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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB Chapter 1 - INTRODUCTION The word ‘bank’ it derived from the word ‘bancus’ or ‘banque’ that is French. There was other of the opinion that the word ‘bank’ is originally derived from the German word ‘back’ meaning joint for which was Italianized into ‘banco’. But whatever be the origin of the word bank as Prof. Rramchandra Rao says.” It would trace the history of banking in Europe from middle ages.” Generally, banks do the business of money they take deposits of moneys from client and give loan to the person who has need of money. But in this age, for the convenience of customer, banks provides some other services to their customer such as bankers cheque, overdraft, internet banking, ATM facility, paying of bills, credit card, telegraphic transfer, insurance, demat etc. For a people, it is difficult to keep a very big amount of money in his house safely. So, people save their money to bank. Bank gives loan to the person who has need of money and gets higher interest on it than the interest of deposit. The margin between the interest of loan and interest of deposit is the income of bank. S. K. Patel Institute of Management and Computer Studies, GANDHINAGAR 1
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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

Chapter 1 - INTRODUCTION

The word ‘bank’ i t der ived from the word ‘bancus’ or ‘banque’ that is French.

There was other of the opinion that the word ‘bank’ is or ig inal ly der ived from the German word ‘back’ meaning jo int for which was I ta l ianized into ‘banco’ . But whatever be the or ig in of the word bank as Prof . Rramchandra Rao says.” I t would t race the history of banking in Europe from middle ages.”

General ly , banks do the business of money they take deposi ts of moneys from cl ient and give loan to the person who has need of money. But in th is age, for the convenience of customer, banks provides some other services to their customer such as bankers cheque, overdraf t , internet banking, ATM faci l i ty , paying of b i l ls , credi t card, te legraphic t ransfer, insurance, demat etc.

For a people, i t is d i f f icul t to keep a very big amount of money in his house safely. So, people save their money to bank. Bank gives loan to the person who has need of money and gets higher interest on i t than the interest of deposi t . The margin between the interest of loan and interest of deposi t is the income of bank.

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Chapter 2 – RESEARCH METHODOLOGY

Research Purpose :Research Purpose :

Comparative Analysis of loans & Advances of Rajkot Nagar ik Sahakar i Bank wi th that of other major compet i tors and f ind out what we are lacking in our products, which area we need to improve and also f ind out the dist inguished services provided by the di f ferent banks in the industry.

We also done another research that is Service Satisfaction Review of Rajkot Nagarik Sahakari Bank’s Customer , The main object ive of the study is to know the sat isfact ion level of the customer f rom bank’s Service.

For accompl ishing the object ive of the study researcher needs pr imary informat ion f rom the respondent and for that exploratory research design is sui table.

Scope of the Study :Scope of the Study :

This Market Research involves the study of –

Comparat ive analysis of Banking products of RNSB with other banks.

Brand preference of RNSB. Service Sat isfact ion Review of RNSB’s Customer

Comparative study of different banking products done at Rajkot Nagarik Sahakari Bank has helped in understanding the products of d i f ferent r ival banks very wel l and also f inds out their market ing strategies which wi l l help us convenience the exist ing customer di f ferent banks wel l and also provide them where we are better than the bank with which they are t ransact ing r ight now. So study wi l l help sale execut ive to convey the r ight services to the r ight customers.

Which features are most prominent for consumers - brand preference is a lso answered by th is Market Research.

Research helps to know the satisfaction level of the RNSB’s customer from Bank’s Services .

Research also involves the inf luence of promot ional and advert is ing act iv i t ies on the consumers’ buying behaviors .

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Market Research also t r ies to f ind out the ident i f icat ion of acceptance of new brand extension or l ine extension .

Source of Data :Source of Data :There are two sources avai lable for data col lect ion. One is primary source and another one is the secondary source .

a) Pr imary Data Quest ionnaire Observat ion

b) Secondary Data From other Bank Previous Reports Websites

Data source :

Primary Data:

We have conducted a survey for knowing the Service Satisfaction of the Rajkot Nagarik Sahakari Bank .

We have taken the in depth interv iew of the persons and ask quest ioner to know the Satisfaction of the customers about the Rajkot Nagarik Sahakari bank, i ts product and service .

Secondary Data : From Other Banks, Websi tes.

For making comparative research of the Banking product , we have personal ly v is i ted the branches of above l is ted di f ferent banks. We have col lected these data f rom the relat ionship Off icer(RO) of the banks and from the internet to know how Rajkot Nagarik Sahakari bank is d i f ferent f rom al l other bank.

Sampling DesignSampling Design :Sampl ing design is one of the most important aspects where the design must be appropr iate in order to have the desired resul t . Sampl ing design includes var ious aspect and they are as fo l lows:

Sampling Area : Saurashatra

Sample Size : 50

Limitation of the Project :Limitation of the Project : The market survey was l imited to area of Saurashatra .

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Sample s ize is only 50 , which may not represent the overal l populat ion.

Lacks of advanced scient i f ic techniques for analysis and interpretat ion.

In such cases respondents were not able to give al l informat ion in such cases as much as possible informat ion was taken.

We can’ t meet each and every user because of Human Limitat ions and other problems so we select some sample.

Conclusion is der ived by onesel f (Decis ion Maker) .

Time constraint .

Chapter 3 – INDUSTRY PROFILE

EARLY HISTORY OF BANKING

As ear ly as 2000 B.C. the Babylonians had developed a banking system. There is evidence to show the temples of Babylon were used as banks. After a per iod of t ime, there was a spread of i r re l ig ion, which soon destroyed the publ ic sense

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of secur i ty in deposi t ing money and valuable in temples. The pr iests were longer act ing as f inancial agents. The Romans did minute regulat ions, as to conduct pr ivate banking and to create conf idence in i t . Loan banks were also common in Rome. From these the poor c i t izens received loans without paying interest , against secur i ty of land for 3 or 4 years.

Dur ing the ear ly per iods, a l though pr ivate indiv idual most ly d id the banking business, many countr ies establ ished publ ic banks ei ther for the purpose of faci l i tat ing commerce or to serve the government.

However, upon the revival of c iv i l izat ion, growing necessi ty forced the issued in the middle of the 12 t h century and banks were establ ished at Venice and Genoa. The Bank of Venice establ ished in 1157 is supposed to be the most ancient bank. Or ig inal ly , i t was not a bank in the modern sense, dur ing s imply an of f ice for the t ransfer of the publ ic debt.

In India, as ear ly as the Vedic Per iod, banking, in most crude from existed. The books of Manu contain references regarding deposi ts, p ledges, pol icy of loans, and rate of interest . True, the banking in those days largely mint money lending and they did not know the compl icated mechanism of modern banking.

This is t rue not only in the case of India but a lso of other countr ies. Al though, the business of banking is as old as authent ic h istory, banking inst i tut ions have s ince than changed in character and content very much. They are developed from a few simple operat ion involv ing the sat isfact ion of a few indiv idual wants to the compl icated mechanism of modern banking, involv ing the sat isfact ion of capi ta l s lowly seeking employment and thus providing the very l i fe b lood of commerce.

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TYPE OF BANKS

Reserve Bank of India (RBI) Nationalized Bank State Bank Group Co-operative Bank Private Bank (old & new) Foreign Bank Regional Rural Banks

RESERVE BANK OF INDIA

The Hi l ton-young commission, appointed in 1926 has recommended the necessi ty of central ly empowered inst i tut ion to have ef fect ive control over currency and f inancial t ransact ion in the county. Accordingly, the Government had then passed Reserve Bank of India Act, 1934 and establ ished the Reserve Bank of India wi th ef fect f rom 1 s t Apr i l 1935. The pr incipal a im behind th is was to organize proper control over the currency management in the interest of country benef i ts and to maintain f inancial stabi l i ty . With th is, the RBI mainly looks af ter the fo l lowing important funct ions:

To keep ef fect ive control over creat ion of credi ts and currency supply To control the Banking transact ions of Central and State Governments. To act as Central administered Author i ty of a l l other Banks in the country. To organize control over Foreign Currency Transact ion. To assist for improvement in f inancial aspect of the country .

NATIONALISED BANKS

The Banking Company Act establ ishes i t in July 1969 by nat ional izat ion of 14 major banks of India. The sent percent ownership of the bank is of government of India.

STATE BANK OF INDIA & GROUP

The State Bank of India was establ ished under the State Bank of India Act, 1955, the subsidiary banks under the State Bank of India (subsidiary Banks) Act 1959. The Reserve Bank of India owns the State Bank of India, to a large extent, and rest of the part is some pr ivate ownership in the share capi ta l of State Bank of India. The State Bank of India owns the subsidiary Banks.

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OLD PRIVATE BANKThese banks are registered under Company Act, 1956. Basic di f ference between co-operat ive banks and pr ivate banks is i ts a im. Co-operat ive banks work for i ts member and pr ivate banks work for earn prof i t .

NEW PRIVATE BANKSThese banks lead the market of Indian banking business in very short per iod. Because of i ts var iety services and approach to handle customer and also because of long working hours and speed of services. This is a lso registered under the Company Act. 1956. Between old and new pr ivate sector bank, there is wide di f ference.

FOREIGN BANKSForeign Bank means mult i -countr ies bank. In case of India Foreign Banks are such Banks. Which open i ts branch of f ice in India and their head of f ice is outs ide of India. For Ex. Ci t i bank,HSBC bank, Standard Chartered.

CO-OPERATIVE BANKS

1. state co-operat ive banks :state co-operat ive bank means the pr incip le co-operat ive society in the state. The pr imary funct ion of i t is to f inance other co-operat ive societ ies in the state.

2. Central /Distr ic t co-operat ive banks :

Central and distr ic t co-operat ive bank means the pr incip le co-operat ive society in a distr ic t . The pr imary object ive of th is banks is to f inance other co-operat ives in the part icular d istr ic t .

REGIONAL RURAL BANKS

Regional rural banks are added in banking s ince October 1975. These banks have been establ ished by the govt. of India in terms of provis ion of the regional rural bank act 1976. The central govt . whi le establ ishing a regional rural bank on the request of a commercial bank, shal l speci fy the local l imi ts wi th in which is shal l operate. The regional rural bank may establ ish i t ’s branches or agencies at any place with in the not i f ied area.State bank of saurashtra sponsors regional rural banks in saurashtra.

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DIFFERENCES BETWEEN COMMERCIAL BANKS ANDCO-OPERATIVE BANKS

(1) This operate through their network of branches spread over mainly in

urban and semi urban areas and their management and pol ic ies are control led by head of f ice.

This have dist inct ent i t ies by themselves wi th separate jur isdict ion and independent broad of d i rectors. Banks are organized on a co-operat ive basis and are governed by their members according to the co-operat ive laws.

(2) Banks are subject to the Banking Regulat ion Act and the control of the

Reserve Bank of India.

Banks are organized on a co-operat ive basis and are governed by their members according to co-operat ive laws and are under the control of state government and to a lesser extent of the Reserve Bank of India certa in provis ion of Banking Regulat ion Act is a lso appl ied.

(3) Banks are audi ted by external audi tors.

Audit and inspect ion of banks is done by the state co-operat ive department and Reserve Bank of India.

(4) Banks are required to maintain minimum rat ios between their balances

with the Reserve Bank of India, other cash an dis investment in approval secur i t ies and demand t ime deposi ts.

Banks maintain cash reserve and l iquid assets in re lat ion to deposi ts only.

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(5) Deposi ts of banks may be col lected in one area and lent in other areas

and they can be shi f ted f rom one centre to another.

Deposi ts can be used for f inancing agr icul tural and other act iv i t ies only.

(6) Banks can invest more f reely than their co-operat ive counterparts.

Bank has to fo l low the rules for investment la id down by the Registrar of Co-operat ive Society and Reserve Bank of India.

(7) Banks enjoy more discret ion in their lending pol ic ies which are determined

by their board of d i rectors subject of course to the regulat ion on Reserve Bank of India.

Banks have to fo l low the loan pol ic ies la id down by the Reserve Bank of India and Co-operat ive department.

(8) Rate of interest payable are control led by Reserve Bank of India.

Rate of interest payable are more in co-operat ive bank.

(9) Any people can borrow from banks.

Only members of the bank are al lowed to borrow.

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Central Bank and Monetary Authority

Reserve Bank of India

Apex Banking Institutions

Development Banks

Industrial Development Banks State Level Land Development Banks

All India State Level Primary Land Development Bank

IFCI ICICI SFC SIDC

Subsidiary Companies

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IDBI NABARD EXIM BANK IIBI NATIONAL HOUSING BANK

SIDBIBanking Institutions

Commercial Banks Regional Rural Banks Co-operative Banks

Public Sector Private Sector

State Bank Group

Nationalized Banks

Subsidiary Companies

SBI Subsidiary Banks

SubsidiaryCompanies

Indian Foreign

Old Banks

NewBanks

Local AreaBanks

State CooperativeBanks

Central & DistrictCo-operative Banks

Industrial Development Banks

All India

IFCI ICICI

Subsidiary Companies

State Level

SFC SIDC

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Chapter 4 – COMPANY PORFILE

HISTORY OF RAJKOT NAGRIK SAHAKARI BANK

Rajkot Nagar ik Sahakar i Bank is a leading Co-Operat ive Bank in Gujarat State, India. I t has completed hal f a century of i t existence. 93% of accounts are bel low Rs.200,000 which makes true i ts s logan “THE SMALL MAN’S BIG BANK”.

Bank was establ ished on 5th October 1953 With a smal l Capi ta l Of Rs. 4890 and Membership of 59 persons under the leadership of Late Keshavlal Amrut la l Parekh as a Chairman, and Late Janmashankar Antani as a M.D. Bank has made tremendous & real progress under the leadership of former Chairman Late Shr i Arvindbhai Maniar. Bank was the f i rst co-operat ive inst i tute to star t funct ioning in the erstwhi le state of Saurashtra. Bank was inaugurated by "SAHAKAR MAHARSHI" late Shr i Vainkunthbhai Metha.

The bank has been awarded ‘A’ c lass of audi t by the Government s ince i ts incept ion. The bank has crossed the pr ior i ty sector lending rate and at taches due importance to Nat ional Planning and Nat ional pr ior i ty f ixed by RBI.

The bank has been conferred Scheduled status by RBI f rom 1 s t Sep. 1988 as per the provis ions RBI Act, 1934.

The bank has also earned the status of Mult is tage Co-operat ive Society f rom Central Registrar of Co-operat ives, New Delhi , on 17 t h Jan. 2001 and has also been issued l icenses by RBI to open four branches at Mumbai. Out of which one branch has been opened on 30 t h March 2002

Being in the service sector wi th a v is ion of current & future t rends, Bank star ted automat ion & modernizat ion way back in 1987 and by 1995 al l the Branches were computer ized.

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REGISTERED & HEAD OFFICE

Nagarik Bhavan No.1,Dhebarbhai Road,Rajkot – 360 001. (Gujarat)Phone : (0281) 2233916-7-8Fax : (0281) 2223933.

Registrat ion No. : 587Registrat ion Date : 21/09/1953.

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Social Contribution

RNSB has endeavored to discharge i ts social obl igat ions by contr ibut ing for the social , academic, cul tural , nat ional , women’s and Defense causes. I t bel ieves to return the earning wherefrom they are der ived. With th is noble ideal in the s ight, the bank has denoted a handsome amount for an Engineer ing Col lege and Archi tectural col lege being run by Vyavasayee Vidya Prat isthan Trust , Rajkot .

1. Donat ion to Educat ional Inst i tut ions and Hospi ta ls.2. Fodder Supply to Catt le Camps.3. Promot ion of Sports Act iv i t ies.4. Loans to Educat ional ly Unemployed Youth. 5. Help to Earthquake Vict ims by Providing Soft Loans.6. Rajkot Nagar ik Sahakar i Bank Prer i t VVP Engg. Col lage Was Sponsored by

BANK .7. Indubhai Parekh School Of Archi tecture was sponsored by BANK. 8. DOLL museum is managed by RNSB in the Rajkot. ( which is 3 r d in the ASIA

and 2 n d in the INDIA ) 9. Bank enter into a histor ic agreement wi th BSNL to provide free of cost

mobi le connect ions to our members, of fer ing them faci l i ty of f ree CUG.

A grate number of social and educat ional inst i tut ions have provide the bank an opportuni ty to assist them in their need of hour and thereby der ive sat isfact ion to just i fy i ts co-operat ive existence.

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FEATURES

1. Largest shareholders in the year 2006-07 are 218059.

2. Introduced smart card system for shareholders.

3. Transact ion of shares only can be done through shareholders associat ion of RNSB

4. Demat faci l i ty as wel l as stamp wending

5. Net NPA is zero

6. RNSB’s reserve is sound backs NPA.

7. Out of 28 branches 26 has i ts own bui ld ing.

8. For bi l ls d iscount and other remit tance, let ter of credi t , export business bank has t ie up with HDFC, Indus bank & ICICI.

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Organizational Structure:

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BANK FRIST DO :

Banks main funct ion is col lect the money from peoples and lend that money to customers. When we ta lk about Indian banking system we see that RBI has made some rules and restr ic t ion for col lect ing and lending money. Banks are always want to made a large f inance because i t ’s seen the working capaci ty of banks so banks are somet ime made a wrong f inance to wrong part ies. So RBI now a day made str ike rules for landing money to customers. So banks are not d i rect ly lending al l money to customers f i rst bank less the CRR (cash reserve rat io) , which are 5% of total deposi ts. Then banks are need 25% to 30% money for SLR. So af ter th is banks are able to lending 65 % to 70 %money form total deposi ts. Af ter th is process al l banks are create a sound l iquidi ty.

