forex Forwards Futures Futures Options Swaps Futures Forwards Forwards Swaps

8. Meaning of Foreign Exchange market The foreign exchange market (also known as forex, FX, or the currencies market) is an over-the-counter (OTC) global marketplace that determines the exchange rate for currencies around the world. The foreign exchange (forex) market is the largest and most liquid asset market on earth, trading 24/7 around the globe . There is actually no central location for the forex market - it is a distributed electronic marketplace with nodes in financial firms, central banks, and brokerage houses.

9. Why is Forex Important? Foreign Exchange Management is the process of managing the exchange of foreign currencies. This includes the conversion of one currency to another , the purchase and sale of foreign currency, and the management of currency risk. When we buy or sell any product from foreign country forex rate affects it deeply. For eg : If Indian importers imports from USA, if USA dollar appreciate the cost of importer will increase. All businessman whether they are doing the business of Forex or not, should arrange forex for reducing the risk.

10. Features of Forex Management It gives powers to the Central government to regulate the flow of payments to and from a person situated outside the country All financial transactions concerning foreign securities or exchange cannot be carried out without the approval of FEMA

11. Role of Forex It serves an important function in society and the global economy They allow for currency conversions, facilitating global trade (across borders) which can include investments, the exchange of goods and services and financial transactions. Example of Forex transaction : The trader buys the EUR/USD @ 1.2500 and purchases $5,000 worth of currency. Later that day the price has increased to 1.2550. The trader is up $25 (5000 * .0050).If the price is dropped to 1.2430 the trader would be losing $35 (5000*.0070)

12. Significance of Foreign Exchange Market It acts as a central focus whereby prices are set for different currencies With the help of foreign exchange market can hedge or minimize the risk of loss due to adverse exchange rate changes Foreign exchange market transfers purchasing power across different countries, which results in enhancing the feasibility of international trade and overseas investment Foreign exchange market allows traders to identify risk free opportunities and arbitrage It facilitates investment function of banks and corporate traders who are willing to expose their firms to currency risks

13. Scope of Forex Management For Example : When good or services are imported into a country, these are paid for in the currency of the country exporting these goods or services. When an Indian traveler goes to a foreign country on a short visit, he needs foreign currency of that country for meeting his expenses. When he stays in that country for a longer duration for employment purpose, he earns foreign currency of that country. When an Indian firm exports goods to Europe, it is earning foreign exchange. Thus when goods and services are sent abroad by India, foreign currencies are earned by them. Forex management being involved in all the trade and non-trade transactions involving forex, it is essential to have a broad idea of international banking and trading practices. Since the transactions are taking place among counter parties from different countries, a standardized format of documentation is used to minimise errors. Apart from the transaction value, forex management finds scope as a mode of investment.

14. History and Evolution of Foreign Exchange Market As long as humans have been trading there has been a foreign exchange market. Ancient civilizations traded goods and currencies through metal coins, whose value was based on their weight. The first true forex market was in Amsterdam, approximately 500 years ago. The exchange allowed people to freely trade currencies to stabilize exchange rates. In 1875 , the gold standard was implemented, meaning countries were only allowed to print currency equal to the amount of their gold reserves. Gold was the metal of choice due to it being rare, malleable, tough to corrode, and hard to obtain. In 1913 , in London, there were 71 forex trading firms, an increase from three in 1903. But the gold standard could not hold up during the world wars, due to countries having to print more money to finance expenses.

15. Contd … After World War II, the Bretton Woods system was established. It called for most currencies to be pegged to the U.S. dollar, which was backed by gold reserves. In 1971 , President Nixon announced a freeze on the dollar's convertibility to gold due to rising inflation and a possible gold run. In 1973 , the gold standard was completely abolished and the U.S. dollar was no longer backed by gold reserves, and foreign exchange switched to a free-floating system. Currencies were free to peg to any currency they chose or to remain unpegged and allow the supply and demand of the currency to determine its value.

