Foreign exchange market

T.Y.F.M. FOREX MARKETS

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CHAPTER 1

OVERVIEW OF FOREIGN EXCHANG MARKET

"Forex" stands for foreign exchange; it's also known as FX. In a forex trade,

you buy one currency while simultaneously selling another - that is, you're

exchanging the sold currency for the one you're buying. The foreign

exchange market is an over-the-counter market.

Currencies trade in pairs, like the Euro-US Dollar (EUR/USD) or US Dollar

/ Japanese Yen (USD/JPY). Unlike stocks or futures . All transactions

happen via phone or electronic network.

Historically, Forex has been dominated by inter-world investment and

commercial banks, money portfolio managers, money brokers, large

corporations, and very few private traders. Lately this trend has changed.

With the advances in internet technology, plus the industry's unique

leveraging options, more and more individual traders are getting involved in

the market for the purposes of speculation. While other reasons for

participating in the market include facilitating commercial transactions

(whether it is an international corporation converting its profits, or hedging

against future price drops), speculation for profit has become the most

popular motive for Forex trading for both big and small participants Traders

generate profits, or losses, by speculating whether a currency will rise or fall

in value in comparison to another currency. A trader would buy the currency

which is anticipated to gain in value, or sell the currency which is

anticipated to lose value against another currency.


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Although good instincts and speculatory skills are invaluable trader, there

are also other, more scientific indicators that traders use to decide whether

they will buy or sell a certain currency.

These are found by fundamental factors include economic and political

events (i.e. elections, wars) that occur worldwide. Monetary and fiscal

policy, government reports such as GDP, CPI, PPI, and measures such as the

unemployment rate also fall in this category. A trader that makes his or her

market decisions in response to these releases and events is using

fundamental analysis. The value of a currency in the forex market is

essentially an indication of the state of one nation's economy in comparison

to another nation's

FOREX, an acronym for Foreign Exchange, is the largest financial market in

the world. With an estimated $1.5 trillion in currencies traded daily, Forex

provides income to millions of traders and large banks worldwide. The

market is so large in volume that it would take the New York Stock

Exchange, with a daily average of under $20 billion, almost three months to

reach the amount traded in one day on the Foreign Exchange Market.

The foreign exchange market operates 24 hours a day, and, unlike the stock

market, has no official openings or closings.

Trading volumes in a given region are always highest during its primary

business hours, when traders at financial institutions are busy filling and

placing orders. The most active times, meaning the times of most liquidity

and movement in the markets, is the London open (3 AM EST), and the

overlap between London/Euro close and New York's open (8-11 AM EST).


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The hours below correspond to someone living in the EST time zone.

• New York session opens at 8:00 am and ends around 5:00 pm.

• Sydney session starts at 5:00 pm and ends around 2:00 am.

• Tokyo session begins at 7:00 pm and ends around 4:00 am.

• Frankfurt session opens at 2:00 am and ends around 11:00 am.

• London opens at 3:00 am and ends around 12:00 am.

Below is a figure showing business hours in the various regions, oriented for

someone in the EST time zone. In this figure you can see the overlap

between the European/London session and the New York session, between 8

am and 11 am EST. The currency markets experience the highest volatility

and volume during that overlap, which also coincides with the release of

important US economic figures.

Indirect Quote

Indirect quote is the reporting of foreign exchange rate in terms of units of foreign currency per unit of domestic currency. For a resident of the United States intending to buy/sell British pounds, it means exchange rates expressed in British pounds per unit of US dollar.

Formula

An indirect quote is the inverse of the direct quote.


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When the foreign exchange rate is expressed as a mid-quote, the following

formula can be used to calculate the indirect quote:

Indirect Quote = 1

Direct Quote

Where the foreign exchange rate is expressed in terms of bid and ask spread,

indirect quote can be calculated by finding the inverse of both prices and

switching their positions. It means that the direct bid becomes the indirect

ask and the direct ask becomes the indirect bid. Direct quote of (x − y)

would become indirect quote of (1/y − 1/x)

Direct quote

Direct quote is the convention of expressing currency exchange in terms of

units of domestic currency per unit of foreign currency.

It is 'direct' in the sense that a resident knows the price of the foreign

currency straight away.

What is a direct quote for a domestic resident is an indirect quote for the

resident of the foreign country. An indirect quote is the exact opposite of the

direct quote.

A direct quote can be converted to indirect quote by the following formula:

Direct Quote = 1

Indirect Quote

When a currency exchange rate is expressed in terms of bid-ask spread

instead of a mid-quote, the direct bid becomes the indirect ask and direct ask

becomes the indirect bid


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CHAPTER 2

FEATUER OF FOREX MARKET

No commissions

No clearing fees, no exchange fees, no government fees, no brokerage fees.

Most retail brokers are compensated for their services through something

called the “bid-ask spread“.

No middlemen

Spot currency trading eliminates the middlemen and allows you to trade

directly with the market responsible for the pricing on a particular currency

pair.

No fixed lot size

In the futures markets, lot or contract sizes are determined by the exchanges.

A standard-size contract for silver futures is 5,000 ounces. In spot forex, you

determine your own lot, or position size. This allows traders to participate

with accounts as small as $25 (although we’ll explain later why a $25

account is a bad idea).