CLASSIFCATION OF ADVANCES :

Bank loan take var ious, depending upon the wishes and business customs of the borrower or the requirement of the bank. The loans usual ly found in a bank are ei ther unsecured or secured .

Unsecured loans

A loan which are arranged no speci f ic col lateral and which are the obl igat ion of borrowers who, in the opinion of the lending bank are excel lent credi t r isks. Such advances are evidenced only by a negot iable instrument, promissory note or b i l l and are cal led “unsecured “ or “c lean”.An unsecured loan is granted by the Bank only af ter considerat ion has been given to the credi t s tanding of the appl icat ion and af ter the bank has been sat isf ied that the prospect ive borrower wi l l be able to make repayment of the loan in a reasonable per iod of t ime which I usual ly determined at the t ime loan is sanct ioned. In the case of unsecured at the banker re l ies on the personal goodwi l l of customer. The basis of such advances s the credi t of the borrower and the banks gets nothing tangible to fa l l back upon in case of defaul t by the borrower to repay the loan. The dist inct ion between secured and unsecured advances recognized legal ly for balance sheet purposes has an undesirable ef fect on the publ ic ’s mind as advances which are made against the personal secur i ty of the borrower have to be shown in the balance sheet as unsecured, which term conveys a feel ings of unsoundness in he popular mind and as such these advances are discouraged by bankers, a l though in ef fect they may be in no way, infer ior to what are known as secured advances.

In consider ing appl icat ion for unsecured advances the banker must sat isfy h imsel f that :

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1. The purpose for which the loan is required is l ikely to be remunerat ive and the product readi ly saleable.

2. Amount and per iod of loan appl ied for and t ime of appl icat ion are appropr iate to purpose.

3. The appl icant understands his business and co-obl igates i f any, are credi t worthy.

4. He has suff ic ient resources of h is own for the expansion of the business and is not over – t rading.

5. He owns suff ic ient landed and immovable property in the local i ty where he carr ies on business.

6. Appl icant has no speculat ive tendencies and is reported to be a good pay master.

7. Borrower wi l l be able to return the money in short per iod and the loan wi l l be used for genuine trade purposes.

8. Borrower has the legal capaci ty.9. Purpose of the loan is wi th in the terms of governments, current credi t

pol icy as expressed in RBI ’s d irect ives issued to banks from t ime to t ime.

Secured LoansA smal l percentage of the loans of banks consist of unsecured loans to borrowers who because of their strong f inancial condi t ion of potent ia l earning capaci ty have been able to convince the bank of repayment at matur i ty.

There are many customers of a bank, who are not so wel l p laced and whose f inancial responsibi l i ty or income is not strong to just i fy unsecured credi t , amount of credi t the borrowers would l ike to obtain is out of proport ion to his net worth. I t is usual for borrowers to strengthen their credi t obl igat ion by some approved tangible secur i ty to support loan. This the bank may sel l in the event of the borrower fa i l ing to pay his loan at the appointed t ime.

Why loans are secured?

1. The f inancial condi t ion of the appl icant for loan is not strong enough to just i fy an advance without secur i ty.

2. Some customers would borrow on a col lateral basis rather than to just i fy an advance without secur i ty.

3. The borrowers may feel that he has an obl igat ion to honor and he may be forced to repay the loan.

4. Sometimes secur i ty is furnished so that more favorable rate of interest may be obtained by the borrower.

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Appraising the securities

The work secur i ty means anything given to protect or safeguard the repayment of an advance and to just i fy the term.

Then the th ing so given should i tsel f be safe otherwise the object for which i t is g iven is not served.

In general the intr insic value as wel l as the current market value is determined. The secur i ty must possess the fo l lowing character ist ics i f i t is to serve tru ly the purpose of a bankers’ secur i ty.

1. Marketabi l i ty2. Stabi l i ty of p lan.3. Durabi l i ty4. Easy transferabi l i ty .5. Easy determinat ion of value.6. Margin7. Yield

Types of security

1. Direct i .e. deposi ted by the debtor to secure his own account.2. Third party i .e. deposi ted by a th i rd party to secure the customers

‘debt.

Approved Securities

1. Tender stocks and shares.2. Guarantees by responsible part ies.3. Ti t le deeds4. Bi l ls of exchange5. Promissory note.6. Goods of document of t i t le to goods7. Third of second mortgage.8. Undeveloped lands.9. Bi l ls of sale, mortgage and books debts.

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TYPES OF LOAN AND HOW IT COMPUTES WITH OTHERS:

LOANS GIVEN TO CUSTOMERS

Personal surely loan Smal l Traders & Shopkeepers loan Vehic le loan Cash Credi t Land and Bui ld ing loan Industr ies loan Gold loan Loan on NSC,KPV,LIC pol icy and Fixed Deposi ts Mortgage loan (Social reason & Emergency Borrowing) Smal l business and industr ies loan Educat ion loan

LOAN GIVEN TO STAFF MEMBERS

Vehic le loan Housing loan Fest ival loan Surety loan Housing equipment loan Overdraf t system

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Personal surely loan

Maximum l imit to Non Government employee Rs.5000. Maximum l imit to Government employee Rs.10000. Two guarantors Sources of income and resident proof In case of Govt. employee instal lment should be direct ly deduct f rom

salary. Repayment of loan in 40 equal instal lments. Rate of interest 15%.

Compares to others it’s;

Pros.

1. Easy to people gett ing th is loan in lower rate than other banks

2. No document charge and t ime saving process.

3. No guarantors required but borrower must be shareholder of bank.

Cons.

1. The amount of loan is very lower then other banks l ike Nat ional ize and other pr ivate banks.

2. Not cover large no. of customer in th is loan l ike other banks because of l imi tat ion of th is scheme.

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Small Traders and Shopkeepers loan

Smal l shopkeepers who do not maintain books of account and have stock in t rade can get loan.

Maximum l imit up to Rs. 15000 or 50% of the stock which is less. Repayment of loan in 40 equal instal lments. Rate of interest 12% p.a. Loan wi l l be given on type of C.C.(cash credi t ) a lso.

Compare to others it’s

Pros.

1. Most useful for smal l income person who has smal l business and their most prefer th is bank.

2. Compare to other nat ional ize banks and pr ivate banks which are not interested in th is type of f inance. RNSB are most use th is chance.

3. No more document requires and no processing charges so i t cheaper to borrowers.

Corn.

1. The recovery of th is loan is some very tuf f because some t ime borrowers are not interested to repayment of loan.

2. The amount of th is loan is lower and now days most of customers are needed more amount loan so there are going for other pr ivate and nat ional ize banks.

3. Rate of interest is somet ime problems for very smal l business persons who are want to borrow the money.

Vehicle loan

Now a days large number of people are want to buy a vehic le because now vehic les are cheaper the past because of compet i t ion in automobi le sector and banks are t r ied for th is loan most. RNSB has also provided th is loan for customer. Banks has di f ferent schemes for th is loan. These are New vehic le loan, Old vehic le loan, Tie up with PAL automobi le manf. In Rajkot .

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

New vehicle loan (except car loan)

Quotat ion of vehic le. Two guarantors. Sources of income. Addit ional secur i t ies. ( e.g. land.bui ld ing,F.D.) NSC,LIC pol icy . Maximum l imit 75%. Repayment of loan in 40 equal instal lments up to amount of Rs.25000 Repayment of loan in 40 equal instal lments i f amount of loan is more than

Rs.25000 Rate of interest 13%.

Old vehicle loan

Maximum l imit var ies between 25% to 60% according to valuat ion. 25% of margin money has to deposi t in bank. Vehic le loan deposi t Rs.1000 to Rs.10000. Old vehic le loan l imi t Rs.4000 to Rs.40000 Rate of interest 13%.

Tie up with PAL Auto. Manf.

RNSB provides loan to PAL Auto. Manf. Which is manufactured Diesel r ickshaw in Rajkot? And bank gives advances on vehic le wi th lower rate of interest .

Rate of interest is 11%. Repayment of loan in maximum 36 equal instal lments.

Compare to other it’s

Pros.

1. Quick f inance for any type of vehic les so any customers are gett ing f inance for any vehic les.

2. Large numbers of borrowers under th is loan than any other co-operat ive banks.

Cons.

1. Limited customers wi l l be el ig ib le for loan because rule of bank that only shareholders wi l l get a loan.

2. Compet i t ion in vehic le f inance now a days in great and RNSB’s work in th is s ight is not more aggressively most of customers are go for other banks.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

Cash Credit (C.C.)

Cash Credi t is the main method of lending in India and accounts for about 70% of total bank credi t . Under th is system, the banker speci f ies a l imi t , cal led the cash credi t . L imit for the each customer, up to which the customer is permit ted to borrow against the secur i ty of tangible assets or guarantees. The customers wi thdraws from his cash credi t account as and when he needs the funds and deposi ts any amount of money, which he funds surplus wi th him on any day. The cash credi t account is thus an act ive and running account to which deposi ts and withdrawals may be af fected frequent ly. The customer is required to provide tangible assets as secur i ty to cover the amount borrowed from the banker. The borrower is charged interest on the actual amount ut i l ized by borrower and for the per iod actual ly ut i l ized only.

There is no any l imi t for a l lowing Cash Credi t . Against business turnover and stock margin th is faci l i ty is avai lable.

There is no any l imi t . Books of account for last three years. Stock l is t at the date of appl icat ion. Income tax return and assessment order of last three years. Audited report f rom C.A. Municipal shop act l icense. Receipt of rent . Partnership deed. Register of f i rms. S.S.I . incense in case of smal l scale industry. In case of company memorandum of associat ion and art ic le of

associat ion. Project report and C.M.A. report . The rates of interest are 13 % to 15 % and also give rebate i f rat ing of

customers is AAA and AA.

Compare to others it’s,

Pros.1. In the region of Rajkot these faci l i ty wi l l be used by customer highest

form RNSB because at that t ime no one co-operat ive bank has large amount for these faci l i ty , so RNSB is wonderful ly compute wi th nat ional ize banks at that t ime.

2. Customer relat ionship is most important in th is faci l i ty and RNSB has large numbers of customers who are cont inue gat ing th is faci l i ty .

3. The processor of f inance of C.C. is t ime saving on behal f of nat ional ize banks. So customer gett ing C.C. in less t ime.

Cons.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

1. Many t imes l imi tat ion of ru les of co-operat ive f inance are make di f f icul ty for banks to give f inance and by th is reason Banks lost few customers.

2. Now day’s new customers making is d i f f icul t because of new comer pr ivate banks and nat ional ize banks. So bank has cont inued with older customers.

3. The restr ic t ion on the co-operat ive banks is st ick af ter the some co-operat ive bank’s demotions so i t ’s not possible to RNSB take big r isk on any l imi ted customers.

Land and building loan

Land and bui ld ing loan is g iven for d i f ferent purposes. Now a day the business of land and bui ld ing are in growth so bank wi l l concentrate on th is type of loan.

(A) Purchases

Only for purchases of bui ld ing or home maximum l imit is 80% of register document.Maximum amount of purchasing house or bui ld ing is Rs.10,00,000/-

Regular customers are gat ing rebate of 1% in interest rate. Rate of interest is 14% Repayment of loan in 144 equals instal lments.

(B) Construction

Maximum l imit is 80% of est imated cost of construct ion. Plan from corporat ion. Permission deed star ted f rom or ig inal owner. Loan wi l l be given in di f ferent t ime per iod of construct ion of

bui ld ing. Rate of interest is 14% Repayment of loan in 144 equals instal lments.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

(C) Repairs

Purpose of repair ing a house or bui ld ing loan amount is maximum 80% of document of bui ld ing.

Maximum amount in Rs.2,00,000/- Rate of interest is 13.5% Repayment of loan in 144 equals instal lments.

Compare to others it’s,

Pros.

1. Most of middle c lass peoples are go for co-operat ive f inance for purchasing a bui ld ing and houses because of cheaper f inance of co-operat ive banking.

2. In the past RNSB is one and only bank who give these type of f inance on cheaper rate of interest to any c lass customers.

3. RNSB’s main funct ion in loan schemes are housing f inance for middle and lower income’s customers so i t ’s today also f i rst choice of the lower and middle c lass.

Cons.

1. Rate of interest is not compute wi th other banks, l ike housing f inance agencies of govt. and other banks.

2. Limitat ion of area of cover ing because vi l lager are not gat ing loan from the banks.

3. Now a days compet i t ion in housing f inance are cut throw so large numbers of f inance companies and pr ivate and nat ional ize banks are in compet i t ion. So RNSB’s customers are going for other easy f inance companies.

Loan for purchasing housing equipment & components

Purpose of th is loan is providing the loan for housing equipment for better l i fe to customers.

Govt.servants / non-govt.servents / or a person who regular ly paid I .T.return.

Loan wi l l be 80% amount of the pr ize of equipment or goods. And maximum amount is Rs.50,000/-

Rate of interest is 13% and t ime per iod of repayment in instal lments is maximum 66 months.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

Compare to others it’s,

Pros.

1. Customers are gat ing loan for any types housing equipment easi ly .

2. Most of urban co-operat ive banks and nat ional ize banks are not g iven th is types of loan so RNSB wi l l do heal thy compet i t ion wi th other banks.

3. Processes of gat ing loan are very easy and repayment faci l i t ies are also very easy for borrowers.

Cons.

1. The amount of loan is lower then other pr ivate banks so many customers are go for other f inance sources.

2. Rate of interest is a lso high then other so i t ’s create problem for heal thy compet i t ion.

3. Banks doesn’ t have any contract for any company for only f inancers.

Industries loan

In th is segment the smal l and middle levels industr ies are el ig ib le for industr ies f inance.

Al l machinery loans are considered as industr ia l loan. For purchasing an of f ice equipments and furni ture are also considered

under th is loan.

For stock and components f inances wi l l g iven 60 % to 75 %. And interest rate is 13 % to 15 %. As per amount of loan.

Rebate wi l l be given to the AAA & AA rat ing customers who are regular pay the instal lment of loan.

For gating this loan bank need,

1. Two guarantors.2. 1 year book of account.3. Shop act l icense.4. S.S.I .NO.5. Addi t ional secur i t ies i .e. land / bui ld ing / F.D.etc

Compare to others it’s,

Pros.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

1. RNSB is very old bank in th is region so i t has many old customers who has good borrower of the banks. And they are cont inuing with the bank.

2. In saurashtra region many few co-operat ive banks has a large number of customers in th is loan segment.

3. Bank also provides loan faci l i ty on import machiner ies. So customers have no problem for other agents for import the machiner ies.

Cons.

1. Bank has a str ic t ly ru les and regulat ion of RBI so bank has l imi tat ion for lending money for customer.

2. Bank’s area of work is not large so banks cant ’s capable to give large amount of money l ike nat ional ize and capable pr ivate banks.

3. Rate i f interest is make di f f icul ty in way of easy f inance to customers.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

Gold loan

Only co-operat ive bank who give th is type of loan. For personal requirement th is loan wi l l lend by bank In the secur i t ies gold jewelry put. Bank wi l l count the rate of gold in regular t ime base and borrower wi l l get

70 % of gold’s amount in to the loan. Maximum amount of loan in c i ty is Rs.50,000/- and out of c i ty wi l l be

Rs.20,000/- wi l l lend by bank. Rate of interest is 11% and the per iod of repayment is 26 months. Minimum 21 carat pure gold wi l l require.

Compare to others it’s,

Pros.

1. Only co-operat ive bank in th is region which are provide th is faci l i ty .

2. A persons who need money in emergency they has easy opt ion of th is loan.

3. Bank has also benef i ts of gat ing a large numbers of customers in th is segment.

Cons.

1. The amount of loan is less so many customers are going for other types of loan

Loan against NSV,KVP,LIC policy and F.D.

For emergency requirement of customers.

Borrower’s name’s NSC,KPV,LIC pol ices are require in secur i t ies’ of th is loan.

Loan wi l l be providing by overdraf t . and no l imi t for f inance.

Rate of interest is NSC/KVP+2% and LIC pol icy-10 %.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

Compare to others it’s,

Pros.

1. Bank’s customers have a good opt ion for internal f inance from banks because they are already FD in bank.

2. No l imi tat ions for f inance so bank is suf f ic ient to borrow money as much borrower is needed.

3. Banks has no more r isk in th is lending money because of guarant ied documents.

Cons.

1. Rate of interest is h igh then other banks. So customers are less interested in th is loan.

Mortgage loan (social reason / emergency borrowing)

For borrowers’ social responsibi l i ty / emergency requirement and in emergency purpose any reason wi l l a l lowed.

Borrowers’ income with fami ly must be more than Rs.2,00,000/- and for govt.severnt gross monthly income wi l l be Rs.15,000/- or more.

In the secur i t ies borrowers’ f ixed assets evi table mortgage and one guarantor require.

Loan wi l l be given f ixed assets ’ valuat ion’s 70 % maximum. Or maximum in amount Rs.5,00,000/-

Rate of interest wi l l be 13 % and repayment t ime per iod is maximum 60 months.

Compare to others it’s, Pros.

1. Easy to borrowing from bank because of no more processing t ime and charge.

2. Bank taken guarant ies so bank has not worr ied for that loans’ repayments.

Cons.