16. Advantages of Foreign Exchange Market There are fewer rules than in other markets, which means investors aren't held to the strict standards or regulations found in other markets. There are no  clearing houses  and no central bodies that oversee the forex market. Most investors won't have to pay the traditional fees or  commissions  that they would on another market. Because the market is open 24 hours a day, you can trade at any time of day, which means there's no cut-off time to be able to participate in the market. Finally, if you're worried about risk and reward, you can get in and out whenever you want, and you can buy as much currency as you can afford based on your account balance and your broker's rules for leverage.

17. Disadvantages of Foreign Exchange Market Though the market being unregulated brings advantages, it also creates risks, as there is no significant oversight that can ensure risk-free transactions. Leverage can help magnify profits but can also lead to high losses. As there are no set limits on leverage, investors stand to lose a tremendous amount of money if their trades move in the wrong direction. Unlike stocks that can also provide returns through dividends and bonds through interest payments, FX transactions solely rely on appreciation, meaning they have less residual returns than some other assets. Lack of transparency in the FX market can harm a trader as they do not have full control over how their trades are filled, may not get the best price, and may have a limited view of information, such as quotes.

18. Forex manager and his skills Awareness of historical development of Worldwide Ability to forecast future trends Comparative analysis skills In-depth knowledge of forex market Knowledge of interest rates Willingness to undertake risks Hedging strategies

19. Why participate in the Foreign Exchange Market Due to its vast volume and large number of participants, no individual or single company has complete control over which way the market will sway. Historically, Forex has been dominated by commercial banks, money portfolio managers, money brokers, large corporations, and very few private traders. Lately this trend has changed. While there are many reasons for participating in foreign exchange including facilitating commercial transactions, corporations converting its profits, or hedging against future price drops, more and more people are getting involved in the market for the purposes of speculation.

20. Participants in the Foreign Exchange Market Forex Dealers Forex dealers are amongst the biggest participants in the Forex market. They are also known as broker dealers . Most Forex dealers in the world are banks. It is for this reason that the market in which dealers interact with one another is also known as the interbank market. However, there are some notable non-bank financial institutions also that deal in foreign exchange. These dealers participate in the Forex markets by providing bid-ask quotes for currency pairs at all times. All brokers do not participate in all currency pairs. Rather, they may specialize in a specific currency pair. Alternatively, a lot of dealers also use their own capital to conduct proprietary trading operations. When both these operations are combined, Forex dealers have a significant participation in the Forex market.

21. CONTD… Brokers The Forex market is largely devoid of brokers. This is because a person need not deal with brokers necessarily. If they have sufficient knowledge, they can directly call the dealer and obtain a favorable rate. However, there are brokers in the Forex market. These brokers exist because they add value to their clients by helping them obtain the best quote. For instance, they may help their clients obtain the lowest buying price or the highest selling price by making available quotes from several dealers. Another major reason for using brokers is creating anonymity while trading. Many big investors and even Forex dealers use the services of brokers who act as henchmen for the trading operations of these big players.

22. CONTD…. Hedgers There are many businesses which end up creating an asset or a liability priced in foreign currency in the regular course of their business. For instance, importers and exporters engaged in foreign trade may have open positions in several foreign currencies. They may therefore be impacted if there is a fluctuation in the value of foreign currency. As a result, to protect themselves against these losses, hedgers take opposite positions in the market. Therefore if there is an unfavorable movement in their original position, it is offset by an opposite movement in their hedged positions. Their profits and losses and therefore nullified and they get stability in the operations of their business.

23. CONTD…. Speculators Speculators are a class of traders that have no genuine requirement for foreign currency. They only buy and sell these currencies with the hope of making a profit from it. The number of speculators increases a lot when the market sentiment is high and everyone seems to be making money in the Forex markets. Speculators usually do not maintain open positions in any currency for a very long time. Their positions are transient and are only meant to make a short term profit.

