Ppt of International Finance

EXCHANGE RATE QUOTATION

AND DETERMINATION

PRESENTING BY:-

VINAL KOTHARI

(GK038)

What is Exchange rate?

Rate of exchange: the charge for exchanging currency of onecountry for currency of another.

The price of one country's currency expressed in anothercountry's currency. In other words, the rate at which onecurrency can be exchanged for another. For example, thehigher the exchange rate for one euro in terms of one yen, thelower the relative value of the yen.

The amount of one currency that a person or institutiondefines as equivalent to another when either buying or sellingit at any particular moment; The rate at which one currencycan be exchanged for another, usually expressed as the valueof the one in terms of the other.

Foreign Exchange Rate

A foreign exchange rate, which is also called aForex rate or currency rate, represents the value ofa specific currency compared to that of anothercountry. Currency rates are applicable only oncurrency pairs. The currency listed on the left iscalled the reference (or base) currency while theone listed to the right is the quote (or term)currency.

Exchange rates are always written in the form ofquotations. A quotation reflects the number ofquote currencies that can be bought by using asingle unit of reference currency.

EXCHANGE RATE QUOTES

In the foreign exchange market, the price of any currency may be quoted in terms of several currencies. It is important to realize that every price or exchange rate is relative. For example, if U.S. $ is worth Rs. 44, then it also implies that Re. 1 is worth $ 1/44. All foreign exchange rates in this way are related to each other in a reciprocal way. In other words, the value of $/Re. is just the reciprocal of the value of Re./$.

Quotations in the foreign exchange market are generally made in terms of local currency or the domestic currency in terms of per unit of a foreign currency. For example, the exchange rates of Re. in India may be quoted in terms of $, say Re./$ = Rs.44/$. It means that one $ is worth Rs.44. A change in price of one currency implies, therefore, a change in price of the other currency that appears in the quote. For example, if the price of Re. against the $ moves from Rs.44/$ to Rs.43.5/$, one can say that Re. has appreciated relative to $ by Re. 0.50. This is the same as saying that $ has depreciated relative to the Re.

Direct Quote – A direct quote means indicates how many units of local currency traders need to buy one unit of foreign currency. In other words, it’s the home currency price of 1 unit of foreign currency. In a direct quote, the domestic currency is always listed as the base currency.For instance, for a US trader to compare the Singapore Dollar (SGD), to say, the US Dollar, the pair will be listed as USD/SGD, which indicates how many US Dollar are required to buy one Singapore Dollar. Here, the USD is the base and the SGD is the counter currency.

Indirect Quote – Indirect quote indicates how many foreign currencies are needed to purchase one unit of domestic currency. In an indirect quote, the foreign currency is the base currency and the domestic currency is the counter or quote currency.For instance, if Singapore is the foreign market, then an Indirect Quote will be displayed as SGD/USD. This quotation is the reverse of direct quote which means that how many Singapore Dollars are needed to buy a single US Dollar.

Forex market is the largest financial market in terms of size. This is so irrespective of the fact that it is fully over the counter market. By far the largest market for currencies is the interbank market, which trades spot and forward contracts. The market can be termed as efficient with enough breadth, depth and resilience.

The basic theories underlying the exchange rates – 1. Law of One Price: In competitive markets free of transportation

costs barriers to trade, identical products sold in different countries must sell at the same price when the prices are expressed in terms of their same currency.

Purchasing power parity: As inflation forces prices higher in one country but not another country, the exchange rate will change to reflect the change in relative purchasing power of the two currencies.

2. Interest rate effects: If capital is allowed to flow freely, the exchange rates stabilize at a point where equality of interest is established.

Exchange rates determinants:

What is Spot Market:-

A market in which commodities, such as grain,gold,crudeoil, or RAM chips, are bought and sold for cash and delivered immediately. Also called cash market. Features:-

high volatility high liquidity short-term contract execution

Forward Market:-

Market dealing in commodities, currencies, and securities for future (forward) delivery at prices agreed-upon today (date of making the contract). In commodity and currency markets, forward trading is used as a means of hedging against sharp fluctuations in their prices. See also futures market :-

Features:-DecentralizationNo standard regarding the settlement dates

.

Foreign Exchange Spot Market:

A foreign exchange spot market is a market fortrading one currency against the another in such away that the delivery takes place within 2 days ofthe execution of the trade. It usually takes twodays to transfer cash from one bank to the other.The price is based on the ongoing exchangerate i.e. the current value of one country'scurrency relative to the another. The foreignexchange spot market is the largest market inthe world with a transaction of more than US $ 1trillion in a single day. The forex futuresmarket is a minor derivative of this market and itssize is 1/100th of that of the foreign exchange spotmarket.

The Forward Foreign Exchange Market

Foreign exchange can be bought and sold notsolely on a spot basis, but also on a forward basisfor delivery on a specified future date. In aforward transaction, the terms of the purchase(buy or sell) are agreed up front but will take placeon a date in the future, thus the exchange rate isfixed now for a future exchange of currencies.Forward transactions are commonly known as‘forward exchange contracts’

A forward exchange contract, commonly known as a FEC or forward cover, is a contract between a bank and its customer, whereby a rate of exchange is fixed immediately, for the buying and selling of one currency for another, for delivery at an agreed future date. Economic, technical and political factors can cause upheaval in the foreign exchange markets, resulting in volatile exchange rates that can hamper international trade. The forward exchange contract (FEC) is an effective hedging tool tantamount to an insurance policy, in that it protects traders and clients from un favourable exchange rate fluctuations which might occur between the contract date and the payment date. The exact value of the import and export order can be calculated on the day it is processed and thus, budgeting and costing are accurate. Both parties can make use of forward exchange contracts and this kind of instrument caters for a diverse range of commercial and financial transactions.