1. Now days most of banks are providing these faci l i ty so compet i t ion is make di f f icul ty to gat ing customers.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

2. Bank’s area of work is l imi ted so i t can’ t compute in good ways.

Small businesses & industries loan

Purpose of th is loan is requirement of current assets l ike stock and money for smal l industr ies and retai ls t raders.

Business wi l l s tar t minimum from three years. Loan wi l l provide by overdraf t . Require documents for these loan are f ixed assets l ike bui ld ing or

machinery’s mortgage and one guarantor. Loan amount was maximum in Rs.10,00,000/- or annual sel l ing’s 25 %

or current asset ’s 80 % or f ixed asset ’s 70 % whichever is less. Rate of interest is 13 %. Only on rule is g ive stock-sheet one t ime in the year.

Compare to others it’s

Pros.

1. Rate of interest is less compet i t ive for other banks and f inancial inst i tut ions.

2. RNSB more ef fect ive in th is segment because i ts main customers come forms smal l businessmen and smal l industr ia l is t .

3. Loan is provided from of overdraf t so bans have also benef i t of not lend lots of money in one t ime .

Cons.

1. Government agencies are most concentrate on growth of SSI so they are provide loan lowest interest rate so bank’s customers are cuts.

2. In the region of saurashtra where SSI is in large number banks can’ t able to provide lots of loan for them because of l imi tat ion of RBI.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

Educational loan

Student of any Govt. approve Universi t ies, Medical , Engineer ing, Management or any professional courses as wel l as any post graduat ion courses can be got.

I f s tudents wants to study with in India and outs ide the India are Rs.7.5lakhs and Rs.15lakhs respect ively.

Loan is included al l the amount re lated with the study l ike course fee, hostel fee, cost of books etc.

Rate of interest is 9.5% Interest should be paid regular ly f rom the date of passing loan. The complet ion of course, af ter 3 months, student must be paid the loan

in 60 equal instal lments. Loanee as wel l as guarantors should be the member of RNSB.

Compare to others it’s

Pros.

1. Rate of interest is very law compare to other nat ional ize and pr ivate banks.

2. Procedure for grant ing is easy.

3. There is rebate faci l i ty i f we are paying loan instal lments wi th study. ( 2% rebate )

Cons.

1. Only member of RNSB takes educat ional loan from the bank.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

Loan for RNSB’s staff

Vehicle loan

With out interest For two wheelers maximum Rs.50000/- For four wheelers there are no l imi ts in loan amount. Repaid wi th in 5 years or service t ime of employee in organizat ion which

ever is less. Employees can get th is loan 3 t imes dur ing their service per iod.

Housing loan

Rate of interest 6.5% for the f i rst t ime and second t ime rate of interest is 7.5%.

Repayment of loan is 20 years or service t ime of employee in organizat ion which ever is less.

No l imit for loan amount to employee.

Festival loan

Rate of interest is n i l . Time durat ion for grant ing th is loan is only one year. Maximum amount is Rs.5000 for taking th is loan. Repayment in 10 equal instal lments. This is g iven most probably in month of October and November.

Surety loan

Surely loan to employees maximum up to Rs.15000. Guarantors are staf f members only. Other terms and condi t ions remain same as per personal surely loan.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

Housing equipment loan

Housing equipment loan to employees are maximum up to Rs.20000. Rate of interest is 6%. Time durat ion of repayment of loan is 60 instal lments. Guarantors are only staf f members.

Overdraft system to employee

Rate of interest is 11%.( PLR – 1% ) Time durat ion of loan amount is 5 years. Amount of loan, for the level of employee

Sub staf f Rs.100000Cler ical staf f Rs.110000Off icers Rs.120000

Limit of overdraf t reduced by every month.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

Rate of interest on Advances from 1 st April 2007

No. Types of loan Int. rate Time duration In months

Instal lmentPer Rs.1000

A Security group vise(machinery loan, c.c. , mass stock)

1 Plat inum group150%secur i ty of loan amt.

11.5% 4066120

30.4520.7714.34

2 Gold group100%secur i ty of loan amt.

12.5% 4066120

30.9321.2814.34

3 Si lver groupLess than 100%secur i ty of loan amt.

14% 4066120

31.6722.0715.82

B Name of loans & advances1 Personal surety loan publ ic 15% 40 31.922 Personal surety loan staf f 15% 66 22.343 Smal l t raders and shopkeepers

loans12% C.C. C.C.

4 Vehic le loan 13% 40 32.005 Cash credi t 13% to 15% C.C. C.C.6 Land and bui ld ing loan

Up to Rs.200000More than Rs.200000

13%14%

144144

14.0514.37

7 Loan for parching house equipment

13% 66 21.54

8 Gold loan 11% 26 43.639 Loan on NSV, KVP, LIC NSV/KVP+2%

LIC 10%O.D. O.D.

10 Mortgage loan any purpose 13% 36 35Social purpose 13% 60 23

11 Loan on F.D. F.D. + 1% F.D. t ime 12 Loan on Demat share 11% 24 46.8413 Nagar ik car loan yojana 11% 48 26.08

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

LOAN PROCEDURE

1. Application

2. Shakh Report

3. Loan Report

4. Inspection

5. Committee Approval

6. Letter of Condition

7. Documentation

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

1. APPLICATION

A customer required any advances from a bank have to apply for the same.

I t is a compulsory for Rajkot Nagar ik Sahakar i Bank that the appl icant must be the member or share holder.

In the appl icat ion form bank need pr imary informat ion about borrower and guarantor.

Income proof a lso required.

2. SHAKH REPORT

I t is a conf ident ia l report prepared by bank for the members who want to take a loan.

In the shakh report loanee’s f inancial posi t ion and also guarantor ’s f inancial posi t ion are ment ioned.

In the case of industr ies loan turn over report wi l l required.

3. LOAN REPORT

After the shakh report approves, customer’s appl icat ion go for the loan report .

Bank analyses the appl icat ion throughout.

And report wi l l go to next stage.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

4. INSPECTION

For knowing correct p icture bank’s of f icers are make an inspect ion of property of customers.

But i t is done in case of total ly new and doubtfu l customer’s appl icat ion.

For regular customer, i t is not required.

5. COMMITTEE APPROVAL

After complet ing everything and i f appl icat ion found correct than loan report should to come along with commit tee.

The system of Rajkot Nagar ik Sahakar i Bank is d iv ided into di f ferent commit tee for sect ioning di f ferent amount of advances.

I f commit tee members feel that the f i le of appl icant for advances is correct and there is not any problem in grant ing loan than they sanct ion the loan.

I f an amount of a loan is less than the actual appl icat ion amount and i f a customer wants the amount which is ment ioned in appl icat ion form at that t ime customer have to prepare one more appl icat ion to the commit tee to sanct ion the fu l l amount.

After the second appl icat ion commit tee th ink over the new appl icat ion and i f they feel sat isf ied than they sanct ioned fu l l amount of

appl icat ion.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

6. LETTER OF CONDITION

In the let ter of condi t ion bank includes the rate of interest , instal lments, deposi ts and other pr imary rules.

Steps taken by the bank i f customer is not able to repay the loan are also ment ioned.

7. DOCUMENTATION

Document means any matter expressed or descr ibed upon any substance by means of let ters, f igures, or marks or by more

than one of those means intended to be used or which may be used for the purpose of recording that matter .

At Rajkot Nagar ik Sahakar i Bank di f ferent documents are required for d i f ferent Loans / Advances l ike promissory note, let ter of guarantee, equi table mortgage and Hypothecat ion of vehic le etc.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

Margin money

1. When bank grant loan, the appl icant have to keep same amount in his account as deposi t which is cal led margin money or s imply deposi t to loans.

2. This deposi t is useful when appl icant fa i ls to repay the loan. At than t ime bank are for fe i ted th is deposi ts.

3. After the repayment of loan the amount of deposi ts should be given back to appl icant.

4. Margin money should be ei ther in form of share deposi ts of in term of loan deposi ts.

5. The margin money fora. Personal surety loan -5% of advancesb. Other loans -2.5% of advances

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

RECOVERY PROCEDURE

A banker has not merely to advance money to t rade, industry and commerce but has to ensure that money which is advanced comes back to him / her.

I f money advances is not recovered, the banker is l ikely to suf fer a loss and wi l l not be able to balance l iquidi ty wi th prof i tabi l i ty . I t is , therefore, necessary for a banker to keep a c lose watch over advances granted by him to di f ferent types of borrowers.

There are numbers of occasions when a banker wi l l th ink i t necessary to ask a borrower to repay the advances, which are l ike below;

1. Death of borrower or guarantor.

2. Insolvency of borrower or guarantor.

3. Dissolut ion of partnership.

4. I f there is a adverse report in the market about the f inancial soundness of borrower.

5. I f change in pol icy is announced by t ime to t ime from the Reserve Bank of India.

6. There may be some other occasion also, when an advance my have to be recover. These may be under the RBI direct ive or under the Government Legis lat ion.

7. I f the borrower fa i ls to repay, the banker should give a not ice preferably through a lower by register post cal l ing upon the borrower to repay the advances, fa i l ing which he may be proceeded against according to the law.

8. I f necessary the borrowers may be advised or persuaded to repay the advance in instal lments to be f ixed up in consul t ing wi th borrower.

9. The legal course wi l l be avai lable to the banker against the borrower depends upon the type of borrower and the type of secur i ty of fered as a cover for the advances.

10.The banker wi l l therefore have to take appropr iate legal act ion keeping in mind the type of borrower and the type of secur i ty.

The most important point to be noted is that as a banker, whi le fo l lowing the recovery procedure the interest of the bank should always be uppermost in h is mind.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

RNSB’s Recovery management

For banking industry Recovery has become most precious matter . Recovery against advances has become di f f icul t task for banking industry in recession.

Recovery is considered core act iv i ty of banking industry. To make al l t ransact ion and services smooth , recovery is most desirable act iv i ty to be carr ied out forceful ly .

“Recovery Management is consist ing of the funct ions of acquir ing back what the bank has advanced with the pr incip le amount as wel l as interest on same.”

Rajkot Nagar ik Sahakar i Bank is Zero NPA bank in saurashtra region. I t ’s a recordable movement in any co-operat ive banks.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

Process of Recovery:

I f three instal lment are out standing -

# Not ice through branch of f ice

# Personal v is i t and meet ing

In no response –

# Not ice through Advocate

St i l l no ef fect –

# Claim through court

# I f party is ready, out of court set t lement is done.

Otherwise –

# After complet ion of formal i t ies, bank wi l l get the order of

for fe i ture of the secur i ty f rom the court to recover the dues.

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LOAN AND ADVANCES SYSTEM THE SMALL MAN’S BIG BANK RNSB

Identification of Non-Performing Advances

How account become non-performing asset ?

1. Term loan

I f interest or instal lment of pr incipal remains past due for a per iod of any one quarter , i t becomes NPA. Past due means i t is an amount due under any of the faci l i ty but not paid wi th in 30 days af ter i t become due.

2. Cash credit and overdrafts

I f the account remains out of order for a per iod of any one quarter , i t becomes NPA. Out of order means the out standing balance cont inuously in excess of the sanct ioned l imi t or drawing power. In th is case, there is no credi t cont inuously for three months or credi t is not enough to cover the interest debi ted dur ing the same per iod.

3. Bill purchasing and discounting

I f the bi l l remains over due and unpaid for the per iod of one quarter dur ing the year, i t becomes NPA.

4. Other credit facility

I f any amount to be received remains past due for a per iod of one quarter dur ing the year, i t becomes NPA.

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Non-Performing AssetsNPAs are loans given by bank or f inancial inst i tute where the borrower defaul ts or delays payments of interest or repayment of pr incip le . Assets here also include leased assets. An NPA was def ined a credi t faci l i ty in respect of which interest and instal lment of pr incip le has remained ‘past due’ for a speci f ic per iod of t ime. The speci f ied per iod in a phase manner is as under:

Year ending If interest/ instal lment has remained unpaid, account becomes NPA

1993 4 quarters(365 days)

1994 3 quarters(270 days)

1995 onwards 2 quarters(180 days)

From 2004 1 quarters(90 days)

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MISSION 0% (ZERO) NPAThis is an extraordinary scheme for the development of RNSB. Last year when th is concept was come into the l imel ight in met ing of d i rectors then th is scheme was establ ished in suddenly in bank. In th is mission RNSB’s al l the staf f members took upon themselves of their own vol i t ion the task of recovery and a zero NPA project was launched under the guidance of Senior Off icers of Head Off ice & the directors of the Bank.

During th is year RBI had t ightened the NPA norms for defaul t f rom 180 days to 90 days. Despi te th is t ightened norms, the ef for ts put in by the staf f members on their own helped the bank ef fect substant ia l recover ies of NPAs dur ing the year and also prevent s l ippage toward NPAs.

1. This is a f i rst t ime and type mission in any co-operat ive banks history where al l banks employee are work in same mission in same way.

2. No one bank could work on th is funct ion by th is way. So i t ’s an achievement of bank to improve i t s taf f support for th is type of mission.

3. For th is work employee are gett ing mot ivat ion by bank through the t rophy and the other pr izes.

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Progress at Glance

Bank is lend i t ’s 83% f inance to middle c lass and lower c lass customers.

Total advances give by bank was in year 2006 Rs.430.91crores and in 2007 i t is Rs.504.94crores.

CHART SHOWING ADVANCES

S. K. Patel Institute of Management and Computer Studies, GANDHINAGAR 46

GROWTH IN ADVANCES RS. IN CRORES

350

400

450

500

550

Adavances

Adavances 421.55 428.99 430.91 504.94

2003-04 2004-05 2005-06 2006-07

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CHART SHOWING SECURITY WISE ADVANCES

SECURITY WISE ADVANCES RS. IN CRORES.

12.22 58.37

10.66

158.09

229.19

32.32.39

1.72

Hypothecation ofstockHypothecation ofPlant & MachinaryPersonal Surity

Shares

Equitable Mortgageof Land & BuildingPledge of gold

pledge of FD

Other Security

The chart above shows secur i ty wise advances in Rs. In crores.

The maximum share of total advances is of Hypothecat ion of stock of Rs. 229.19 crores

The share of equi table mortgage of land and bui ld ing of Rs. 158.09 with the second number among al l other secur i t ies.

The least share is of personal surety of Rs. 1.72 crore

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Chapter 5 - Theoretical Aspects of the Study

SWOT ANALYSIS

STRENGTH

RNSB was star ted at the in i t iat ives wi th a smal l capi ta l of Rs.4890 and membership of 59 persons but at present bank has developed in manifo lds wi th the t ime. Membership (share holder) of bank is mount ing towards 2, 50,000/- which is record by i t sel f & provides an example of how a mass movement can be turned in to the instrument for social enl is tment of Government of India.

RNSB does other act iv i t ies such Demat safe Deposi tory Walt , custodial service, p ledge etc. that increase the strength of RNSB.

Promoters of RNSB are reputed persons and they al l are f inancial ly sound. No. one of them is involved in speculat ive act iv i ty.

Well spread branch network across the Gujarat and one branch is at Mumbai a lso.

More than 50 years exper ience of banking act iv i t ies.

Qual i f ied manpower. .

Banking services being the core business expert ise in render ing the service.

I t is leading not only in Rajkot but a lso in al l Saurashtra’s co-operat ive bank.

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WEAKNESS

Very l i t t le knowledge about computer ized banking among old staf f .

Lack of personal ized service and direct market ing staf f .

I t is very smal l uni t of industry i t is very di f f icul t to Compete wi th giant pr ivate Sector banks, nat ional ized banks, and mult inat ional banks.

Lack of competent staf f on several important department such as legal , loan, recovery etc.

Recrui tment is not on the professional basis and also i t is same far promot ion pol icy hence there are very less no. of . Ef f ic ient staf f at senior levels.

Technological ly i t is far behind from other banks.

OPPORTUNITY

Developing of banking industry wi l l g ive i t more business opportuni t ies.

Co-operat ive banks can reach easi ly to rural are, which is d i f f icul t for pr ivate Banks.

Providing better qual i ty service, i t can at t ract b ig c l ient .

Convert ing co-operat ive bank into pr ivate Bank. I t can increase i ts strength.

More states can also be covered.

Adopt ion of modern techno.

Logy to remain compet i t ive.

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THREATS

Increasing compet i t ion in th is business no. of compet i tors came in recent t ime.

Co-operat ive sector is neglected by government Constant ly.

Cutthroat compet i t ion by local p layer in terms of service charges. Lack of technological v is ion, lack of v is ion of seeing future.

Pvt. Bank can be big compet i tors and even i f we compare i t wi th schedules bank than also i t ’s compet i tors are in very sound condi t ion.

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BCG MBCG MATRIXATRIX

BCG Growth- Share Matrix

STAR QUESTION MARK

CASH COW DOG

S. K. Patel Institute of Management and Computer Studies, GANDHINAGAR 51

MARKET

GROWTH

RATE

RELATIVE MARKET SHARE

Loans and advances in co-operative sectorFixed Deposite

Demat faci l i tystamp wending

SAVINGS A/C

CURRENT A/C.

LOW

INSURANCE

H

I

G

H

Low

HIGH

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Chapter 6 – DATA ANALYSIS & INTERPRETATION

We Col lect Data of 50 Customer’s of Rajkot Nagar ik sahakar i Bank for knowing sat isfact ion level of Customer’s f rom i t ’s service.

Q-1 Occupation of the Customer?