24. CONTD…. Arbitrageurs Arbitrageurs are traders that take advantage of the price discrepancy in different markets to make a profit. Arbitrageurs serve an important function in the foreign exchange market. It is their operations that ensure that a market as large, as decentralized and as diffused as the Forex market functions efficiently and provides uniform price quotations all over the world. Whenever arbitrageurs find a price discrepancy in the market, they start buying in one place and selling in another till the discrepancy disappears.

25. CONTD… Central Banks Central Banks of all countries participate in the Forex market to some extent. Most of the times, this participation is official. Although many times Central Banks do participate in the market by covert means. This is because every Central Bank has a target range within which they would like to see their currency fluctuate. If the currency falls out of the given range, Central Banks conduct open market operations to bring it back in range. Also, whenever the currency of a given nation is under speculative attack, Central Banks participate extensively in the market to defend their currency.

26. CONTD…. Retail Market Participants Retail market participants include tourists, students and even patients who are travelling abroad. Then there are also a variety of small businesses that indulge in foreign trade. Most of the retail participants participate in the spot market whereas people with long term interests operate in the futures market. This is because these participants only buy/sell currency when they have a personal/professional requirement and dealing with foreign currencies is not a part of their regular business.

27. FUNCTIONS The foreign exchange operations are mainly classified into three major functions which are crucial in any foreign exchange. They are as follows 1. Transfer Function 2. Credit Function 3. Hedging Function 1. Transfer Function: The main function of foreign exchange is to transfer money between countries. The foreign bill of exchange is the instrument normally used. The instrument most in use in foreign payments is the Telegraphic Transfer (T. T). There are many other modes like open account, letter of credit, cash in advance etc. 2. Credit Function : The international trade depends to a great extent on credit facilities. Exporters may get pre-shipment and post-shipment credit. Credit facilities are also available for importers. As foreign bills of exchange are the instrument used for exchange.

28. The importer gets usually 90 days or three months’ time to pay the money for goods. This 90 day is enough for importer to take possession of goods, sell them and secure the amount to pay off the bill. 3. Hedge Function: The other important function of the foreign exchange market is to provide hedging facilities. When exchange rates are fixed and controls are imposed then there is no risk involved in foreign exchange dealings. Hedging refers to covering of export/ import risks It provides a mechanism to exporters and importers to guard themselves against losses arising from fluctuations in exchange rates.

29. Appreciation and Depreciation of Currencies Appreciation is when a currency experiences an increase in value when it is compared to other currencies. Depreciation is when a currency experiences a decrease in value when it is compared to other currencies. When $1 = Rs.   75 becomes $1 = Rs.   76 , while the Dollar is said to have appreciated , simultaneously, Indian Rupees is said to have depreciated against the Dollar . Alternatively, if $1 = Rs.75 becomes $1 = Rs. 73 , while the Dollar is said to have depreciated at the very same time, Indian Rupees is said to have appreciated .

30. CONTD…. Formula: ([New Price Currency / Base Currency ] / [Old Price Currency / Base Currency]) — 1 = Depreciation (Negative Percent Change) or Appreciation (Positive Percent Change) For example, let’s say a U.S. dollar fetches 20 Mexican pesos during trading on a Monday. In this case, the base currency is the U.S. dollar, while the price currency is the Mexican peso. Monday’s exchange rate can be expressed as 20 Mexican pesos per U.S. dollar. The following day, Tuesday, the dollar is quoted at 22 Mexican pesos. = ([22 / 1] / [20 / 1] ) — 1 = (22 / 20) — 1 = 1.1 — 1 = 0.1 percent.