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Low transaction costs

The retail transaction cost (the bid/ask spread) is typically less than 0.1%

under normal market conditions. At larger dealers, the spread could be as

low as 0.07%. Of course this depends on your leverage and all will be

explained later.

A 24-hour market

There is no waiting for the opening bell. From the Monday morning opening

in Australia to the afternoon close in New York, the forex market never

sleeps. This is awesome for those who want to trade on a part-time basis,

because you can choose when you want to trade: morning, noon, night,

during breakfast, or in your sleep.

No one can corner the market

The foreign exchange market is so huge and has so many participants that no

single entity (not even a central bank or the mighty Chuck Norris himself)

can control the market price for an extended period of time.

Leverage

In forex trading, a small deposit can control a much larger total contract

value. Leverage gives the trader the ability to make nice profits, and at the

same time keep risk capital to a minimum.


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For example, a forex broker may offer 50-to-1 leverage, which means that a

$50 dollar margin deposit would enable a trader to buy or sell $2,500 worth

of currencies. Similarly, with $500 dollars, one could trade with $25,000

dollars and so on. While this is all gravy, let’s remember that leverage is a

double-edged sword. Without proper risk management, this high degree of

leverage can lead to large losses as well as gains.

High Liquidity.

Because the forex market is so enormous, it is also extremely liquid. This is

an advantage because it means that under normal market conditions, with a

click of a mouse you can instantaneously buy and sell at will as there will

usually be someone in the market willing to take the other side of your trade.

You are never “stuck” in a trade. You can even set your online trading

platform to automatically close your position once your desired profit level

(a limit order) has been reached, and/or close a trade if a trade is going

against you (a stop loss order).


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Low Barriers to Entry

You would think that getting started as a currency trader would cost a ton of

money. The fact is, when compared to trading stocks, options or futures, it

doesn’t. Online forex brokers offer “mini” and “micro” trading accounts,

some with a minimum account deposit of $25.

We’re not saying you should open an account with the bare minimum, but it

does make forex trading much more accessible to the average individual

who doesn’t have a lot of start-up trading capital.

Free Stuff Everywhere

Most online forex brokers offer “demo” accounts to practice trading and

build your skills, along with real-time forex news and charting services.

And guess what?! They’re all free!

Demo accounts are very valuable resources for those who are “financially

hampered” and would like to hone their trading skills with “play money”

before opening a live trading account and risking real money.


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CHAPTER 3

PARTICIPENT FOREX MARKET

At the first level, are tourists, importers, exporters, investors, and

so on. These are the immediate users and suppliers of foreign

currencies. At the second level, are the commercial banks, which

act as clearing houses between users and earners of foreign

exchange. At the third level, are foreign exchange brokers through

whom the nation’s commercial banks even out their foreign

exchange inflows and outflows among themselves. Finally at the

fourth and the highest level is the nation’s central bank, which acts

as the lender or buyer of last resort when the nation’s total foreign

exchange earnings and expenditure are unequal. The central then

either draws down its foreign reserves or adds to them.

CUSTOMERS:

The customers who are engaged in foreign trade participate

in foreign exchange markets by availing of the services of banks.

Exporters require converting the dollars into rupee and importers

require converting rupee into the dollars as they have to pay in


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dollars for the goods / services they have imported. Similar types

of services may be required for setting any international obligation

i.e., payment of technical know-how fees or repayment of foreign

debt, etc.

COMMERCIAL BANKS

They are most active players in the forex market.

Commercial banks dealing with international transactions offer

services for conversation of one currency into another. These

banks are specialised in international trade and other transactions.

They have wide network of branches. Generally, commercial

banks act as intermediary between exporter and importer who are

situated in different countries. Typically banks buy foreign

exchange from exporters and sells foreign exchange to the

importers of the goods. Similarly, the banks for executing the

orders of other customers, who are engaged in international

transaction, not necessarily on the account of trade alone, buy and

sell foreign exchange. As every time the foreign exchange bought

and sold may not be equal banks are left with the overbought or

oversold position. If a bank buys more foreign exchange than what

it sells, it is said to be in ‘overbought/plus/long position’. In case

bank sells more foreign exchange than what it buys, it is said to be


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in ‘oversold/minus/short position’. The bank, with open position,

in order to avoid risk on account of exchange rate movement,

covers its position in the market. If the bank is having oversold

position it will buy from the market and if it has overbought

position it will sell in the market. This action of bank may trigger a

spate of buying and selling of foreign exchange in the market.

Commercial banks have following objectives for being active in

the foreign exchange market:

o They render better service by offering competitive rates to their

customers engaged in international trade.

o They are in a better position to manage risks arising out of

exchange rate fluctuations.

o Foreign exchange business is a profitable activity and thus such

banks are in a position to generate more profits for themselves.

• They can manage their integrated treasury in a more efficient

manner

.


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CENTRAL BANKS

In most of the countries central bank have been charged

with the responsibility of maintaining the external value of the

domestic currency. If the country is following a fixed exchange

rate system, the central bank has to take necessary steps to

maintain the parity, i.e., the rate so fixed. Even under floating

exchange rate system, the central bank has to ensure orderliness in

the movement of exchange rates. Generally this is achieved by the

intervention of the bank. Sometimes this becomes a concerted

effort of central banks of more than one country.