Criteria No.Business 20Professional 6Service 2Ret i red 10Student 10Other 2Total 50

OCCUPATION

0%0%0%0%0%0%

40%

12%4%

20%

20%

4%

BUSSINESS

PROFESSION

RETIER

SERVICE

STUDENT

OTHER

Analysis:

From the above content we can see that the research that contain the data of businessman, professional people, service c lass person and ret i red persona and we also include student for knowing actual data.

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Q-2 Since How long you deal with the Rajkot Nagarik sahakari Bank?

Criteria Less than 1 Yr. 1 to 5 Yr. 5 & AboveNo. of customer 15 15 20

LOYALTY

40%

30%

30%

LESS THAN 1 YEAR

1 TO 5 YEARS

MORE THAN 5 YEARS

Analysis:

From the given data we can analyze that near about 40 % of customer who deals in bank s ince more than 5 year and 30% of customer who are deals wi th 1 to 5 Year and 30% of customer who deals wi th less than 1 year and they are very much sat isf ied wi th the services of banks and also convince to invest in only Rajk iot Nagar ik Sahakar i bank.

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Q-3 How often you visit in Rajkot Nagarik sahakari Bank.

Criteria No.Dai ly 13Two Days in Week 7Weekly 5Not Fix 25Total 50

CONTACT WITH BANK

26%

14%

10%

50%

DAILY

2 DAYS IN A WEEK

WEEKLY

NO FIX

Analysis:

From above given research we can f ind that 26% of customer v is i ts bank dai ly and 14% of customer that v is i ts the bank 2 days in week and 10% of customer v is i t the bank week and 50% of customer are not f ix to v is i t bank they come to bank to make transact ion according to their need.

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Q-4 With Which Product you dealing in Rajkot Nagarik sahakari Bank?

Option No.Saving A/c. 30Current A/c. 72Recurr ing A /c. 0Sp.saving A/c. 9C.C.A/c. 28Other 11Total 150

TYPES OF ACCOUNT

44%

30%

0%

10%

8%

8%

SAVING A/C

CURRENT A/C

RECURRING A/C

SP. SAVING A/C

CASH CREDIT

OTHER

Analysis:

The data which we col lected is contain the 30% of current account customer whi le 44% of saving a/c and other customer holding di f ferent product of bank l ike 8% customer holding cash credi t account, 10% customer holding special saving account and approximately 8% customer holding other types of account .

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Q. 5 Have you take any loan from Rajkot Nagarik Sahakari Bank?

Yes 33

No 17

Total 50

LOANS

66%

34%

YES

NO

Analysis:

The Data which we col lect I contain the 66% having loan from bank and 34% costumer has not taking loan from RNSB.

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Q.6 How much time taken by bank to pass loan?

2 Days 33

4 Days 99

1 week 1111

More than 1 week 1010

Total 33

TIME DURATION

9%

27%

34%

30%

2 DAYS

4 DAYS

1 WEEK

MORE THAN WEEK

Analysis:

From above given research we can f ind that 34% loan passing in 1 week, 30% loans are passing trough more than 1 week, 27% loans are passing in 4 days and 9% loans are passing in 2 days.

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Q-7 What is the level of Satisfaction from Rajkot Nagarik Sahakari Bank?

Option No.

Highly Sat isf ied 11

Sat isf ied 25

Indi f ferent 13

Dissat isf ied 1

Highly Dissat isf ied 0

Total 50

CONSUMER SATISFACTION

50%

26%22%

2% 0%

HIGHLY SATISFIED

SATISFIED

INDIFFERENT

DISSATISFIED

HIGHLY DISSATISFIED

Analysis:

From this research quest ion, we can analyze sat isfact ion level of the customer is

near about 50% of the customers are sat isf ied wi th the service of the bank and

near about 20% of customer are highly sat isf ied wi th the services given by

RNSB.

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Chapter 7 – FINDINGS

FINDINGS

This chapter contains some of the f indings f rom my study of selected Rakot Nagar ik Sahakar i Bank (Urban Co-operat ive Banks).

1. The strong points of RNSB is i t ’s f inancial strength, amount of deposi tors and good services.

2. In some of the area l ike loan, f i rm is very r ig id so, f lexib i l i ty is needed.

3. One of the important point is that new cl ient comes through the recommendat ions of the exist ing customers.

4. The main th ing is that RNSB is lacking the market ing strategy in the banking area.

5. The new cl ient must be member of RNSB (Share Holder) .

6. In the area of Loans and Advances, RNSB having a least rate of interest among the nat ional ize as wel l as co-operat ive sector.

7. The tendency to donate generously to inst i tut ions by the Board of Directors of Rajkot Nagar ik Sahakar i Bank is commendable. Some of inst i tut ions to whom huge contr ibut ions are given are V.V.P. Engineer ing Col lege, Satya Sai Heart Hospi ta l , Ashok Gondhia Memorial Hospi ta l (Now Wockhart) etc.

8. Pract ice of easy avai labi l i ty of of f ice bearers of the Rajkot Nagar ik Sahakar i Bank Ltd. For the members, a customer or loanees is wel l adopted. This also serves as the intel l igent agency to keep a watch on the ways and means how the Bank advances are ut i l ized.

Chapter 8 - SUGGESTIONS

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There are certa in glar ing suggest ions by fo l lowing that there can be better development of Rajkot Nagar ik Sahakar i banks.

1. Many people wants the on- l ine demat faci l i ty f rom the bank.

2. Bank should also provide ATM, Phone Banking and Net-Banking.

3. I t is a lso required to increase working hours not l ike pr ivate bank but more than the other co-operat ive banks because i t creates very good image in the mind of the people.

4. Banks area of working is l imi ted so, people wants more branches at urban area l ike Ahmedabad and other area of Gujarat .

5. RNSB must have to adopt new and advance technology, by th is adopt ion bank can provide better qual i ty service and process and saving of t ime.

6. Bank’s some loan schemes are very good, but the amount of that loans are lower than the other banks. So, customers are at t ract towards other banks.

7. Bank has to take customer sat isfact ion review per iodical ly l ike some pr ivate banks.

8. To improve ef f ic iency of employees of Co-operat ive Banks, a fu l l f ledged tra in ing centre for the benef i ts of the employees should be establ ished and regular ly run by the leading Co-operat ive Bank v iz. Rajkot Nagar ik Sahakar i Bank Ltd.

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QUESTIONNAIRE FOR RNSB USING CUSTOMER

This research is only for purpose of studying the satisfaction level of customers. The information provided by you is not used for any other purpose. As I am student of MBA, I surveying about the satisfaction level of customer’s of RNSB. I expected your kind cooperation for filling this questionnaire.

( 1 ) General Information of Customers :-A.) Name :-

______________________________________________B.) Address :-

____________________________________________________________________________________________

C.) Contact No. ___________ _______________________

D.) Occupation :-

Business Profession Retire

Service Students Other

E.) Yearly Income :-____ _______________________

( 2 ) Since how long you deal with RNSB ?

(A.) Less than 1 year

(B.) 1 to 5 years

(C.) More than 5 year

( 3 ) how often have you been in contact with RNSB ?

Daily Two days in a week

Weekly No fix

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( 4 ) Which type of account do you have in RNSB ?Saving a/c Current a/c Recurring a/c

Sp. Saving a/c Cash Credit Other

( 5 ) Your Selection of Bank is Based on ( Give Rank 1 to 5 )

(A.) Safety

(B.) Service

(C.) Reputation

(D.) Rates

(E.) Proximity

( 6 ) Have you take any loan from RNSB?YES NO

( 7 ) IF YES than describe it.

( 8 ) How much time taken by bank to pass loan?

2 days 4 days

1 week more than 1week.

( 9 ) Do you deal with other Bank ?

Yes No

( 10 ) If yes, where ?_______________________________________________________

( 11 ) Do you find any difference in service of RNSB with comparison of other Banks ?

Yes No

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( 12 ) If yes, state the Difference :

______________________________________________________

( 13 ) What is the level of satisfaction about service provided by RNSB ?

(A.) Highly Satisfied

(B.) Satisfied

(C.) Indifferent

(D.) Dissatisfied

(E.) Highly Dissatisfied

( 14 ) Have you faced any difficulty with RNSB ?

Yes No

( 15 ) Was it Solved ?

Yes No

( 16 ) In what time ?

1 day 2 days

Week more than week

( 17 ) Would you Recommend RNSB to others ?

Yes No

( 18 ) Suggestions :______________________________________________________

__________________________________________________________________________________________________________________________________________________________________

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BIBLIOGRAPHY

Websites

www.rnsbindia.com

www.rbi.com

www.google.com ( search engine )

Reference Books & Journal

Financial Management by Prasanna Chandra 5 t h edit ion

Banking & Finance

Bank’s Document

Annual Report 2006-07

Information Collected from other bank.

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TABLE OF CONTENT

CHAPTERNO.

CHAPTER NAME Page no.

Declarat ion I

Preface II

Acknowledgement III

Execut ive summary IV

1 Introduct ion 1

2 Research Methodology2.1 Research purpose2.2 Scop of study2.3 Sources of data2.4 Sampl ing design2.5 Limitat ion of study

2

3 Industry prof i le 3.1 Ear ly h istory of banking 3.2 Types of Bank 3.3 Di f ferences of commercial bank and co- operat ive bank

5

4 Company prof i le4.1 History of RNSB4.2 Social contr ibut ion4.3 Features4.4 Organizat ional structure4.5 Types of loans and advances4.6 Loan procedure4.7 Margin money4.8 Recovery procedure4.9 Non Performing Assests4.10 Progress at Glance

11

5 Theoret ical Aspects of the Study 48

6 Data analysis and interpretat ion 52

7 Research Findings 59

8 Suggest ions 60

9 Annexure 61

10 Bibl iography 64

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AGRAND PROJECT REPORT

ON

“FUNDAMENTAL ANALYSIS OF FOREIGN EXCHANGE RATES”

As a Part of Partial Fulfillment of the MBA Degree2006-08

Guided ByProf. Abhishek Ranga

Prof. Sonu Gupta

Prepared ByMayur Vaniya (114)Deepak Danger (15)

Submitted To

S. K. Patel Institute of Management & Computer Studies

GANDHINAGAR

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ACKNOWLEDEMENT

We, the students of S.K.Patel Institute of Management & Computer

Studies are extremely thankful to our institute for giving us an

opportunity to undertake this Grand Project.

We are very much thankful to and their supervision and patiently

responding to our various queries and for his valuable guidance. We

are also thankful to our Director Prof. S.Chinnam Reddy & Prof. Sonu

Gupta and Prof. Abhishek Ranga (project guide) and Prof. Prakas

Chawala (co-ordinator) for providing us the helpful support for

completing the report in a for given schedule. Thanks for their

benevolent support and kind attention. Their valuable guidance at

each and every stage of the project always gave a Phillip to our

enthusiasm.

Last but not the least we express our gratitude to all people who are

directly or indirectly involved in the preparation of this report.

Deepak Danger

Mayur vaniya

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EXECUTIVE SUMMARY

The rapid industrialization, advancement in technology and

communication facilities, the availability of rapid means of

transportation has all contributed towards the globalization of business

across the frontiers of countries. There have been new innovations in

the products developments. The government of India has also opened

Indian economy. Various fiscal, trade and industrial policy decisions

have been taken and new avenues provided to foreign investors like

FII’s and NRI’s etc. for investment especially infra-structural sectors

like power, and telecommunications etc.

This projects attempts to study the intricacies of the Foreign Exchange

Market and to develop Fundamental model of exchange rate

prediction. The main purpose of this study is to give a better idea and

the comprehensive details of foreign exchange market and risk

management and how to predict exchange rate.

The project starts with the various concept and system used in the

foreign exchange market in the world. It also highlights about the

exchange rate system used in various countries till date. The second

part of the study focus on fundamental model of exchange rate

predication and risk management techniques available.

The project then highlights the various hedging tools used by various

banks and individuals to hedge their risk. The major hedging tools

included are forward, options, swaps and futures.

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Sr.No. Particulars Page no.

1. Introduction

1.1 Foreign Exchange Overview.

1.2 About Foreign Exchange Market.

1.3 Participants in foreign exchange

2. Research Methodology

2.1 Main objective

2.2 Data collection

2.3 Data analysis

2.4 Limitations of the Study.

3. Industry Profile

3.1 Exchange Rate System.

3.2 Fundamentals in Foreign Exchange

3.3 Hedging Tools

4. Theoretical Aspect of the study

4.1 Forecasting Exchange Rates

5. Research Findings and Conclusions

5.1 Data Analysis

5.2 Conclusions

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6. Bibliography

6.1 Name of Books

6.2 Name of Bulletins

6.3 Name of Websites

6.4 Search engine

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INTRODUCTION

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FOREIGN EXCHANGE MARKET OVERVIEW

In today’s world no economy is self sufficient, so there is need for

exchange of goods and services amongst the different countries. So in

this global village, unlike in the primitive age the exchange of goods

and services is no longer carried out on barter basis. Every sovereign

country in the world has a currency that is legal tender in its territory

and this currency does not act as money outside its boundaries. So

whenever a country buys or sells goods and services from or to

another country, the residents of two countries have to exchange

currencies. So we can imagine that if all countries have the same

currency then there is no need for foreign exchange.

NEED FOR FOREIGN EXCHANGE

Let us consider a case where Indian company exports cotton

fabrics to USA and invoices the goods in US dollar. The American

importer will pay the amount in US dollar, as the same is his home

currency. However the Indian exporter requires rupees means his

home currency for procuring raw materials and for payment to the

labor charges etc. Thus he would need exchanging US dollar for rupee.

If the Indian exporters invoice their goods in rupees, then importer in

USA will get his dollar converted in rupee and pay the exporter.

From the above example we can infer that in case goods are bought or

sold outside the country, exchange of currency is necessary.

Sometimes it also happens that the transactions between two

countries will be settled in the currency of third country. In that case

both the countries that are transacting will require converting their

respective currencies in the currency of third country. For that also the

foreign exchange is required.

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ABOUT FOREIGN EXCHANGE MARKET

Particularly for foreign exchange market there is no market place

called the foreign exchange market. It is mechanism through which

one country’s currency can be exchange i.e. bought or sold for

The currency of another country. The foreign exchange market does

not have any geographic location.

Foreign exchange market is described as an OTC (over the counter)

market as there is no physical place where the participant meets to

execute the deals, as we see in the case of stock exchange. The

largest foreign exchange market is in London, followed by the New

York, Tokyo, Zurich and Frankfurt. The markets are situated throughout

the different time zone of the globe in such a way that one market is

closing the other is beginning its operation. Therefore it is stated that

foreign exchange market is functioning throughout 24 hours a day.

In most market US dollar is the vehicle currency, viz., the currency

sued to dominate international transaction. In India, foreign exchange

has been given a statutory definition. Section 2 (b) of foreign exchange

regulation ACT,1973 states:

Foreign exchange means foreign currency and includes :

All deposits, credits and balance payable in any foreign currency

and any draft, traveler’s cheques, letter of credit and bills of

exchange. Expressed or drawn in India currency but payable in

any foreign currency.

Any instrument payable, at the option of drawee or holder

thereof or any other party thereto, either in Indian currency or in

foreign currency or partly in one and partly in the other.

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In order to provide facilities to members of the public and foreigners

visiting India, for exchange of foreign currency into Indian currency

and vice-versa. RBI has granted to various firms and individuals,

license to undertake money-changing business at seas/airport and

tourism place of tourist interest in India. Besides certain authorized

dealers in foreign exchange (banks) have also been permitted to

open exchange bureaus.

Following are the major bifurcations:

Full fledge moneychangers – they are the firms and

individuals who have been authorized to take both, purchase and

sale transaction with the public.

Restricted moneychanger – they are shops, emporia and

hotels etc. that have been authorized only to purchase foreign

currency towards cost of goods supplied or services rendered by

them or for conversion into rupees.

Authorized dealers – they are one who can undertake all types

of foreign exchange transaction. Banks are only the authorized

dealers. The only exceptions are Thomas cook, western union,

UAE exchange which though, and not a bank is an AD.

Even among the banks RBI has categorized them as follows:

Branch A – They are the branches that have nostro and vostro

account.

Branch B – The branch that can deal in all other transaction but

do not maintain nostro and vostro a/c’s fall under this category.

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Branch C - such branches cannot do anything with forex

business.

For Indian we can conclude that foreign exchange refers to

foreign money, which includes notes, cheques, bills of exchange,

bank balance and deposits in foreign currencies.

PARTICIPANTS IN FOREIGN EXCHANGE MARKET

The main players in foreign exchange market are as follows:

1. CUSTOMERS

The customers who are engaged in foreign trade participate in

foreign exchange market by availing of the services of banks.

Exporters require converting the dollars in to rupee and importers

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

dollars for the goods/services they have imported.

2. COMMERCIAL BANKS

They are most active players in the forex market. Commercial bank

dealing with international transaction offer services for conversion

of one currency in to another. They have wide network of branches.

Typically banks buy foreign exchange from exporters and sells

foreign exchange to the importers of goods. As every time the

foreign exchange bought or oversold position. The balance amount

is sold or bought from the market.

3. CENTRAL BANK

In all countries Central bank have been charged with the responsibility

of maintaining the external value of the domestic currency. Generally

this is achieved by the intervention of the bank.

4. EXCHANGE BROKERS

Forex brokers play very important role in the foreign

exchange market. However the extent to which services of

foreign brokers are utilized depends on the tradition and practice

prevailing at a particular forex market center. In India as per

FEDAI guideline the Ads are free to deal directly among

themselves without going through brokers. The brokers are not

among to allowed to deal in their own account allover the world

and also in India.