31. Exchange rates and Quotations In financial terms, the exchange rate is the price at which one currency will be exchanged against another currency. Exchange rate quotations can be quoted in two ways –  Direct quotation  and  Indirect quotation . Direct quotation is when the one unit of foreign currency is expressed in terms of domestic currency. Similarly, the indirect quotation is when one unit of domestic currency us expressed in terms of foreign  currency

32. PURCHASE AND SALE TRANSACTIONS Any trading has two aspects – ( i ) purchase, and (ii) sale. A trader has to purchase goods from his suppliers which he sells to his customers. Likewise, the bank (which is authorized to deal in foreign exchange) purchase as well as sells its commodity – the foreign currency. Two points need be constantly kept in mind while talking of a foreign exchange transaction: The transaction is always talked of from the bank’s point of view; and (ii) The item referred to is the foreign currency. Therefore, when we say a purchase, we imply that ( i ) the bank has purchased; and(ii) it has purchased foreign currency. Similarly, when we say a sale, we imply that ( i ) the banks has sold; and (ii) it has sold foreign currency. In a purchase transaction the bank acquires foreign currency and parts with home currency. In a sale transaction the bank parts with foreign currency and acquires home currency.

33. Problem : Determine which of the following transactions constitute ( i ) purchase, and (ii) sale of foreign exchange: The bank issues a demand draft on London for GBP100. (b) the customer of the bank purchases a telegraphic transfer on New York for 500. (c) A traveler encashes at the bank a traveler cheque for GBP 50. (d) The bank purchases a demand draft drawn on London for GBP 500.

34. Exchange rate risk and Exposure Exchange rate risk refers to the risk that a company's operations and profitability may be affected by changes in the exchange rates between currencies. Companies are exposed to three types of risk caused by currency volatility: transaction exposure, translation exposure, and economic or operating exposure.

35. Transaction Exposure Transaction exposure refers to the risk associated with changes in foreign exchange rates for foreign currency transactions. Whereas translation exposure refers to the risk associated with changes in the value of a company's financial statements due to exchange rate changes. Exchange rate fluctuations are a primary cause of transaction exposure. They are influenced by various factors, including inflation rates, interest rates, political instability, economic performance, and speculation. For example , a US-based company that exports goods to Europe and receives payment in Euros is exposed to transaction exposure. If the value of the Euro decreases relative to the US Dollar, the company will receive fewer US Dollars for its exports, resulting in a loss.

36. Translation Exposure Translation exposure (also known as translation risk) is the risk that a company's equities, assets, liabilities, or income will change in value as a result of exchange rate changes. When a firm denominates a portion of its equities, assets, liabilities, or income in a foreign currency, translation risk occurs. For example,  let's say a U.S. company has assets in Europe valued at 1 million euros, and the euro versus the U.S. dollar exchange rate has depreciated by 10% on a quarter-to-quarter basis. The value of the assets, when converted from euros into dollar terms, would also decline by 10%.

37. Economic Exposure Economic exposure is a type of foreign exchange exposure caused by the effect of unexpected currency fluctuations on a company's future cash flows, foreign investments, and earnings For Example : The dollar's strength means that the 50% of revenues and cash flows the company receives from overseas will be lower when converted back into dollars, which will have a negative effect on its profitability and valuation.

38. The role of Central banks in Foreign exchange markets Central banks, which represent their nation's government, are extremely important players in the forex market. Open market operations and interest rate policies of central banks influence currency rates to a very large extent. A central bank is responsible for fixing the price of its native currency on forex . Open Market Operations is a task by the central bank to provide or withdraw liquidity from a financial institution or a collection of financial institutions. There are two ways to execute open market operations: buying government bonds from a bank or selling government bonds to the bank. The RBI acts as the custodian of the country's foreign exchange reserves and manages exchange control. It dominates the market as a regulator, a player and the jury.

39. CONTD…. Dollar/rupee rate- The RBI Act stipulates that the Central Government orders the rate at which the RBI shall buy or sell forex to banks. Foreign exchange markets facilitate the trade of one foreign currency for another. Most exchanges are made in bank deposits and involve U.S. dollars. Over a trillion dollars in foreign exchange trades take place every day; foreign exchange dealers handle most transactions. Central banks manage currency by issuing new currency, setting interest rates, and managing foreign currency reserves. Monetary authorities also manage currencies on the open market to weaken or strengthen the exchange rate if the market price rises or falls too rapidly.