Apart from this central banks deal in the foreign exchange

market for the following purposes:

o Exchange rate management:

Though sometimes this is achieved through intervention,

yet where a central bank is required to maintain external rate of

domestic currency at a level or in a band so fixed, they deal in the

market to achieve the desired objective

o Intervention by Central Bank


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It is truly said that foreign exchange is as good as any other

commodity. If a country is following floating rate system and there

are no controls on capital transfers, then the exchange rate will be

influenced by the economic law of demand and supply. If supply

of foreign exchange is more than demand during a particular

period then the foreign exchange will become cheaper. On the

contrary, if the supply is less than the demand during the particular

period then the foreign exchange will become costlier. The

exporters of goods and services mainly supply foreign exchange to

the market. If there are no control over foreign investors are also

suppliers of foreign exchange.

During a particular period if demand for foreign exchange

increases than the supply, it will raise the price of foreign

exchange, in terms of domestic currency, to an unrealistic level.

This will no doubt make the imports costlier and thus protect the

domestic industry but this also gives boost to the exports.

However, in the short run it can disturb the equilibrium and

orderliness of the foreign exchange markets. The central bank will

then step forward to supply foreign exchange to meet the demand

for the same. This will smoothen the market. The central bank


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achieves this by selling the foreign exchange and buying or

absorbing domestic currency. Thus demand for domestic currency

which, coupled with supply of foreign exchange, will maintain the

price of foreign currency at desired level. This is called

‘intervention by central bank’.

If a country, as a matter of policy, follows fixed exchange

rate system, the central bank is required to maintain exchange rate

generally within a well-defined narrow band. Whenever the value

of the domestic currency approaches upper or lower limit of such a

band, the central bank intervenes to counteract the forces of

demand and supply through intervention.

In India, the central bank of the country, the Reserve Bank

of India, has been enjoined upon to maintain the external value of

rupee. Until March 1, 1993, under section 40 of the Reserve Bank

of India act, 1934, Reserve Bank was obliged to buy from and sell

to authorised persons i.e., AD’s foreign exchange. However, since

March 1, 1993, under Modified Liberalised Exchange Rate

Management System (Modified LERMS), Reserve Bank is not

obliged to sell foreign exchange. Also, it will purchase foreign

exchange at market rates. Again, with a view to maintain external


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value of rupee, Reserve Bank has given the right to intervene in the

foreign exchange markets.

EXCHANGE BROKERS

Forex brokers play a very important role in the foreign exchange

markets. However the extent to which services of forex brokers are

utilized depends on the tradition and practice prevailing at a

particular forex market centre. In India dealing is done in interbank

market through forex brokers. In India as per FEDAI guidelines

the AD’s are free to deal directly among themselves without going

through brokers. The forex brokers are not allowed to deal on their

own account all over the world and also in India.

Banks seeking to trade display their bid and offer rates on their

respective pages of Reuters screen, but these prices are indicative

only. On inquiry from brokers they quote firm prices on telephone.

In this way, the brokers can locate the most competitive buying

and selling prices, and these prices are immediately broadcast to a

large number of banks by means of hotlines/loudspeakers in the

banks dealing room/contacts many dealing banks through calling

assistants employed by the broking firm. If any bank wants to


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respond to these prices thus made available, the counter party bank

does this by clinching the deal. Brokers do not disclose counter

party bank’s name until the buying and selling banks have

concluded the deal. Once the deal is struck the broker exchange the

names of the bank who has bought and who has sold. The brokers

charge commission for the services rendered.

SPECULATORS

Speculators play a very active role in the foreign exchange

markets. In fact major chunk of the foreign exchange dealings in

forex markets in on account of speculators and speculative

activities.

The speculators are the major players in the forex markets.

Banks dealing are the major speculators in the forex

markets with a view to make profit on account of favourable

movement in exchange rate, take position i.e., if they feel the rate

of particular currency is likely to go up in short term. They buy

that currency and sell it as soon as they are able to make a quick

profit.

Corporations particularly Multinational Corporations and

Transnational Corporations having business operations beyond


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their national frontiers and on account of their cash flows. Being

large and in multi-currencies get into foreign exchange exposures.

With a view to take advantage of foreign rate movement in their

favour they either delay covering exposures or does not cover until

cash flow materialize. Sometimes they take position so as to take

advantage of the exchange rate movement in their favour and for

undertaking this activity, they have state of the art dealing rooms.

In India, some of the big corporate are as the exchange control

have been loosened, booking and cancelling forward contracts, and

a times the same borders on speculative activity.

Governments narrow or invest in foreign securities and

delay coverage of the exposure on account of such deals.

Individual like share dealings also undertake the activity of

buying and selling of foreign exchange for booking short-term

profits. They also buy foreign currency stocks, bonds and other

assets without covering the foreign exchange exposure risk. This

also results in speculations.


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Corporate entities take positions in commodities whose

prices are expressed in foreign currency. This also adds to

speculative activity.