5. OVERSEAS FOREX MARKET

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Today the daily global turnover is estimated to be more

than US $ 1.5 trillion a day. The international trade however

constitutes hardly 5 to 7 % of this total turnover. The rest of

trading in world forex market is constituted of financial

transaction and speculation. As we know that the forex market is

24-hour market, the day begins with Tokyo and thereafter

Singapore opens, thereafter India, followed by Bahrain, Frankfurt,

paris, London, new york, Sydney, and back to Tokyo.

6. SPECULATORS

The speculators are the major players in the forex market.

Bank dealing are the major pseculators in the forex market

with a view to make profit on account of favorable movement

in exchange rate, take position i.e. if they feel that rate of

particular currento go up in short term. They buy that

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

profit.

Corporation’s particularly multinational corporation and

transnational corporation having business operation

beyond their national frontiers and on account of their

cash flows being large and in multi currencies get in to

foreign exchange exposures. With a view to make

advantage of exchange rate movement in their favor they

either delay covering exposures or do not cover until cash

flow materialize.

Individual like share dealing 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 result in speculations.

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Research

Methodology

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Research Methodology

OBJECTIVES

This project attempts

To study the intricacies of the foreign exchange market.

To develop fundamental model of exchange rate prediction.

To know the trend of exchange rate fluctuation.

To know about the various concepts and technicalities in

foreign exchange.

To get the knowledge about the hedging tools used in foreign

exchange.

DATA COLLECTION

Secondary data collection

From 1. Books

2. Websites

3. Journals and Bulletins

DATA ANALYSIS

Data are analyzed by brainstorming

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LIMITATIONS OF THE STUDY

As project concerned with Indo-US data but Rupee is not fully

convertible so monetary approach to exchange rate may lead

to error.

Some data are taken by interpolations so it can have some

amount of error.

Some where in the data are converted from financial year to

Annual form.

Some places data are approximated to match the date as per

requirement.

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INDUSTRY

PROFILE

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EXCHANGE RATE SYSTEM

INTRODUCTION

Countries of the world have been exchanging goods and services

amongst themselves. This has been going on from time immemorial.

The world has come a long way from the days of barter trade. With the

invention of money the figures and problems of barter trade have

disappeared. The barter trade has given way ton exchanged of goods

and services for currencies instead of goods and services.

The rupee was historically linked with pound sterling. India was a

founder member of the IMF. During the existence of the fixed

exchange rate system, the intervention currency of the Reserve Bank

of India (RBI) was the British pound, the RBI ensured maintenance of

the exchange rate by selling and buying pound against rupees at fixed

rates. The inter bank rate therefore ruled the RBI band. During the

fixed exchange rate era, there was only one major change in the parity

of the rupee- devaluation in June 1966.

Different countries have adopted different exchange rate system at

different time. The following are some of the exchange rate system

followed by various countries.

THE GOLD STANDARD

Many countries have adopted gold standard as their monetary system

during the last two decades of the 19th century. This system was in

vogue till the outbreak of world war 1. under this system the parties of

currencies were fixed in term of gold. There were two main types of

gold standard:

1) gold specie standard

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Gold was recognized as means of international settlement for receipts

and payments amongst countries. Gold coins were an accepted mode

of payment and medium of exchange in domestic market also. A

country was stated to be on gold standard if the following condition

were satisfied:

Monetary authority, generally the central bank of the country,

guaranteed to buy and sell gold in unrestricted amounts at the

fixed price.

Melting gold including gold coins, and putting it to different uses

was freely allowed.

Import and export of gold was freely allowed.

The total money supply in the country was determined by the

quantum of gold available for monetary purpose.

2) Gold Bullion Standard

Under this system, the money in circulation was either partly of

entirely paper and gold served as reserve asset for the money supply..

However, paper money could be exchanged for gold at any time. The

exchange rate varied depending upon the gold content of currencies.

This was also known as “ Mint Parity Theory “ of exchange rates.

The gold bullion standard prevailed from about 1870 until 1914, and

intermittently thereafter until 1944. World War I brought an end to the

gold standard.

BRETTON WOODS SYSTEM

During the world wars, economies of almost all the countries suffered.

In ordere to correct the balance of payments disequilibrium, many

countries devalued their currencies. Consequently, the international

trade suffered a deathblow. In 1944, following World War II, the United

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States and most of its allies ratified the Bretton Woods Agreement,

which set up an adjustable parity exchange-rate system under which

exchange rates were fixed (Pegged) within narrow intervention limits

(pegs) by the United States and foreign central banks buying and

selling foreign currencies. This agreement, fostered by a new spirit of

international cooperation, was in response to financial chaos that had

reigned before and during the war.

In addition to setting up fixed exchange parities (par values) of

currencies in relationship to gold, the agreement established the

International Monetary Fund (IMF) to act as the “custodian” of the

system.

Under this system there were uncontrollable capital flows, which lead

to major countries suspending their obligation to intervene in the

market and the Bretton Wood System, with its fixed parities, was

effectively buried. Thus, the world economy has been living through an

era of floating exchange rates since the early 1970.

FLOATING RATE SYSTEM

In a truly floating exchange rate regime, the relative prices of

currencies are decided entirely by the market forces of demand and

supply. There is no attempt by the authorities to influence exchange

rate. Where government interferes’ directly or through various

monetary and fiscal measures in determining the exchange rate, it is

known as managed of dirty float.

PURCHASING POWER PARITY (PPP)

Professor Gustav Cassel, a Swedish economist, introduced this system.

The theory, to put in simple terms states that currencies are valued for

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what they can buy and the currencies have no intrinsic value attached

to it. Therefore, under this theory the exchange rate was to be

determined and the sole criterion being the purchasing power of the

countries. As per this theory if there were no trade controls, then the

balance of payments equilibrium would always be maintained. Thus if

150 INR buy a fountain pen and the samen fountain pen can be bought

for USD 2, it can be inferred that since 2 USD or 150 INR can buy the

same fountain pen, therefore USD 2 = INR 150.

For example India has a higher rate of inflation as compaed to country

US then goods produced in India would become costlier as compared

to goods produced in US. This would induce imports in India and also

the goods produced in India being costlier would lose in international

competition to goods produced in US. This decrease in exports of India

as compared to exports from US would lead to demand for the

currency of US and excess supply of currency of India. This in turn,

cause currency of India to depreciate in comparison of currency of Us

that is having relatively more exports.

FUNDAMENTALS IN EXCHANGE RATES

METODS OF QOUTING RATE

Exchange rate is a rate at which one currency can be exchange in to

another currency, say USD = Rs.48. This rate is the rate of conversion

of US dollar in to Indian rupee and vice versa.

EXCHANGE QUOTATION

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______________________

DIRECT INDIRECT

VARIABLE UNIT VARIABLE UNIT

HOME CURRENCY FOREIGN CURRENCY

There are two methods of quoting exchange rates.

1) Direct methods

Foreign currency is kept constant and home currency is kept variable.

In direct quotation, the principle adopted by bank is to buy at a lower

price and sell at higher price.

2) In direct method:

Home currency is kept constant and foreign currency is kept variable.

Here the strategy used by bank is to buy high and sell low. In India

with effect from august 2, 1993 all the exchange rates are quoted in

direct method.

It is customary in foreign exchange market to always quote two rates

means one for buying and another rate for selling. This helps in

eliminating the risk of being given bad rates i.e. if a party comes to

know what the other party intends to do i.e. buy or sell, the former can

take the letter for a ride.

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There are two parties in an exchange deal of currencies. To initiate the

deal one party asks for quote from another party and other party

quotes a rate. The party asking for a quote is known as’ asking party

and the party giving a quotes is known as quoting party.

The advantage of two–way quote is as under

i. The market continuously makes available price for buyers or

sellers

ii. Two way price limits the profit margin of the quoting bank and

comparison of one quote with another quote can be done

instantaneously.

iii. As it is not necessary any player in the market to indicate

whether he intends to buy or sale foreign currency, this

ensures that the quoting bank cannot take advantage by

manipulating the prices.

iv. It automatically insures that alignment of rates with market

rates.

v. Two way quotes lend depth and liquidity to the market, which

is so very essential for efficient market.

`

In two way quotes the first rate is the rate for buying and another for

selling. We should understand here that, in India the banks, which are

authorized dealer always, quote rates. So the rates quoted- buying and

selling is for banks point of view only. It means that if exporters want

to sell the dollars then the bank will buy the dollars from him so while

calculation the first rate will be used which is

Buying rate, as the bank is buying the dollars from exporter. The same

case will happen inversely with importer as he will buy dollars from the

bank and bank will sell dollars to importer.

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FACTOR AFFECTINGN EXCHANGE RATES

In free market, it is the demand and supply of the currency which

should determine the exchange rates but demand and supply is the

dependent on many factors, which are ultimately the cause of the

exchange rate fluctuation, some times wild.

The volatility of exchange rates cannot be traced to the single reason

and consequently, it becomes difficult to precisely define the factors

that affect exchange rates. However, the more important among them

are as follows:

STRENGTH OF ECONOMY

Economic factors affecting exchange rates include hedging activities,

interest rates, inflationary pressures, trade imbalance, and euro

market activities. Irving fisher, an American economist, developed a

theory relating exchange rates to interest rates. This proposition,

known as the fisher effect, states that interest rate differentials tend to

reflect exchange rate expectation.

On the other hand, the purchasing- power parity theory relates

exchange rates to inflationary pressures. In its absolute version, this

theory states that the equilibrium exchange rate equals the ratio of

domestic to foreign prices. The relative version of the theory relates

changes in the exchange rate to changes in price ratios.

POLITICAL FACTOR

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The political factor influencing exchange rates include the established

monetary policy along with government action on items such as the

money supply, inflation, taxes, and deficit financing. Active

government intervention or manipulation, such as central bank activity

in the foreign currency market, also have an impact. Other political

factors influencing exchange rates include the political stability of a

country and its relative economic exposure (the perceived need for

certain levels and types of imports). Finally, there is also the influence

of the international monetary fund.

EXPACTATION OF THE FOREIGN EXCHANGE MARKET

Psychological factors also influence exchange rates. These factors

include market anticipation, speculative pressures, and future

expectations.

A few financial experts are of the opinion that in today’s environment,

the only ‘trustworthy’ method of predicting exchange rates by gut feel.

Bob Eveling, vice president of financial markets at SG, is corporate

finance’s top foreign exchange forecaster for 1999. eveling’s gut

feeling has, defined convention, and his method proved uncannily

accurate in foreign exchange forecasting in 1998.SG ended the

corporate finance forecasting year with a 2.66% error overall, the most

accurate among 19 banks. The secret to eveling’s intuition on any

currency is keeping abreast of world events. Any event,from a

declaration of war to a fainting political leader, can take its toll on a

currency’s value. Today, instead of formal modals, most forecasters

rely on an amalgam that is part economic fundamentals, part model

and part judgment.

Fiscal policy

Interest rates

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Monetary policy

Balance of payment

Exchange control

Central bank intervention

Speculation

Technical factors

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HEDGING TOOLS

INTRODUCTION

Consider a hypothetical situation in which ABC trading co. has to

import a raw material for manufacturing goods. But this raw material is

required only after three months. However, in three months the price

of raw material may go up or go down due to foreign exchange

fluctuations and at this point of time it can not be predicted whether

the price would go up or come down. Thus he is exposed to risks with

fluctuations in forex rate. If he buys the goods in advance then he will

incur heavy interest and storage charges. However, the availability of

derivatives solves the problem of importer. He can buy currency

derivatives. Now any loss due to rise in raw material price would be

offset by profits on the futures contract and viceversa. Hence, the

derivatives are the hedging tools that are available to companies to

cover the foreign exchange exposure faced by them.

Definition of Derivatives

Derivatives are financial contracts of predetermined fixed duration,

whose values are derived from the value of an underlying primary

financial instrument, commodity or index, such as : interest rate,

exchange rates, commodities, and equities.

Derivatives are risk shifting instruments. Initially, they were used to

reduce exposure to changes in foreign exchange rates, interest rates,

or stock indexes or commonly known as risk hedging. Hedging is the

most important aspect of derivatives and also its basic economic

purpose. There has to be counter party to hedgers and they are

speculators.

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Derivatives have come into existence because of the prevalence of risk

in every business. This risk could be physical, operating, investment

and credit risk.

Derivatives provide a means of managing such a risk. The need to

manage external risk is thus one pillar of the derivative market. Parties

wishing to manage their risk are called hedgers.

The common derivative products are forwards, options, swaps and

futures.

1. Forward Contracts

Forward exchange contract is a firm and binding contract, entered into

by the bank and its customers, for purchase of specified amount of

foreign currency at an agreed rate of exchange for delivery and

payment at a future date or period agreed upon at the time of entering

into forward deal.

The bank on its part will cover itself either in the interbank market or

by matching a contract to sell with a contract to buy. The contract

between customer and bank is essentially written agreement and bank

generally stand to make a loss if the customer defaults in fulfilling his

commitment to sell foreign currency.

A foreign exchange forward contract is a contract under which the

bank agrees to sell or buy a fixed amount of currency to or from the

company on an agreed future date in exchange for a fixed amount of

another currency. No money is exchanged until the future date.

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A company will usually enter into forward contract when it knows there

will be a need to buy or sell for an currency on a certain date in the

future. It may believe that today’s forward rate will prove to be more

favourable than the spot rate prevailing on that future date.

Alternatively, the company may just want to eliminate the uncertainity

associated with foreign exchange rate movements.

The forward contract commits both parties to carrying out the

exchange of currencies at the agreed rate, irrespective of whatever

happens to the exchange rate.

The rate quoted for a forward contract is not an estimate of what the

exchange rate will be on the agreed future date. It reflects the interest

rate differential between the two currencies involved. The forward rate

may be higher or lower than the market exchange rate on the day the

contract is entered into.

Forward rate has two components.

Spot rate

Forward points

Forward points, also called as forward differentials, reflects the

interest differential between the pair of currencies provided capital

flow are freely allowed. This is not true in case of US $ / rupee rate as

there is exchange control regulations prohibiting free movement of

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capital from / into India. In case of US $ / rupee it is pure demand and

supply which determines forward differential.

Forward rates are quoted by indicating spot rate and premium /

discount.

In direct rate,

Forward rate = spot rate + premium / - discount.

Example:

The inter bank rate for 31st March is 44.60

Premium for forwards are as follows.

Month Paise

April 40/42

May 65/67

June 87/88

If a one month forward is taken then the forward rate would be

44.60 + .42 = 49.12

If a two months forward is taken then the forward rate would be

44.60. + .67 = 49.37.

If a three month forward is taken then the forward rate would be

44.60 + .88 = 49.58.

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Example:

Let’s take the same example for a broken date Forward

Contract Spot rate = 48.70 for 31st March.

Premium for forwards are as follows

30th April 48.70 + 0.42

31st May 48.70 + 0.67

30th June 48.87 + 0.88

For 17th May the premium would be (0.67 – 0.42) * 17/31 = 0.137

Therefore the premium up to 17th May would be 48.70 + 0.807 =

49.507.

Premium when a currency is costlier in future (forward) as compared

to spot, the currency is said to be at premium vis-à-vis another

currency.

Discount when a currency is cheaper in future (forward) as compared

to spot, the currency is said to be at discount vis-à-vis another

currency.

Example:

A company needs DEM 235000 in six months’ time.

Market parameters :

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Spot rate IEP/DEM – 2.3500

Six months Forward Rate IEP/DEM –2.3300

Solutions available:

The company can do nothing and hope that the rate in six

months time will be more favorable than the current six months

rate. This would be a successful strategy if in six months time

the rate is higher than 2.33. However, if in six months time the

rate is lower than 2.33, the company will have to loose money.

It can avoid the risk of rates being lower in the future by

entering into a forward contract now to buy DEM 235000 for

delivery in six months time at an IEP/DEM rate of 2.33.

It can decide on some combinations of the above.

Various options available in forward contracts:

A forward contract once booked can be cancelled, rolled over,

extended and even early delivery can be made.

Roll over forward contracts

Rollover forward contracts are one where forward exchange contract is

initially booked for the total amount of loan etc. to be re-paid. As and

when installment falls due, the same is paid by the customer at the

exchange rate fixed in forward exchange contract. The balance

amount of the contract rolled over till the date for the next installment.

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The process of extension continues till the loan amount has been re-

paid. But the extension is available subject to the cost being paid by

the customer. Thus, under the mechanism of roll over contracts, the

exchange rate protection is provided for the entire period of the

contract and the customer has to bear the roll over charges. The cost

of extension (rollover) is dependent upon the forward differentials

prevailing on the date of extension. Thus, the customer effectively

protects himself against the adverse spot exchange rates but he takes

a risk on the forward differentials. (i.e. premium/discount). Although

spot exchange rates and forward differentials are prone to fluctuations,

yet the spot exchange rates being more volatile the customer gets the

protection against the adverse movements of the exchange rates.

A corporate can book with the Authorised Dealer a forward cover on

roll-over basis as necessitated by the maturity dates of the underlying

transactions, market conditions and the need to reduce the cost to the

customer.

Example:

An importer has entered into a 3 months forward contract in the month

of February.

Spot Rate = 48.65

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Forward premium for 3 months (May) = 0.75

Therefore rate for the contract = 48.65 + 0.75 = 49.45

Suppose, in the month of May the importer realizes that he will not be

able to make the payment in May, and he can make payment only in

July. Now as per the guidelines of RBI and FEDAI he can cancel the

contract, but he cannot re-book the contract. So for this the importer

will go for a roll-over forward for May over July.