40. International Monetary System International monetary system refers to the system and rules that govern the use and exchange of money around the world and between countries . Each country has its own currency as money and the international monetary system governs the rules for valuing and exchanging these currencies. The international monetary system is a set of conventions and rules that support cross-border investments, trades, and the reallocation of capital between different countries. These rules define how exchange rates, macroeconomic management, and balance of payments are addressed between nations . It consists of four elements: exchange arrangements and exchange rates; international payments and transfers relating to current international transactions; international capital movements; and international reserves.

41. Balance of payments and International Trade The balance of payments (BOP), also known as the balance of international payments , is a statement of all transactions made between entities in one country and the rest of the world over a defined period, such as a quarter or a year. The balance of payments account of a country is constructed on the principle of double-entry bookkeeping. Each transaction is entered on the credit and debit side of the balance sheet. Thus, the total debit and the total credit of the balance of payments are always equal. These include  economic policies, exchange rates, inflation, and interest rates . For example, if a country has a higher interest rate than its trading partners, it may attract more foreign investment, resulting in a surplus balance of payments.

42. The impact of balance of payments in international trade is i t helps the government to analyse the potential of a particular industry export growth and formulate policy to support that growth . It gives the government a broad perspective on a different range of import and export tariffs. The balance of payments is a record of all financial transactions countries make. There are three major parts of a balance of payments: current account, financial account and capital account . The balance of payments is important for several reasons, including financial planning and analysis.

43. Foreign Exchange Market Regulations and Practices The Foreign Exchange Management Act officially came into existence on 1 st  June 2000 . Thus the forex market in India is operated by RBI and the arrival of The Foreign Exchange Management paved the path for the introduction of the Prevention of Money Laundering Act (PMLA) of 2002. The foreign exchange regulations in India are regulated by the Foreign Exchange Management Act, 1999 (“FEMA”). The highest foreign exchange regulatory authority in India is the Reserve Bank of India (“RBI”) which makes the law and is responsible for all major approvals.

44. FEMA FEMA is applicable to all parts of India and it is also applicable to all offices, and set-ups outside India which are owned or operated by an individual who is a citizen of India. It is also applicable to all branches, offices and set-ups in India which are run or owned by a person who is a resident outside India. FEMA regulates all aspects of foreign exchange and has direct involvement in external trade and payments. FEMA also impacts foreign nationals who are working inside or outside India.

45. FERA FERA – stands for Foreign Exchange Regulation Act is a codification that was introduced  in 1973 with the purpose to rule the  dealings in foreign exchange, enforce restrictions on specific payments and to keep an eye on the transactions impinging the foreign exchange and the import and export of currency. FERA is applicable to all the citizens of India, the intention of making FERA was to conserve the foreign exchange resources of the nation.

46.   Some of the key features of the act are as follows: It is authorized by RBI to any person/company to deal in foreign exchange It is authorized for the dealers by the Reserve Bank of India for making payments in foreign currencies, subject to review and revoking the authorisation in any case of non-compliance It also gives authorization to the money changers for conversion of currencies as per the rates determined by RBI Restricting import/export of currencies

47. Restricting the people other than the authorised dealers from getting involved in transactions involving the financial currency Restrictions on issue of bearer securities Restrictions on containing or holding any immovable properties outside India It also restricts making/receiving payment to/from a resident outside India The RBI has the power to request information and seize records, wherever or whenever possible.

48. OBJECTIVES OF FOREIGN EXCHANGE MARKET REGULATION The objective of regulation is to ensure fair and ethical business demeanor . In their turn all foreign exchange brokers, investment banks and signal sellers have to work in acceptance with the rules and standards made or laid down by the Forex regulators. Generally, they must be registered and licensed in the country where they work. Brokers having a license may be subject to repeated audits, reviews and assessments to check that they meet the industry standards. Foreign exchange brokers may have capital requirements that enable them to contain a sufficient amount of funds to be able to conduct and complete their customers’ completed foreign exchange contracts and also to return intact funds to customers in the event of bankruptcy.

49. DIFFERENCE BETWEEN FEMA &FERA