The speculators or traders in the forex market cause

significant swings in foreign exchange rates. These swings,

particular sudden swings, do not do any good either to the national

or international trade and can be detrimental not only to national

economy but global business also. However, to be far to the

speculators, they provide the much need liquidity and depth to

foreign exchange markets. This is necessary to keep bid-offer

which spreads to the minimum. Similarly, liquidity also helps in

executing large or unique orders without causing any ripples in the

foreign exchange markets. One of the views held is that

speculative activity provides much needed efficiency to foreign

exchange markets. Therefore we can say that speculation is

necessary evil in forex markets.


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CHAPTER 4

FACTOR AFFECTING TO FOREX MARKET

1. Inflation Rates

Changes in market inflation cause changes in currency exchange rates. A

country with a lower inflation rate than another's will see an appreciation in

the value of its currency. The prices of goods and services increase at a

slower rate where the inflation is low. A country with a consistently lower

inflation rate exhibits a rising currency value while a country with higher

inflation typically sees depreciation in its currency and is usually

accompanied by higher interest rates

2. Interest Rates

Changes in interest rate affect currency value and dollar exchange rate. Forex rates,

interest rates, and inflation are all correlated. Increases in interest rates cause a country's

currency to appreciate because higher interest rates provide higher rates to lenders,

thereby attracting more foreign capital, which causes a rise in exchange rates

3. Country’s Current Account / Balance of Payments

A country’s current account reflects balance of trade and earnings on foreign

investment. It consists of total number of transactions including its exports,

imports, debt, etc. A deficit in current account due to spending more of its

currency on importing products than it is earning through sale of exports


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causes depreciation. Balance of payments fluctuates exchange rate of its

domestic currency.

4. Government Debt

Government debt is public debt or national debt owned by the central

government. A country with government debt is less likely to acquire

foreign capital, leading to inflation. Foreign investors will sell their bonds in

the open market if the market predicts government debt within a certain

country. As a result, a decrease in the value of its exchange rate will follow.

5. Terms of Trade

Related to current accounts and balance of payments, the terms of trade is

the ratio of export prices to import prices. A country's terms of trade

improves if its exports prices rise at a greater rate than its imports prices.

This results in higher revenue, which causes a higher demand for the

country's currency and an increase in its currency's value. This results in an

appreciation of exchange rate.

6. Political Stability & Performance

A country's political state and economic performance can affect its currency

strength. A country with less risk for political turmoil is more attractive to

foreign investors, as a result, drawing investment away from other countries

with more political and economic stability. Increase in foreign capital, in

turn, leads to an appreciation in the value of its domestic currency. A country

with sound financial and trade policy does not give any room for uncertainty


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in value of its currency. But, a country prone to political confusions may see

a depreciation in exchange rates.

7. Recession

When a country experiences a recession, its interest rates are likely to fall,

decreasing its chances to acquire foreign capital. As a result, its currency

weakens in comparison to that of other countries, therefore lowering the

exchange rate.

8. Speculation

If a country's currency value is expected to rise, investors will demand more

of that currency in order to make a profit in the near future. As a result, the

value of the currency will rise due to the increase in demand. With this

increase in currency value comes a rise in the exchange rate as well.


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CHAPTER 5

TRANSACTION IN FOREX MARKET

Spot Market

The term spot exchange refers to the class of foreign exchange transaction

which requires the immediate delivery or exchange of currencies on the

spot. In practice the settlement takes place within two days in most markets.

The rate of exchange effective for the spot transaction is known as the

spot rate and the market for such transactions is known as the spot market.

Forward Market

The forward transactions is an agreement between two parties, requiring the

delivery at some specified future date of a specified amount of foreign

currency by one of the parties, against payment in domestic currency be the

other party, at the price agreed upon in the contract. The rate of exchange

applicable to the forward contract is called the forward exchange rate and

the market for forward transactions is known as the forward market.

The foreign exchange regulations of various countries generally regulate the

forward exchange transactions with a view to curbing speculation in the

foreign exchanges market. In India, for example, commercial banks are

permitted to offer forward cover only with respect to genuine export and

import transactions.

Forward exchange facilities, obviously, are of immense help to exporters

and importers as they can cover the risks arising out of exchange rate

fluctuations be entering into an appropriate forward exchange contract.


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With reference to its relationship with spot rate, the forward rate may be at

par, discount or premium.

If the forward exchange rate quoted is exact equivalent to the spot rate at the

time of making the contract the forward exchange rate is said to be at par.

The forward rate for a currency, say the dollar, is said to be at premium with

respect to the spot rate when one dollar buys more units of another currency,

say rupee, in the forward than in the spot rate on a per annum basis.

The forward rate for a currency, say the dollar, is said to be at discount with

respect to the spot rate when one dollar buys fewer rupees in the forward

than in the spot market. The discount is also usually expressed as a percentage

deviation from the spot rate on a per annum basis.

The forward exchange rate is determined mostly be the demand for and

supply of forward exchange. Naturally when the demand for forward

exchange exceeds its supply, the forward rate will be quoted at a premium

and conversely, when the supply of forward exchange exceeds the demand

for it, the rate will be quoted at discount. When the supply is equivalent to

the demand for forward exchange, the forward rate will tend to be at par.