The premium for May is 0.75 (sell) and the premium for July is 0.95

(buy).

Therefore the additional cost i.e. (0.95 – 0.75) = 0.25 will have to be

paid to the bank.

The bank then fixes a notional rate. Let’s say it is 48.66.

Therefore in May he will sell 48.66 + 0.75 = 49.41

And in July he will buy 48.66 + 119.75 = 49.85

Therefore the additional cost (49.85 – 49.41) = 0.4475 will have to be

paid to the Bank by the importer.

Cancellation of Forward Contract

A corporate can freely cancel a forward contract booked if desired by

it. It can again cover the exposure with the same or other Authorised

Dealer. However contracts relating to non-trade transaction\imports

with one leg in Indian rupees once cancelled could not be rebooked till

now. This regulation was imposed to stem bolatility in the foreign

exchange market, which was driving down the

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rupee.

Thus the whole objective behind this was to stall speculation in the

currency.

But now the RBI has lifted the 4-year-old ban on companies re-booking

the forward transactions for imports and non-traded transactions. It

has been decided to extend the freedom of re-booking the import

forward contract up to 100% of un-hedged exposures

Falling due within one year, subject to a cap of $ 100 Mio in a financial

year per corporate.

The removal of this ban would give freedom to corporate Treasurers

who sould be in apposition to reduce their foreign exchange risks by

canceling their existing forweard transactions and re-booking them at

better rates. Thus this in not liberalization, but it is restoration of the

status quo ante.

Also the Details of cancelled forward contracts are no more required to

be reported to the RBI.

The following are the guidelines that have to be followee in case of

cancellation of a forward contract.

1.) In case of cancellation of a contract by the client (the request

should be made on or before the maturity date) the Authorised Dealer

shall recover/pay the, as the case may be, the difference between the

contracted rate and the rate at which the cancellation is effected. The

recovery/payment of exchange difference on canceling the contract

may be up front or back – ended in the discretion of banks.

2.) Rate at which the cancellation is to be effected :

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Purchase contracts shall be cancelled at the contracting

Authorised Dealers spot T.T. selling rate current on the date of

cancellation.

Sale contract shall be cancelled at the contracting Authorised

Dealers spot T.T. selling rate current on the date of cancellation.

Where the contract is cancelled before maturity, the appropriate

forward T.T. rate shall be applied.

3.) Exchange difference not exceeding Rs. 100 is being ignored by

the contracting Bank.

4.) In the absence of any instructions from the client, the contracts,

which have matured, shall be automatically cancelled on 15 th day falls

on a Saturday or holiday, the contract shall be cancelled on the next

succeeding working day.

In case of cancellation of the contract

1.) Swap, cost if any shall be paid by the client under advice to him.

2.) When the contract is cancelled after the due date, the client is

not entitled to the exchange difference, if any in his favor, since the

contract is cancelled on account of his default. He shall however, be

liable to pay the exchange difference, against him.

Early Delivery

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Suppose an Exporter receives an Export order worth USD 500000 on

30/06/2000 and expects shipment of goods to take place on

30/09/2000. On 30/06/200 he sells USD 500000 value 30/09/2000 to

cover his FX exposure.

Due to certain developments, internal or external, the exporter now is

in a position to ship the goods on 30/08/2000. He agrees this change

with his foreign importer and documents it. The problem arises with

the Bank as the exporter has already obtained cover for 30/09/2000.

He now has to amend the contract with the bank, whereby he would

give early delivery of USD 500000 to the bank for value 30/08/2000.

i.e. the new date of shipment.

However, when he sold USD value 30/09/2000, the bank did the same

in the market, to cover its own risk. But because of early delivery by

the customer, the bank is left with a “ long mismatch of funds

30/08/2000 against 30/09/2000, i.e. + USD 500000 value 30/08/2000

(customer deal amended) against the deal the bank did in the inter

bank market to cover its original risk USD value 30/09/2000 to cover

this mismatch the bank would make use of an FX swap.

The swap will be

1.) Sell USD 500000 value 30/08/2000.

2.) Buy USD 500000 value 30/09/2000

The opposite would be true in case of an importer receiving documents

earlier than the original due date. If originally the importer had bought

USD value 30/09/2000 on opening of the L/C and now expects receipt

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of documents on 30/08/2000, the importer would need to take early

delivery of USD from the bank. The Bank is left with a “ short mismatch

“ of funds 30/08/2000 against 30/09/2000. i.e. USD 500000 value

(customer deal amended) against the deal the bank did in the inter

bank market to cover its original risk + USD 500000

To cover this mismatch the vank would make use of an FX swap, which

will be ;

1. Buy USD value 30/08/2000.

2. Sell USD value 30/09/2000.

The swap necessitated because of early delivery may have a swap cost

or a swap difference that will have to be charged / paid by the

customer. The decision of early delivery should be taken as soon as it

becomes known, failing which an FX risk is created. This means that

the resultant swap can be spot versus forward (where early delivery

cover is left till the very end) or forward versus forward. There is every

likelihood that the origial cover ratre will be quite different from the

maket rates when early delivery is requested. The difference in rates

will create a cash outlay for the bank. The interest cost or gain on the

cost outlay will be charged / paid to the customer.

Substitution of Orders

The substitution of forward contracts is allowed. In case shipment

under a particular import or export order in respect of which forward

cover has been booked does not take place.

The corporate can be permitted to substitute another order under the

same forward contract, provided that the proof of the genuineness of

the transaction is given.

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Advantages of using forward contracts:

They are useful for budgeting, as the rate at which the company

will buy or sell is fixed in advance.

There is no up-front premium to pay whn using forward

contracts.

The contract can be drawn up so that the exchange takes place

on any agreed working day.

Disadvantages of forward contracts:

They are legally binding agreements that must be honoured

regardless of the exchange rate prevailing on the actual forward

contract date.

They may not be suitable where there is uncertainty about future

cash flows. For example, if a company tenders for a contract and

the tender is unsuccessful, all obligations under the Forward

Contract must still be honoured.

2. OPTIONS

An option is a Contractual agreement that gives the option buyer the

right, but not the obligation, to purchase (in the case of a call option)

or to sell (in the case of put option) a specified instrument at a

specified price at any time of the option buyer’s choosing by or before

a fixed date in the future. Upon exercise of the right by the option

holder, and option seller is obliged to deliver the specified instrument

at a specified price.

The option is sold by the seller (writer)

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To the buyer (holder)

In return for a payment (premium)

Option lasts for a certain period of time – the right expires at its

maturity

Options are of two kinds

1.) Put Options

2.) Call Options

PUT OPTIONS

The buyer (holder) has the right, but not an obligation, to sell the

underlying asset to the seller (writer) of the option.

CALL OPTIONS

The buyer (holder) has the right, but not the obligation to buy

the underlying asset from the seller (writer) of the option.

STRIKE PRICE

Strike price is the price at which calls & puts are to be exercised (or

walked away from)

AMERICAN & EUROPEAN OPTIONS

American Options

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The buyer has the right (but no obligation) to exercise the option at

any time between purchase of the option and its maturity.

European Options

The buyer has the right (but no obligations) to exercise the option at

maturity only.

UNDERLYING ASSETS :

Physical commodities, agriculture products like wheat, plus

metal, oil.

Currencies.

Stock (Equities)

INTRINSIC VALUE:

It is the value or the amount by which the contract is in the option.

When the strike price is better than the spot price from the buyers’

perspective.

Example:

If the strike price is USD 5 and the spot price is USD 4 then the buyer

of put option has intrinsic value. By the exercising the option, the

buyer of the option, can sell the underlying asset at USD 5 whereas in

the spot market the same can be sold for USD 4.

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The buyer’s intrinsic value is USD 1 for every unit for which he has a

right to sell under the option contract.

IN, OUT, AT THE MONEY:

In-the-money:

An option whose strike price is more favorable than the current market

exchange rate is said to be in the money option. Immediate exercise of

such option results in an exchange profit.

Example:

If the US $ call price is (put) £1 = (call) US $ 1.5000 and the market

price is £1 = US $ 1.4000, the exercise of the option by purchaser of

US $ call will result in profit of US $ 0.1000 per pound. Such types of

option contract is offered at a higher price or premium.

Out-of-the-money:

If the strike price of the option contract is less favorable than the

current market exchange rate, the option contract is said to be out-of-

the-money to its market price.

At-the-money:

If the market exchange rate and strike prices are identical then the

option is called to be at-the-money option. In the above example, if the

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market price is £1 = US $ 1.5000, the option contract is said to be at

the money to its market place.

Summary

Prices Calls Puts

Spot>Strike in-the-money out-of-the-money

Spot=Strike at-the-money at-the-money

Spot<Strike out-of-the-money in-the-money

Naked Options:

A naked option is where the option position stands alone, it is not used

in the conjunction with cash marked position in the underlying asset,

or another potion position.

Pay-off for a naked long call:

A long call, i.e. the purchaser of a call (option), is an option to buy the

underlying asset at the strike price. This is a strategy to take

advantage of any increase in the price of the underlying asset.

Example:

Current spot price of the underlying asset : 100

Strike price : 100

Premium paid by the buyer of the call : 5

(Scenario-1)

If the spot price at maturity is below the strike price, the option will not

be exercised (since buying in the spot is more advantageous). Buyer

will lose the premium paid.

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(Scenario-2)

If the spot price is equal to strike price (on maturity), there is no

reason to exercise the option. Buyer loses the premium paid.

(Scenario-3)

If the spot price is higher than the strike price at the time of maturity,

the buyer stands to gain in exercising the option. The buyer can buy

the underlying asset at strike price and sell the same at current market

price thereby make profit.

However, it may be noted that if on maturity the spot price is less than

the INR 43.52 (inclusive of the premium) the buyer will stand to loose.

CURRENCY OPTIONS

A currency option is a contract that gives the holder the right (but not

the obligation) to buy or sell a fixed amount of a currency at a given

rate on or before a certain date. The agreed exchange rate is known as

the strike rate or exercise rate.

An option is usually purchased for an up front payment known as a

premium. The option then gives the company the flexibility to buy or

sell at the rate agreed in the contract, or to buy or sell at market rates

if they are more favorable, i.e. not to exercise the option.

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How are Currency Options are different from Forward Contracts?

A Forward Contract is a legal commitment to buy or sell a fixed

amount of a currency at a fixed rate on a given future date.

A Currency Option, on the other hand, offers protection against

unfavorable changes in exchange raters without sacrificing the

chance of benefiting from more favorable rates.

Types of Options :

A Call Option is an option to buy a fixed amount of currency.

A Put Option is an option to sell a fixed amount of currency.

Both types of options are available in two styles :

1. The American style option is an option that can be exercised

at any time before its expiry date.

2. The European style option is an option that can only be exercised at

the specific expiry date of the option.

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Option premiums :

By buying an option, a company acquires greater flexibility and

at the same time receives protection against unfavorable

changes in exchange rates. The protection is paid for in the

form of a premium.

Example:

A company has a requirement to buy USD 1000000 in one

months time.

Market parameters:

Current Spot Rate is 1,600 one month forward rate is 1.6000

Solutions available:

Do nothing and buy at the rate on offer in one months time. The

company will gain if the dollar weakens (say 1.6200) but will lose

if it strengthens (say 1.5800).

Enter into a forward contract and buy at a rate of 1.6000 for

exercise in one month’s time. In company wil gain if the dollar

strengthens, but will lose if it weakens.

But a call option with a strike rate of 1.6000 for exercise in one

month’s time. In this case the company can buy in one months

time at whichever rate is more attractive. It is protected if the

dollar strengthens and still has the chance to benefit if it

weakens.

How does the option work?

The company buys the option to buy USD 1000000 at a rate of 1.6000

on a date one month in the future (European Style). In this example,

let’s assume that the option premium quoted is 0.98 % of the USD

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amount (in this case USD 1000000). This cost amounts to USD 9800 or

IEP 6125.

Outcomes:

If, in one months time, the exchange rate is 1.5000, the cost of

buying USD 1000000 is IEP 666,667. However, the company

can exercise its Call Option and buy USD 1000000 at 1.6000.

So, the company will only have to pay IEP 625000 to buy the

USD 1000000 and saves IEP 41667 over the cost of buying

dollars at the prevailing rate. Taking the cost of the potion

premium into account, the overall net saving for the company

is IEP 35542.

On the other hand, if the exchange rate in one month time is

1.7000. The company can choose not to exercise the Call

Option and can buy USD 1000000 at the prevailing rate of

1.7000. The company pays IEP 588235 for USD 1000000 and

saves IEP 36765 over the cost of forward cover at 1.6000. The

company has a net saving of IEP 30640 after taking the cost of

the option premium into account.

In a world of changing and unpredictable exchange rates, the payment

of a premium can be justified by the flexibility that options provide.

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MAKING THE MOST OF OPTIONS

Options are particularly flexible:

The buyer can choose any strike rate and any end date. The

management of an option position can be made even more flexible

with the following techniques :

Selling back an option

The bank will at any time quote a price at which it is prepared to buy

back an option it has sold. The valued of the option can be paid

directly to the holder or can be incorporated in the rate on any new

spot or forward deals done at the time.

Extending or shortening an option

The expiry date on an option can be changed, usually with payment of

premium, either by the company to the bank (for an extension) or by

the bank to the company (for shortening). A payment of premium can

be avoided by adjusting the strike rate when the expiry date is altered.

Changing other features of an option

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In principle, any feature of an option may be changed at any tiem

(strike rate, option amount), with a resulting payment of premium in

one direction or the other.

Uses of Options

On account of market volatility, if one is not very sure of the

rates, option contract is useful to limit losses and gives access to

unlimited profit potential.

In calm markets, writing of options is a profitable business with

relatively low risk.

Options contracts are ideal when tendering for a business

contract where the outcome is uncertain.

Options are useful in carrying out ongoing transactions where

exposures are uncertain in terms of timings amounts etc.

Option provides the best tool to hedge balance sheet translation

exposure.

Options are useful for hedging foreign currency loan exposures.

OPTIONS- Indian Scene

In the past, Indian market other than currency market has

experienced derivative instruments in the form of futures, etc. The

process of globalisation and integration of Indian Financial sector

with the global economy has opened up vast potential of the world

currency markets in the business, expecially the matured, highly

liquid and competitive markets of currency options. The successful

management of stability of rupee exchange rate against the US

dollar dampened the sentiments of volatility of $/rupee rate.

Stability of exchange rate stimulates growth of international trade in

good/services, investment flows etc. The volatility and vulnerability

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of rupee against the currencies other than the US dollar is beyond

management in terms of exchange rate stability of rupee.

Considering this aspect and also the maturity of the world currency

options market, the RBI introduced the cross currency options with

effect from January 1994 in terms of its AD.

The main features are:

At present Indian residents can buy cross currency options

only to hedge their foreign exchange exposures in non-US

dollar currencies.

Corporate can buy but cannot write options.

Due to certain structural deficiencies of the Financial markets in India;

the RBI has not permitted rupee-based currency options. Options are

allowed to be bought by clients only to cover their genuine exposures.

Banks selling currency options have to hedge themselves immediately

on back-to-back basis. The managing committee of FEDAI adopted,

with certain modifications, “International Currency Options

Master”(ICOM) agreement of British Bankers Association, London for

cross currency options market in India.

The cross currency options market is still in an infancy stage in India

and the initial euphoria over cross currency subsided on account of the

following factors.

The RBI introduced cross currency options in non US dollar

currencies for covering genuine exposures of the corporate.

Nearly 60 to 70% of the corporate exposures are denominated in

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the US dollar. As a result major of the corporate exposures did

not require currency options as a hedging tool.

Reluctance of the corporates to part with the front-end fee as the

price for purchase of an option contract.

The premium or price of the currency option contract is higher

than the expectation of the corporates about the volatility of

currency movements.

Rigidities attached to the cross currency option contract deals.

Absence of long term rupee yield curve, structural deficiencies of

the financial market.

The most important problem is the absence of rupee based

currency options.

The above factors have certainly shunted the growth of cross currency

options as a first derivative product on the Indian Foreign Exchange

market.

Earlier Indian corporate clients had only two options to manage foreign

exchange risk.

To do nothing till the maturity of the transactions of

To book a forward contract and settle the transaction at

contracted date of maturity of the contract.

However, today corporate have additional tool at their disposal in the

form of cross currency option for managing their currency exposures.

Introduction of cross currency options is a certain raiser and its

subsequent development application in the currency market will bring

in onslaught of complex derivative products for both the corporates as

well as the bankers.

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Example:

Suppose French company expects to pay against it imports, USD

10,000,000 in six months time. They expect US $ to fall but do not

want to take the chance of being wrong.

Current market rates

Spot USD/FRF 6.9150

6 months USD/FRF 6.9450

A 6 month “at the money” USD call/FRF put option contract costs 1 %

The strike price would therefore be 6.9450

Option Premium is 10,000,000 * 1 % = FRF 691,500

The choices that the company has are :

Do nothing (aggressive).

Buy USD/sell FRF Forward (defensive) @ 6.9450

Hedge is means of the option (selective) USD Put/CHF call costs

1 %

In six months time

Case I: Spot USD/FRF = 7.0550

Choice 1

Where the company did nothing tthey buy USD from the market and

pay USD 10,000,000 * 7.0550 = FRF 70,550,000.