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Futures

While a focus contract is similar to a forward contract, there are several

differences between them. While a forward contract is tailor made for the

client be his international bank, a future contract has standardized features

the contract size and maturity dates are standardized. Futures cab traded only

on an organized exchange and they are traded competitively. Margins are

not required in respect of a forward contract but margins are required of all

participants in the futures market an initial margin must be deposited into a

collateral account to establish a futures position.

Options

While the forward or futures contract protects the purchaser of the contract

from the adverse exchange rate movements, it eliminates the possibility of

gaining a windfall profit from favorable exchange rate movement.

An option is a contract or financial instrument that gives holder the right, but

not the obligation, to sell or buy a given quantity of an asset as a specified

price at a specified future date. An option to buy the underlying asset is

known as a call option and an option to sell the underlying asset is known as

a put option. Buying or selling the underlying asset via the option is known

as exercising the option. The stated price paid (or received) is known as the

exercise or striking price. The buyer of an option is known as the long and

the seller of an option is known as the writer of the option, or the short. The

price for the option is known as premium.

Types of options: With reference to their exercise characteristics, there are

two types of options, American and European. A European option cab is


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exercised only at the maturity or expiration date of the contract, whereas an

American option can be exercised at any time during the contract.

Swap operation

Commercial banks who conduct forward exchange business may resort to a

swap operation to adjust their fund position. The term swap means

simultaneous sale of spot currency for the forward purchase of the same

currency or the purchase of spot for the forward sale of the same currency.

The spot is swapped against forward. Operations consisting of a

simultaneous sale or purchase of spot currency accompanies by a purchase

or sale, respectively of the same currency for forward delivery are

technically known as swaps or double deals as the spot currency is swapped

against forward.


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CHAPTER 6

SETTELMENT IN FOREX MARKET

Foreign exchange markets make extensive use of the latest developments in

telecommunications for transmitting as well settling foreign exchange

transaction, Banks use the exclusive network SWIFT to communicate

messages and settle the transactions at electronic clearing houses such as

CHIPS at New York.

SWIFT

: SWIFT is a- acronym for Society for Worldwide Interbank Financial

Telecommunications, a co -operative society owned by about 250 banks in

Europe and North America and registered as a co -operative society in

Brussels, Belgium. It is a communications network for international

financial market transactions linking effectively more than 25,000 financial

institutions throughout the world who have been allotted bank identified

codes. The messages are transmitted from country to country via central

interconnected operating centers located in Brussels, Amsterdam and

Culpeper, Virginia. The member countries are connected to the centre

through regional processors in each country. The local banks in each country

reach the regional processors through the national net works.

The SWIFY System enables the member banks to transact among

themselves quickly (i) international payments (ii) Statements (iii) other

messages connected with international banking. Transmission of messages

takes place within


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seconds, and therefore this method is economical as well as time saving.

Selected banks in India have become members of SWIFT. The regional

processing centre is situated at Mumbai.

The SWIFT provides following advantages for the local banking

community:

1. Provides a reliable (time tested) method of sending and receiving

messages from a vast number of banks in a large number of locations around

the world.

2. Reliability and accuracy is further enhanced by the built in authentication

facilities, which has only to be exchanged with each counterparty before

they can be activated or further communications.

3. Message relay is instantaneous enabling the counterparty to respond

immediately, if not prevented by time differences.

4. Access is available t a vast number of banks global for launching new

cross border initiatives.

5. Since communication in SWIFT is to be done using structure formats for

various types of banking transactions, the matter to be conveyed will be very

clear and there will not be any ambiguity of any sort for the received to

revert for clarifications. This is mainly because the formats are used all

ove3r the world on a standardized basis for conducting all types of banking

transactions. This makes the responses and execution very efficient at the

receiving banks end thereby contributing immensely to quality service being

provided to the customers of both banks (sending and receiving).


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6. Usage of SWIFT structure formats for message transmission to

counterparties will entail the generation of local banks internal records using

at least minimum level of automation. This will accelerate the local banks

internal automation activities, since the maximum utilization of SWIFT a

significant internal automation level is required.

CHIPS:

CHIPS stands for Clearing House Interbank Payment System. It is an

electronic payment system owned by 12 private commercial banks

constituting the New York Clearing House Association. A CHIP began its

operations in 1971 and has grown to be the world‘s largest payment system.

Foreign exchange and Euro dollar transactions are settled through CHIPS. It

provides the mechanism for settlement every day of payment and receipts of

numerous dollar transactions among member banks at New York, without

the need for physical exchange of cheques/funds for each such transaction.

The functioning of CHIPS arrangement is explained below with a

hypothetical transaction: Bank of India, maintaining a dollar account with

Amex Bank, New York, sells USD 1 million to Canara Bank, maintaining

dollar account with Citibank.

1. Bank of India intimate Amex Bank debuts the account of Bank through

SWIFT to debit its account and transfer USD 1 million to Citibank for credit

of current account of Canara Bank.


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2. Amex Bank debits the account of Bank of India with USD 1 million and

sends the equivalent of electronic cheques to CHIPS for crediting the

account of Citibank. The transfer is effected the same day.

3. Numerous such transactions are reported to CHIPS by member banks and

transfer effected at CHIPS. By about 4.30 p.m, eastern time, the net

position of each member is arrived at and funds made available at

Fedwire for use by the bank concerned by 6.00 p.m. eastern time.