Choice 2

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Where the company bought forward they pay 10,000,000 * 6.9450

= FRF 69,450,000.

Choice 3

Where the company hedged the option they exercise the option to buy

USD and pay FRF 69,450,000 plus Option Premium FRF 691,500.

Case II: Spot USD/FRF = 6.9450

Choice 1

Where the company did nothing they buy USD from the market and

pay 10,000,000 * 6.9450 = FRF 69,450,000.

Choice 2

Where the company bought forward USD they pay 10,000,000 *

6.9450 = FRF 69,45,000.

Choice 3

Where the company hedge with option, whether the exercise the

option or not they pay FRF 69,450,000 + the option premium = FRF

70,141,500.

Case III: Spot USD/FRF = 6.8500

Choice 1

Where the company bought forward USD from the market and pay

10,000,000 * 6.8500 = FRF 68,500,000.

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Choice 2

Where the company bought forward USD they pay 10,000,000 *

6.9450 = FRF 69,45,000.

Choice 3

Where the company hedge with option, they don’t exercise the option

but buy USD from the market and pay FRF 68,500,00 + the option

premium = FRF 69,191,500.

Choice Case 1

USD/

FRF7.0550

Case 2

USD/FRF 6.9450

Case 3

USD/FRF

6.8500

1. Nothing 70,550,000 69,450,000 68,500,000

2.

Forward

69,450,000 64,450,000 69,450,000

3. Option 70,141,500 70,141,000 69,191,500

Choice 2 is best Choices 1 & 2 are

best

Choice 1 is best

Thus the general rule for hedging exposures with options is that with

hindsigtht one can deduce that there was always a better strategy. The

question to be asked is what the risk is and does the option premium

justify it ? Beside, always look at an option as an insurance policy, it

never qualifies as a good investment but always provides protection

against the unknown.

3. SWAPS

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WHY DID SWAPS EMERGE?

In the late 1970’s, the first currency swap was engineered to

circumvent the currency control imposed in the UK. A tax was levied

on overseas investments to discourage capital outflows. Therefore, a

British company could not transfer funds overseas in order to expand

its foreign operations without paying sizeable penalty. Moreover, this

British company had to take an additional currency risks arising from

servicing a sterling debt with foreign currency cash flows. To overcome

such a predicament, back-to-back loans were used to exchange debts

in different currencies. For example, a British company wanting to

raise capital in the Frace would raise the capital in the UK and

exchange its obligations with a French company, which was in a

reciprocal position. Though this type of arrangement was providing

relief from existing protections, one could imagine, the task of locating

companies with matching needs was quite difficult in as much as the

cost of such transactions was high. In addition, back-to-back loans

required drafting multiple loan agreements to strate respective loan

obligations with clarity. However this type of arrangement leads to

development of more sophisticated swap market of today.

WHAT ARE SWAPS?

A contract between two parties, referred to as counter parties, to

exchange two streams of payments for agreed period of time. The

payments, commonly called legs or sides, are calculated based on the

underlying notional using applicable rates. Swaps contracts also

include other provisional specified by the counter parties. Swaps are

not debt instrument to raise capital, but a tool used for financial

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management. Swaps are arranged in many different currencies and

different periods of time. US $ swaps are most common followed by

Japanese yen, sterling and Deutsche marks. The length of past swaps

transacted has ranged from 2 to 25 years.

PRESENT SCENARIO IN THE INDIAN MARKET

Genesis of the Interest Rate Swaps in India

Interest rates in India have been RBI determined for decades now. In

the past five years, we have seen this situation changing. Gradually,

India is moving towards a market determined interest rate regime. RBI

is gradually freeing interest rates, and this has forced banks to manage

risks on their own. Moreover, the Indian companies were used to the

earlier easy go approach and surety in interest rates that they can

borrow on. But now, corporate have a plethora of rates at which they

can borrow. They have the option of loans linked to fixed or floating

rates. Thus, Indian companies have to be se efficient with regards to

management fo financial uncertainities, like s are elsewhere in the

world. With all this deregulation and integration with global practices,

there was a felt needs for Instruments to hedge against various risks.

Derivatives for the money market were the next logical step in the

process. This is exactly what RBI has done.

The RBI Governor’s Statement on ‘Mid Term Review of Monetary and

Credit Policy for 1998-99 announced on October 30, 1998, indicated

that to further deepening the money market and to enable banks,

primary dealers (PDs) and all India financial instituti9ons (FIs) to hedge

interest risks, the RBI had decided to create an environment that

would favor the introduction of Interest Rate Swaps.

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Accordingly, on July 7, 1999 RBI issued final guidelines to introduce IRS

and Forward Rate Agreements (FRAs). The players are allowed to

practice IRS/FRAs as product for their own balance sheet management

and for market making purposes.

The RBI has been criticized for being hasty in introducing such interest

rate derivatives. It was said that our debt market is not mature enough

to incorporate and deal with such products. Though the Indian debt

market has not been properly developed, blaming the RBI move does

not seem to be proper because there products will have to be

introduced sooner or later and the present time appears to be as good

a time as any other. Moreover, this move may also help in quickening

the development of a mature debt and money market.

The legal framework: RBI Guidelines (summary)

A brief summary of RBI guidelines regarding IRS issued on July 7, 1999

follows :

Interest rate swap refers to a financial contract between two

parties exchanging a stream of interest payments for a notional

principal amount on multiple occasions during a specified period.

Forward rate agreement (FRA) is being defined as the same on

settlement date for a specified period from start date to maturity

date.

The players:

Scheduled commercial banks excluding regional rural banks, primary

dealers (PDs) and all India financial institutions have been allowed to

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undertake IRS as a product of their own asset liability management

and market-making purposes.

Types:

Banks/PDs/FIs undertake different types of plain vanilla FRAs/IRS for

interest rate risks arising on account of landings or borrowings made at

fixed or variable interest rates. However, swaps having explicit/implicit

option features like caps, floors or collars are not permitted.

Benchmark Rate:

The players can use any domestic money or debt market rates as

reference rate for entering into FRA/IRS, provided methodology of

computing the rate is objective, transparent and mutually acceptable

to counter parties. The reason stated for the same is that the

benchmark rate is expected to evolve on its own in the market.

Size of the notional principal amount :

There will be no limit on the maximum or minimum size of the notional

principal amount of FRA/IRS or the tenor of the IRS/FRAs. Regarding

the exposure limits the banks; FIs and PDs have to arrive at the credit

equivalent amount for the purpose of reckoning exposure to counter

party.

Exposure:

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The exposure should be within the sublimits and the participants

concerned should fix this for the FRAs/IRS to corporate/FIs, banks/PDs.

In case of the banks and the FIs, the credit exposure should be within

the single/group borrower limits as prescribed by the RBI.

Facilitators

The problem of locating potential counter parties was solved through

dealers and brokers. A swap dealer takes on one side of the

transaction as counter party. Dealers work for investment, commercial

or merchant banks. “By positioning the Swap”, dealers earn bid-ask

spread for the service. In other words, the swap dealer earns the

difference between the amount received from a party and the amount

paid to the other party. In an ideal situation, the dealer would offset his

risks by matching one step with another to streamline his payments. If

the dealer were a counter party paying fixed rate payments and

receiving floating rate payments, he would prefer to be a counter party

receiving fixed payments and paying floating rate payments in another

swap. A perfectly netted position as just described is not necessary.

Dealers have the flexibility to cover their exposure by matching

multiple parties and by using other tools such as fitires to cover an

exposed position until the book is complete.

Swap Market Participations

Since swaps are privately negotiated products, there is no restriction

on who can use the market : however, parties with low credit quality

have difficulty entering the market. This is due to fact that they cannot

be matched with counter parties who are willing to take on their risks.

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In the U.S. many parties require their counter parties to have minimum

assets of $ 10 million. This requirement has become a standardized

representation of “ eligible swap participants “.

The following list includes a Sample of Swaps Market Participants :

1. Multinational Companies.

Shell, IBM, Ronda, Unilever, Procter & Gamble, Pepsi Co.

2. Banks

Banks participate in the swap market either as an intermediary for two

or more parties or as counter party for their own financial

management.

3. Sovereign and public sector institutions

Japan, Republic of Italy, Electricity de France, Sallie Mae (U.S. Student

Loan Marketing Association).

4. Super nationals

World Bank, European Investment Bank, Asian Development Bank.

5. Money Managers

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Insurance companies, Pension funds.

Secondary Factors in the Development of the Swap

Market

As international barriers to financial markets began to disappear, swap

dealers were able to switch between different indexes and different

markets. By arbitraging capital and credit markets, they were able to

borrow at the best index available and then swap to the desired index.

Heavy borrowing by the US government and government agencies in

the ‘80s played a major role in the development of the swap market.

Borrowing at the floating rates and swapping to the fixed rates met the

needs of the corporations and in effect added to the depth and the

liquidity of the swap market.

Taking a view on the future direction of the interest rates, swaps can

be proved to very attractive instruments, and under a variety of yield

curve conditions, they are among the cheapest to transact. Speculative

trading of the swaps added enormously to the depth and liquidity of

the market.

Foreign Exchange Swap

Swaps are derivatives that involve a private agreement between two

parties to exchange cash flows in the future according to a

prearranged formula. The underlying instruments are liabilities or

assets with interest expenses or incomes. Swaps can be broadly

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classified into two types – Interest Rate Swaps and Currency Swaps.

The first recorded swaps were negotiated in 1981. Since then, the

markets have grown very rapidly.

A basic foreign exchange swap is the simultaneous purchase and sale

of one currency for another, where the two contracts have different

dates (different positions of same or different amount on different

dates).

Cash Management Swap

It is used to realize efficient cash management or to adjust the

maturity dates of existing forward contracts.

Handling Surplus and Deficit Cash Positions

The international scope of business conducted by financial and non-

financial organization will often require the management of cash flows

in more than one currency. From time to time, an entity will find itself

with surplus cash balance in one currency and deficit balances in

another currency.

Swapping Forward Contracts Forward at Historical Rates.

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Corporations often face considerable uncertainty in timing and /of

amount when forecasting currency cash flows. Forward contracts that

were dealt to hedge such flows may mature on a date that does not

match the actual cash flow. In such cases, the maturity of the original

forward contract crates cash flows for which there is no immediate

offset.

Once again, the cash manager can borrow to fund the deficit, invest

the surplus, or execute a cash management swap. Another method to

deal with this type of situation is to swap contracts at historical rates.

The new forward contract consists of the maturing forward rate

adjusted by the current points and a working capital interest factor.

Historical rate rollovers have the same basic economic as market rate

saps. The also eliminate the need for any cash settlements on the

original maturity date and avoid the accounting problems frequently

associated with the FX gain/loss account. On small forward contractrs,

the actual dollar amount of the net settlement ma be small, and cost of

settling may be excessive given the amount involved. In other cases,

an entity may not have the cash to settle on the swap but still want the

swap done.

As a general comment, usage of historical rate swaps varies from

market to market, but this type of swap is not a heavily traded

transaction. One of the major reasons is its susceptibility to abuse.

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There are basically two types of swap transactions :

Interest Rate Swap

Currency Swap

1. INTEREST RATE SWAPS

The most common type of interest rate swaps are “plain vanilla” IRS.

Here, one party A, agrees to pay to the other party B, cash flows equal

to interest at a predetermined fixed rate on a notional principal for a

number ofyears. Simultaneously, A agrees to pay party B cash flows

equal to interest at a floating rate on the same notional principal for

the same period of time. The currencies of the two sets of interest cash

flows are the same. Moreover, only the difference in the interest

payments is paid/received; the principal is used only to calculate the

interest amounts and is never exchanged.

It is an arrangement whereby one party exchanges one set of interest

payment for another e.g. fixed or floating.

An exchange between two parties of interest obligations (payment of

interest) in the same currency on an agreed amount of notional

principal for an agreed period of time.

Example :

Two counter parties are involved in a swap agreement, corporate A

and corporate B and a dealer arranges the swap (taking a spread).

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Amount to be borrowed : USD 100 Mn. For 15 years.

Following are the rates at which A and B can raise funds :

Fixed Floating

Corporate A 5 % 6M LIBOR + 50bp

Corporate B 7 % 6M LIBOR + 100bp

It can be observed that Corporate A has advantage in borrowing in

both fixed and floating market. (Fixed market 2 % and Floating market

50bp).

However, by swapping interest rate obligation both A and B can borrow

at lower rates.

Corporate A borrows fixed @ 5 %

Corporate B borrows floating @ 6 month LIBOR + 100bp.

By entering into a swap agreement : A will become floating ratepayer;

and B will become fixed rate player.

Cash flow under the swap agreement;

Corporate A

PAY RECEIVE

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6 M LIBOR* 5 %

5 % & -----

Net cost: 6 M LIBOR (Pay 5 % cancels Receive 5 %)

Corporate B

PAY RECEIVE

5.5 %* 6 M LIBOR *

6 M LIBOR + 100bp & -----

Net Cost : 6.5 %

PAY/RECEIVE TO/FROM DEALER & PAY TO THE LENDER IN CASH

MARKET

NOTE:

1. Corporate have to borrow in cash market and meet their

obligations.

2. It is assumed that the dealer takes a spread of 50bp.

Corporate A achieves floating rate at 6 M LIBOR better by

50bp than without swap.

Corporate B achieves fixed rate at 6.5 % better by 50bp

than without swap.

Dealer makes 50bp.

Types of IRS

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We have discussed the plain vanilla swaps till now. These swaps can

be subdivided into swaps made directly between two parties or with an

exchange. Moreover, they can be classified on the basis of the floating

reference rate used, which may be LIBOR, CP rate, T-Bill rate, etc.

Apart from “plain vanilla” IRS discussed above, there are several other

types of swaps.

Basis Swaps:

Where both the legs are floating interest rates.

Amortizing Swaps:

Where the principal reduces in a predetermined way to correspond to

the amortization schedule on a loan.

Step-up Swaps:

Where principal increases in a predetermined way

Deferred/Forward Swaps:

Where parties do not begin to exchange interest payments until some

future date.

Combinations with currency Swaps:

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where fixed rate in one currency is exchanged with floating rate in

another currency.

Extendable Swaps:

Where one party has the option to extend the life of the swap beyond

the specified period.

Put table Swaps:

where one party has the option to terminate the swap early.

Swaptions :

which is options on swaps.

Constant Maturity Swaps (CMSs):

Where LIBOR is used as reference rate.

Constant Maturity Treasury Swaps (CMTs):

Where LIBOR is exchanged for a particular Treasury rate.

Indexed principal Swaps:

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Where the principal reduces based on an index of interest rate levels.

Differential Swaps:

Where a floating rate in domestic currency is exchanged for a floating

rate in foreign currency, with both interest rates applied on same

domestic principal.

Back valued Swaps:

Where past effective dates are used.

Prepaid Swaps:

where the fixed leg payer pays his obligations in advance, and only

receives payments till maturity, zero coupon swaps are exactly

opposite to prepaid swaps, where the whole payment is given at the

maturity.

Trends in Indian Markets

Before coming to the actual trends in the market, let us look at the

players. Most of the active participation is by foreign banks, followed

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by Indian banks, Corporate and finally, FI’s. The absence of

nationalized banks from the Irs scene is noteworthy. Today, if a

corporate wishes to enter an IRS deal, it will have to submit the

following to its banker :

Certified copy of the firm’s Memorandum and Articles of

Associations.

Board resolution authorizing derivative deals.

An ISDA Master Agreement.

Risk disclosure statement.

Certificate wing underlying loan exposure.

A certificate stating that IRS is for hedging risks, not for

speculation.

Thus, we see that IRS today can be used by corporate only for an

actual hedging exercise, and it has to have board permission.

Moreover, the deal would be within the exposure limits of that firm for

the bank with which it is dealing. These measures are to ensure that

corporate do not undertake speculative activities, and start dealing

only after they have proper risk management systems in place.

On the first day of trading, more than 30 deals were recorded, worth

over Rs. 600 crores in notional principal terms. Rs. 500 crores of this

was accounted for by corporate deals. The rush was because the

European and private banks wanted to be a part of the history, dealing

on first day, rather than actual hedging. It has also been reported that

some deals were circular between three players, with no real effect in

any players’ position. No deal was stuck for more than a year’s tenor.

Since the first day, there have been almost no deals, and the markets

are cold. The reasons for this are many. At the short-term level, almost

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all the players expect the interest rates to go down in the next few

months. This means that there are no conflicting views among players

about interest rates, and so IRS deals are not very tempting. Again,

there are very few floating rate loans around. These and other

fundamental reasons have been discussed in the next secti9on.

In spite of these, there are many underlying reasons for going for IRS.

Today, the major financial intermediaries viz. Indian banks, foreign

banks, financial institutions, and corporate have radically different sets

of asset-liability structures. Thus for ALM alone, IRS are a good options.

For example, the FI’s have much of their liabilities as bullet repayment

bonds, and the bulk of their assets by way of installment repayment

loans. Thus, chances are that their liabilities portfolio is longer than

their assets portfolio. Commercial banks, on the other hand, have bulk

of their liability portfolio in relatively short-term maturities, and assets

are at longer maturities with fixed interest rates. Thus, banks and FI’s

alone can enter in a lot of mutually beneficial deals.

Corporate would also like to hedge their interest rate risks, and convert

their fixed rate loans to floating rates, now that the options are

available. However, their needs would be medium term in nature (2 to

8 years), and as yet there are no takers for this long maturities.