4. Citibank which receives the credit intimates Canara Bank through

SWIFT.

It may be noted that settlement of transactions in the New York foreign

exchange market takes place in two stages, First clearance at CHIPS and

arriving at the net position for each bank. Second, transfer of fedfunds for

the net position. The real balances are held by banks only with Federal

Reserve Banks (Fedfunds) and the transaction is complete only when

Fedfunds are transferred. CHIPS help in expediting the reconciliation and

reducing the number of entries that pass through Fedwire.


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CHAPS:

is an arrangement similar to CHIPS that exists in London. CHAPS stands

for Clearing House Automated Payment System since 1996 it operates

RTGS .CHAPS payment are irrevocable and irreversible CHAPS use by 19

settlement banks include the bank of England and sub –member financial

institution .

Fedwire

The transactions at New York foreign exchange market ultimately get

settled through Fedwire. It is a communication network that links the

computers of about 7000 banks to the computers of federal Reserve Banks.

The fedwire funds transfer system, operate by the Federal Reserve Bank, are

used primarily for domestic payments, bank to bank and third party transfers

such as interbank overnight funds sales and purchases and settlement

transactions. Corporate to corporate payments can also be made, but they

should be effected through banks. Fed guarantees settlement on all payments

sent to receivers even if the sender fails.


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CHAPTER 7

THE GOLD STANDARD

A system of setting currency values whereby the participating countries

commit to fix the prices of their domestic currencies in terms of a specified

amount of gold. The gold standard as an international monetary system

gained acceptance in Western Europe in the 1870s. The United States was

something of a latecomer to the system, not officially adopting the standard

until 1879. The ―rules of the game under the gold standard were clear and

simple. Each country set the rate at which its currency (paper or coin) could

be converted to a weight of gold. The United States, for example, declared

the dollar to be convertible to gold at a rate of $20.67/ounce of gold (a rate

in effect until the beginning of World War 1). The British pound was pegged

at £4.2474/ounce of gold. As long as both currencies were freely convertible

into gold, the dollar/pound exchange rate was:

$20.67/ounce of gold

= $4.8665/£ £4.2474/ounce of gold

Because the government of each country on the gold standard agreed to buy

or sell gold on demand to anyone at its own fixed parity rate, the value of

each individual currency in terms of gold, and therefore the fixed parities

between currencies, was set. Under this system it was very important for a

country to maintain adequate reserves of gold to back its currency‘s value.

The system also had the effect of implicitly limiting the rate at which any

individual country could expand its money supply. The growth in money

was limited to the rate at which additional gold could be acquired by official

authorities. The gold standard worked adequately until the outbreak of


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World War 1 interrupted trade flows and the free movement of gold. This

caused the main trading nations to suspend the operation of the gold

standard


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CHAPTER 8

BRETTON WOOD

In 1944, as World War II drew toward a close, the Allied Powers met at

Bretton Woods, New Hampshire, in order to create a new post-war

international monetary system. The Bretton Woods Agreement,

implemented in 1946, whereby each member government pledged to

maintain a fixed, or pegged, exchange rate for its currency vis-à-vis the

dollar or gold. These fixed exchange rates were supposed to reduce the

riskiness of international transactions, thus promoting growth in world trade.

The Bretton Woods Agreement established a US dollar-based international

monetary system and provide for two new institutions, The IMF and the

World Bank. The IMF aids countries with balance of payments and

exchange rate problems. The International Bank for Reconstruction and

Development (World Bank) helped post-war reconstruction and since then

has supported general economic development.

The IMF was the key institution in the new international monetary system,

and it has remained so to the present. The IMF was established to render

temporary assistance to member countries trying to defend their currencies

against cyclical, seasonal, or random occurrences. It also assists countries

having structural trade problems if they take adequate steps to correct their

problems. However, if persistence deficits occur, the IMF cannot save a

country from eventual devaluation. In recent years it has attempted to help

countries facing financial crises. It has provided massive loans as well as

advice to Russia and other former Russian republics, Brazil, Indonesia, and

South Korea, to name but a few.


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Under the original provisions of the Bretton Woods Agreement, all countries

fixed the value of their currencies for gold. Only the dollar remained

convertible into gold (at $35 per ounce). Therefore, each country decided

what it wished its exchange rate to be vis-à-vis the dollar and then calculated

the gold per value of its currency to create the desired dollar exchange rate.


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CHAPTER 9

FIXED EXCHANGE RATES

The currency arrangement negotiated at Bretton Woods and monitored by

the IMF worked fairly well during the post-World War II period of

reconstruction and rapid growth in world trade. However, widely diverging

national monetary and fiscal policies, differential rates of inflation, and

various unexpected external shocks eventually resulted in the system‘s

demise. The U.S. dollar was the main reserve currency held by central banks

and was the key to the web of exchange rate values. Unfortunately, the

United States ran persistent and growing deficits on its balance of payments.

A heavy capital outflow of dollars was required to finance these deficits and

to meet the growing demand for dollars from investors and businesses.

Eventually, the heavy overhang of dollars held abroad resulted in a lack of

confidence in the ability of the United States to meet its commitment to

convert dollars to gold.

On August 15, 1971, President Richard Nixon was forced to suspend official

purchases or sales of gold by the U.S. Treasury after the United States

suffered outflows of roughly one-third of its official gold reserves in the first

seven months of the year. Exchange rates of most of the leading trading

countries were allowed to float in relation to the dollar and thus indirectly in

relation to gold. By the end of 1971 most of the major trading currencies had

appreciated vis-à-vis the dollar. This change was – in effect – a devaluation

of the dollar.

In early 1973, the U.S. dollar came under attack once again, thereby forcing

a second devaluation on February 12, 1973, this time by 10% to $42.22 per

ounce. By late February 1973, a fixed –rate system no longer appeared


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feasible given the speculative flows of currencies. The major foreign

exchange makets were actually

closed for several weeks in March 1973. When they reopened, most

currencies were allowed to float to levels determined by market forces. Par

values were left unchanged. The dollar had floated downward an average of

10% by June 1973.


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CHAPTER 10

RESERVE MANAGEMENT

Reserve management is a process that ensures that adequate official public

sector foreign assets are readily available to and controlled by the authorities

for meeting a defined range of objectives for a country or union. In this

context, a reserve management entity is normally made responsible for the

management of reserves and associated risks. Typically, official foreign

exchange reserves are held in support of a range of objectives including to:

• support and maintain confidence in the policies for monetary and

exchange rate management including the capacity to intervene in support of

the national or union currency;

• limit external vulnerability by maintaining foreign currency liquidity to

absorb shocks during times of crisis or when access to borrowing is curtailed

and in doing so;

• provide a level of confidence to markets that a country can meet its

external obligations;

• demonstrate the backing of domestic currency by external assets;

• assist the government in meeting its foreign exchange needs and external

debt obligations; and

• maintain a reserve for national disasters or emergencies.

2. Sound reserve management practices are important because they can

increase a country's or region's overall resilience to shocks. Through their

interaction with financial markets, reserve managers gain access to valuable

information that keeps policy makers informed of market developments and


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views on potential threats. The importance of sound practices has also been

highlighted by experiences where weak or risky reserve management

practices have restricted the ability of the authorities to respond effectively

to financial crises, which may have accentuated the severity of these crises.

Moreover, weak or risky reserve management practices can also have

significant financial and reputational costs. Several countries, for example,

have incurred large losses that have had direct, or indirect, fiscal

consequences.4 Accordingly, appropriate portfolio management policies

concerning the currency composition, choice of investment instruments, and

acceptable duration of the reserves portfolio, and which reflect a country's

specific policy settings and circumstances, serve to ensure that assets are

safeguarded, readily available and support market confidence.

3. Sound reserve management policies and practices can support, but not

substitute for, sound macroeconomic management. Moreover, inappropriate

economic policies (fiscal, monetary and exchange rate, and financial) can

pose serious risks to the ability to manage reserves.


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CHAPTER 11

FOREX MARKET IMPACT ON EXPORT AND

IMPORT

lies in understanding the export – import payment process. When a company

imports any good/service it makes payment in internationally acceptable

currencies, like USD. On the other hand, when a company exports any

good/service, it accepts USD from the buyer. However in both the cases, the

company has to do the rest of the business in domestic currency (INR –

Indian Rupees, as per our example) since, only domestic currency is

considered as a legal tender within a country. Hence, an importer has to first

buy USD from a bank by exchanging equivalent domestic currency, for

making payments to the international supplier and an exporter has to sell

USD to a bank, received from international buyer, and get equivalent

domestic currency in return from the bank.

Let us take an example to understand this,

CASE 1: $1 is equal to 60 INR as on 21st Aug 2015

CASE 2: $1 is equal to 63 INR as on 21st Sep 2015

CASE 3: $1 is equal to 57 INR as on 21st Oct 2015

Now, for an importer, every product that he buys, he has to first buy USD

from a bank. If he buys a good which costs $100 in the international market,

then, as on 21st Aug 2015, the importer will have to buy $100 by giving

6,000 INR (60 X 100) to a bank. However, as on 21st Sep 2015 the INR has


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depreciated against dollar (lost its value against dollar). Hence, if the

importer now wants to buy $100 from the bank, he will have to pay 6,300

(63 X 100) to the bank. Thus, depreciation of domestic currency results in

the increased cost for an importer. Consider the last scenario, $1 = 57 INR,

so when the importer wants to buy $100 from a bank, he will now have to

pay 5,700 (57 X 100). Thus, appreciation of domestic currency reduces

importers’ cost.

The exact reverse impact happens on an exporter. Consider an exporter,

selling a good worth $100 in the international market. Under first scenario,

the exporter will get $100 for selling a good and will exchange it for INR

with a bank and will get 6,000 INR (100 X 60). However, in the second

case, the exporter will end up getting 6,300 INR (100 X 63) for the same

good sold. Hence, depreciation of domestic currency increases exporters

profit margins. But, in case of last scenario, the export ends up getting only

5,700 INR (100 X 57) for the same good. Hence, exporter loses on profit

margins whenever domestic currency appreciates.

The above example can be shown in a table as –

Case Situation INR position Cost of Good

1 $1 = 60 INR Stable $100 – –

2 $1 = 63 INR Depriciation $100 Loss Profit

3 $1 = 57 INR Appreciation $100 Profit Loss

The cost and quality of good remains the same, but the fluctuations in the

currency rates determines the profit and loss extent for the exporter and the


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importer. Looking at the table one can infer that depreciation in the currency

always profits an exporter.

Any country would like to increase its exports so that the balance of trade

(Exports – Imports) stays positive and the exports also provides a country

with foreign exchange. This in turn strengthen the country’s economy. A

country can purposely depreciate its currency by increasing the supply of its

domestic currency in the market. Whenever a country does this, we term it

as devaluation.

But if all countries follow this approach, then the exports will become more

competitive and the imports will keep reducing. However, for one country to

have good export sector, there must be importers in other countries who are

willing to buy their goods.If imports keep getting costlier, the importer

would just stop buying from the exporter, thereby adversely impacting

exports of other countries. The exporters will be left with no buyers for their

products. Hence, there is a mutual understanding within the countries to

avoid such intentional devaluation and allow the simply market forces

determine the exchange rates.


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CHAPTER 12

CASE STUDY DEVALUATION OF YUAN

CURRANCY

WASHINGTON: China’s currency fell further Wednesday, keeping global

investors on edge. The yuan slid 1.6 percent on top of a 1.9 percent drop

engineered Tuesday by the Chinese government. The currency’s nosedive is

giving investors plenty to worry about:

The risk the Chinese economy, the world’s second-biggest, is weakening

even faster than expected.

The threat that a cheaper yuan poses to exports and economic growth in

other countries.

The possibility that China’s move will trigger a beggar-thy-neighbor

currency war.

And the prospect that it will force the Federal Reserve to rethink a widely

expected U.S. interest rate hike this year — a possibility that creates

uncertainties for financial markets.


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—HOW DID THIS START?

In a surprise move, China devalued the yuan on Tuesday. Beijing doesn’t let

buying and selling in financial markets set its exchange rate the way the

United States and other developed countries do. Instead, it links the yuan’s

value to a basket of currencies. The composition of the basket is a secret, but

it’s believed to be dominated by the U.S. dollar.

Each day, the People’s Bank of China sets a target for the yuan, then lets the

currency trade 2 percent above or below that level. On Tuesday, the central bank

set the target 1.9 percent below Monday’s — the biggest one-day change in a decade.

—WHAT’S CHINA’S MOTIVATION?

China says the devaluation was part of an effort to give market forces a

bigger say in the exchange rate — something the United States and the

International Monetary Fund have long called for. Chinese people, worried

about the economy and seeking investment opportunities abroad, have been

pulling money out of the country. That exodus has held down the yuan’s

value. But because the yuan was tied to a rising U.S. dollar, it remained at

high levels. By devaluing the yuan, the Chinese government was catching up

to the market, not trying to counteract it.

Or so Beijing says. Many economists also suspect a contributing factor:

Beijing may be desperately trying to boost its economy. A cheaper yuan

gives Chinese exporters a price advantage in foreign markets. And they need

help: Exports dropped a steep 8.3 percent in July year over year.


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—WHY ARE INVESTORS SO FREAKED OUT?

Plenty of reasons. The surprise devaluation suggests that something is

spooking the Chinese government. Perhaps the Chinese economy is

decelerating even faster than anyone realizes. Already, the IMF is

forecasting 6.8 percent economic growth in China this year, the slowest rate

since 1990. Signs of trouble are accumulating. On Wednesday, for instance,

China reported that auto sales sank 6.6 percent in July.

Investors are also worried about how a weaker yuan will affect exporters in

other countries. Shares in exporters such as Caterpillar and General Electric

fell in the market rout this week, though many economists say the yuan’s

drop so far isn’t significant enough to do much damage.

Then there’s the chance that other countries will adopt copycat devaluations

to help their exporters compete with China, thereby igniting a currency war

that disrupts international trade. On Wednesday, Vietnam allowed its

currency to weaken in response to China’s move.

Finally, the Chinese devaluation complicates the Fed’s decision-making.

The U.S. central bank, increasingly confident in the strength of the U.S.

economy, is expected to raise the short-term rate it controls later this year.

The Fed has kept the rate at zero since December 2008. But a cheaper yuan

poses a threat to U.S. exports and economic growth. It also lowers inflation,

already running below the Fed’s 2 percent annual target. Still, most

economists suspect the yuan’s drop won’t have much of a lasting impact.

They continue to expect the Fed to raise rates at its September meeting.


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CHAPTER 13

CONCLUSION

Foreign Exchange market bright many more banks and advisors convert

themselves into good service of a forex trade and deliver much more

efficient . There is wide scope in . I look basic nature of Indian forex

exchange market and its growth over the period . Volatility of Indian foreign

exchange market is on rise due to encourage in the cross-border trade . huge

capital flow in and out integration of the international financial market it is

observed the particularly after liberalization of the Indian economy the

market has become voletile and their by affecting the revenue and

expenditure of corporates.


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CHAPTER 14

REFERENCE

• www.wikipidia.com

• www.investopedia.com

• www.infomedia.com

• ARTHSHATRA.WORDPRESS.com

Foreign exchange market

Education