The market is only about 2 months old now, and is yet to evolve. The

likely problem in its evolution and the future is discussed in the

following sections.

FUTURE OUTLOOK FOR IRS IN INDIA

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As India shifts from RBI controlled to market driven interest rate

regime, volatility in the interest rate is bound to increase. This implies

greater use of risk hedging mechanism like IRS. As the obstacles

discussed in Section 5 are tackled, we shall see the evolution of the

money market derivative markets. The speed of this evolution depends

on how quickly the fundamental problems are addressed and the

market revives. The major concern, of course, will be the emergence of

a floating rate loan market, as at least one leg of the IRS has

necessarily to be a floating rate. This is the single major reason why

thee are no only many IRS deals, but also even no possibilities of deals

ill the current scenario for corporate.

Then, we have seen that the stage is set for the financial institutions,

commercial banks and corporate to enter into swaps as soon as they

have risk management systems in place and the market matures. In

the short run however, there will not be much activity as the

fundamentals are unlikely to change quickly. A major concern is the

govt. borrowing, which distorts the interest rates and has a major

impact on the market. In a mature market, no player should be so big

that it can affect the interest rates in a large way, causing rates, which

do not really reflect the sentiments of the markets. On the other hand,

this same point causes volatility in the markets, which is another

reason to hedge against risks, where IRS comes in. We wait to see how

the markets evolve.

Also likely in the medium term is the emergence of various types of

swaps not currently allowed in India. Like IRS/FRA’s kicked off the

derivative market in India, swaptions may well kick off the options

market in India, though today, it looks as though equity options will

come up earlier. As awareness increases, and it dawns on the players

that swaps are excellent hedging instruments, the market can only

improve.

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Finally, we come to speculation. This is likely to stay away from Indian

markets, at least for the corporate till a long time to come. REI, or the

govt. does not encourage speculation in any other markets by the

corporates or individuals. This is likely to continue, as

The current guidelines show. Moreover, for speculation, one needs

volatility and diverse views, which are not present today. As these

emerge, some players may be allowed to speculate, but the limits are

likely to be strict and discouraging.

Overall, IRS is here to stay, and players will soon learn to use them

effectively. Though in infancy now, the markets may evolve sooner

than one may expect.

3. CURRENCY SWAPS

Each entity has a different access and different long term needs in the

international markets. Companies receive more favorable credit ratings

in their country of domicile that in the country in which they need to

raise capital. Investors are likely to demand a lower return from a

domestic company, which they are more familiar with than from a

foreign company. In some cases a company may be unable to raise

capital in a certain currency.

Currency swaps are also used to lower than risk of currency exposure

or to change returns on investment into another, more favorable

currency. Therefore, currency swaps are used to exchange assets or

capital in one currency for another for the purpose of financial

management.

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A currency swap transaction involves an exchange of a major currency

against the U.S. dollar. In order to swap two other non-U.S. currencies,

a dealer may need to arrange two separate swaps. Although, any

currency can be used in swaps, many counter parties are unable to

exchange of the principals takes place at the commencement and the

termination of the swaps in addition to exchange of interest payments

on agreed intervals. The exchange of principal and interest is

necessary because counter parties may need to utilize the respective

exchanged currencies.

The uses of currency swaps are summarized below:

Lowering funding cost

Entering restricted capital markets

Reducing currency risk

Supply-demand imbalances in the markets

As for interest rate swaps, many variants of the plain vanilla currency

swaps were created to meet some of the common financial

management needs.

Amortizing currency swaps

The notional principals of these swaps are scheduled to decrease over

the life of the swaps. Therefore, principals are exchanged accordingly.

Accreting currency swaps

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The notional principals of these swaps increase periodically. Principals

are exchanged as scheduled.

Floating-for-floating rate currency swaps

As indicated by the name, this swap involves the exchange of a

floating interest rate payment schedule in one currency against

another floating interest rate payment schedule in another currency.

Features:

Converts a stream of payments (fixed or floating) in one currency

into a stream of another currency.

Usually involves an exchange of principal at the end of the term

at an exchange rate agreed at the outset of the deal.

Following are risks associated with swaps :

Interest rate risk

Exchange rate risk

Default risk

Sovereign risk

Mismatch risk (for dealers only)

In 1987, a set of principal were arranged by the central banking

authorities of the Group of Ten plus Luxembourg known as the Easle

Supervisor’s Committee to standardize capital requirements across

nations. According to this set of requirements, called the Easle Accord,

dealers of swaps and other off – balance sheet instruments are

imposed risk-adjusted capital requirements.

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CAPS & COLLARS

Caps are like insurance

Protect against rise in rates of interest

Benefits of falling rates available

Interest Rate Cap is agreement between a corporate and a bank

borrower with floating rate debt. Under the terms of the agreement,

the bank undertakes to bear extra cost on account of interest rate

going up beyond the agreed rate during the agreed period. For this

undertaking, the borrower pays premium.

This instrument caps the interest payment of the borrower as any rise

above the cap will be borne by the bank which sells cap to the

borrower.

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FLOORS

It is a hedging product for investors for protection against falls in

interest rates. Interest Rate floors, when it protects against fall in

interest rates, investors benefit from rising interest rates. Investor has

to pay premium to the seller of Interest rate floor.

This instrument defines the floor i.e. the minimum rate of interest the

investor would earn in case the interest rate falls beyond the agreed

limit.

COLLARS

Where a corporate takes a view that the interest rate will remain in

range, the corporate can combine cap and floor to achieve this

objective. The corporate will buy Interest Rate Collar of between 7 %

and 9 % if it believes that the interest rates would move between 7 %

and 9 %. Corporate looses the benefit if rate falls below 7 %. However,

as against this ‘loss’ the corporate pays fewer premiums and is

protected against the upside risk. (Of interest rates rising).

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4. FUTURES

In a futures contract there is an agreement to buy or sell a specified

quantity of financial instrument in a designated Future month at a

price agreed upon by the buyer and seller.

A Future contract is evolved out of a forward contract and posses

many of the same characteristics. In essence, they are like liquid

forward contracts. Unlike forward contracts however, futures contracts

trade on organized exchanges called futures markets.

The characteristics of a future contract are

Standardization

The future contracts are standardized in terms of quantity and quality

and future delivery date.

Margining

The other characteristics of a futures contract is the margining

process. The margin differs from exchange to exchange and may

change as the exchange’s perception of risk changes. This is known as

the initial margin. In addition to this there is also daily variation margin

and this process is known as marking to market.

Participants

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The majority of users are large corporations and financial institutions

either as traders or hedgers.

Futures are exchange traded

1. In futures market there is availability of clearing house for

settlement of transactions.

CURRENCY FUTURES

Currency futures markets were developed in response to the shift from

fixed to flexible exchange rates in 1971. They became particularly

popular after rates were allowed to float free in 1973, because of the

resulting increased volatility in exchange rates.

A currency future is the price of a particular currency for settlement in

a specified future date. A currency future contract is an agreement to

buy or sell, on the future exchange, a standard quantity of foreign

currency at a future date at the agreed price. The counterpart to

futures contracts is the future exchange, which ensures that all

contracts will honored. This effectively eliminates the credit risk to a

very large extent.

Currency futures are traded on futures exchanges and the most

popular exchange are the ones where the contracts are fungible or

transferable freely. The Singapore International Monetary Exchange

(SIMEX) and the International Monetary Market, Chicago (IMM) are the

most popular futures exchanges. There are smaller futures exchanges

in London, Sydney, Tokyo, Frankfurt, Paris, Brussels, Zurich, Milan, New

York and Philadelphia.

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Pricing of Futures Contract

Futures Price = Spot Price + Cost of Carrying (Interest)

Cost of carrying is the sum of all costs incurred to carry till the maturity

of the futures contract less any revenue, which may result in this

period.

In India there is no futures market available for the Indian Corporates

to hedge their currency risks through futures.

The advantages of Future Contract

Low Credit Risk : In case of futures the credit risk is low as the

clearing house is the counter party to every futures.

Gearing : Only small margin money is required to hedge large

amounts.

The disadvantages of Future Contract

Basic Risk : As futures contract are standardized they do not

provide a perfect hedge.

Margining Process : The administration is difficult.

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It is observed that a futures contract is a type of forward contract, but

there are several characteristics that distinguish from forward

contracts.

Standardized Vs. Customized Contract :

Forward contract is customized while the future is standardized.

Counter Party Risk :

In case of futures contract, once the trade is agreed upon the

exchange becomes the counter party. Thus reducing the risk to

almost nil. In case of forward contract, parties take the credit risk to

each other.

Liquidity :

Futures contract are much more liquid and their price is much more

transparent as compared to forwards.

Squaring Off:

A forward contract can be reversed only with the same counter

party with whom it was entered into. A futures contract can be

reversed with any member of the exchange.

CONTRIBUTION OF DERIVATIVES IN THE GROWTH OF FOREX MARKETS.

The tremendous growth of the financial derivatives market and reports

of major losses associated with derivative products have resulted in a

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great deal of confusion about these complex instruments. Are

derivatives a cancerous growth that is slowly but surely destroying

global financial markets ? Are people who use derivative products

irresponsible because they use financial derivatives as part of their

overall risk management strategy ?

Thos who oppose financial derivatives fear a financial disaster of

tremendous proportions a disaster that could paralyze the world’s

financial markets and force governments to intervene to restore

stability and prevent massive economic collapse, all at taxpayers’

expense. Critics believe that derivatives create risks that are

uncontrollable and not well understood.

People have certain believes about derivatives which hampers the

growth of the derivatives market. They are :

Derivatives are new, complex, high-tech financial products.

Derivatives are purely speculative, highly leveraged

instruments.

The enormous size of the financial derivatives market dwarfs

Bank Capital, Thereby Making Derivatives Trading an Unsafe

and Unsound Banking Practice.

Only large multinational corporations and large banks have a

purpose for using derivatives.

Financial derivatives are simply the latest risk management fad.

Derivatives take money out of productive processes and never

put anything back

Only risk-seeking organizations should use derivatives

The risks associated with financial derivatives are new and

unknown

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Derivatives ink market participants more tightly together,

thereby increasing systematic risks.

This is what some people believe, but it’s not the case.

Actually the financial derivatives have changed the face of finance by

creating new ways to understand, measure, and manage financial

risks. Ultimately, derivatives offer organizations the opportunity to

break financial risks into smaller components and then to buy and sell

those components to best meet specific risk-management objectives.

Moreover, under a market-oriented philosophy, derivatives allow for

the free trading of individual risk components, thereby improving

market efficiency. Using financial derivatives should be considered a

part of any business’s risk-management strategy to ensure that value-

enhancing investment opportunities can be pursued.

Thus, financial derivatives should be considered for inclusion in any

corporation’s risk-control arsenal. Derivatives allow for the efficient

transfer of financial risks and can help to ensure that value-enhancing

opportunities will not be ignored. Used properly, derivatives can

reduce risks and increase returns.

Derivatives also have a dark side. It is important that derivatives

players fully understand the complexity of financial derivatives

contracts and the accompanying risks. Users should be certain that the

proper safeguards are built into trading practices and that appropriate

incentives are in place so that corporate traders do not take

unnecessary risks.

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The use of financial derivatives should be integrated into an

organization’s overall risk-management strategy and be in harmony

with its broader corporate philosophy and objectives. There is no need

to fear financial derivatives when they are used properly and with the

firm’s corporate goals as guides.

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THEORITICAL ASPECT OF THE

STUDY

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FORECASTING EXCHANGE RATES

EFFICIENT MARKET APPROACH

Financial markets are said to be efficient if the current asset prices fully reflect all the available and relevant information. The efficient market hypothesis(EMH), which is largely attributable to Professor Eugene Fama of the University of Chicago, has strong implications for forecasting.

The exchange rate will then change only when the Market receives new information. Since news by definition is unpredictable, in the exchange rate will change randomly over time. If the exchange rate indeed follows a random walk, the future exchange rate is expected to be the same as the current exchange rate, that is,

St = E(St+1)

In a sense, the random walk hypothesis suggests that today’s exchange rate is the best predictor of tomorrow’s exchange rate.

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FUNDAMENTAL APPROACHS

The fundamental approach to exchange rate forecasting uses various models. For example, the monetary approach to exchange rate determination suggests that the exchange rate is determined by three independent variables :

1) relative money supplies2) relative velocity fo monies, and3) relative national output.

One can thus formulate the monetary approach in the following empirical form.

S = α + β1(m-m*) + β2(v-v*) + β3(y*-y) + u

Where,S = natural logarithm of the spot exchange rate.

m-m* = natural logarithm of domestic/foreign money supply. v-v* = natural logarithm of domestic/foreign velocity of money. y*-y = natural logarithm of foreign/domestic output.

U = random error term, with mean zero

α,β’s = model parameters.

Generating forecasting using the fundamental approach would involve three steps:

Step 1 = Estimation of the structural model to determine the numerical

values for the parameters such as α and β.

Step 2 = Estimation of future values of the independent variable like (m-m*), (v-v*) and (y*-y).

Step 3 = Substituting the estimated values of the independent variables into the estimated structural model to generate the exchange rate forecasts.

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TECHNICAL APPROACH

The technical approach first analyzes the past behavior of exchange rate for the purpose of identifying “patterns” and then projects them into the future to generate forecasts. Clearly, the technical approach is based on the premise that history repeats itself. The technical approach thus is at odds with the efficient market approach. At the same time, it differs from the fundamental approach in that it does not use the key economic variable such as money supplies or trade balances for the purpose of forecasting. However, technical analysts sometimes consider various transaction data like trading volume, outstanding interests, and bid-ask spreads to aid their analyses.

While academic studies tend to discredit the validity of technical analysis, many traders depend on technical analyses for their trading strategies. If a trader knows that other traders use technical analysis, it can be rational for the trader to use technical analysis too. If enough traders use technical analysis, the predictions based on it can become self-fulfilling to some extent, at least in the short run.

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Data analysis and

interpretation

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FUNDAMENTAL ANALYSIS OF INDO-US FOREIGN EXCHANGE RATE

Here we are analyzing about the Indo-US exchange rate for that the required data and in formations are as under

INDIA

(Amt. in Billion Rs.)

YEAR GNP VELOCITY

MONEY SUPPLY

1994 14008.532

321.66 4355.048

1995 15031.155

286.59 5244.862

1996 16185.772

269.14 6013.918

1997 17077.373

246.89 6916.923

1998 18177.345

224.81 8085.808

1999 19239.779

201.97 9526.208

2000 20647.907

189 10924.748

2001 22363.875

176.5 12670.767

2002 24138.275

166.01 14540.155

2003 26886.393

161.35 16663.455

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2004 30363.198

144.83 20964.760

2005 34570.318

132.83 26025.210

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UNITED STATE (US)

(Amt. in Billion Dollar)

YEAR GNP VELOCITY

MONEY SUPPLY

1994 28288.9 655.95 4312.6251995 29590.6 6549 4518.2831996 31267.3 648.4 4822.11997 33217.3 635.7 5224.7661998 34987.6 606.7 5765.9411999 370373.7 591.2 6270.3082000 39267.9 573.06 6852.2082001 40511.8 529.6 7648.4922002 41878.4 507.06 8259.0422003 43843 498.9 8787.3252004 46743.7 506.1 9234.7252005 49375.7 508.2 9786.467

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FUNDAMENTAL MODEL FOR EXCHANGE RATE

S = α + β1(m-m*) + β2(v-v*) + β3(y*-y) + u

Where,S = natural logarithm of the spot exchange rate.

m-m* = natural logarithm of domestic/foreign money supply. v-v* = natural logarithm of domestic/foreign velocity of money. y*-y = natural logarithm of foreign/domestic output.

U = random error term, with mean zero

α,β’s = model parameters.

To obtain model parameters α and β we should have S = natural logarithm of the spot exchange rate.m-m* = natural logarithm of domestic/foreign money supply.v-v* = natural logarithm of domestic/foreign velocity of money. y*-y = natural logarithm of foreign/domestic output.

YEAR S m-m* v-v* y*-y1994 -3.446 -0.0097 0.713 0.7021995 -3.476 -0.149 0.826 0.6771996 -3.570 -0.221 0.876 0.6581997 -3.594 -0.281 0.948 0.6651998 -3.722 -0.338 0.993 0.6541999 -3.764 -0.418 1.074 0.6552000 -3.804 -0.466 1.109 0.6432001 -3.855 -0.504 1.098 0.5942002 -3.884 -0.565 1.116 0.5512003 -3.834 -0.639 1.129 0.4882004 -3.812 -0.819 1.251 0.4312005 -3.784 -0.978 1.341 0.363Putting above data in model we can get followings equations

1994 – 1997

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α = -3.446 + 0.0097 β1 -0.713 β2 - 0.702 β3 -0.033 = -0.139 β1 + 0.113 β2 - 0.025 β3 -0.124 = -0.2113 β1 + 0.163 β2 - 0.044 β3

-0.148 = -0.2713 β1 + 0.235 β2 - 0.037 β3

Now, we have four equations and four unknowns. So, solving four α,β1,β2,β3.

α = -5.18 β1 = -8.54 β2 = -8.12 β3 = 10.6

1998 – 2001

α = -3.722 + 0.338 β1 -0.993 β2 - 0.654 β3 -0.042 = -0.08 β1 + 0.081 β2 - 0.001 β3 -0.085 = -0.128 β1 + 0.116 β2 - 0.011 β3

-0.133 = -0.166 β1 + 0.105 β2 - 0.06 β3

Now, we have four equations and four unknowns. So, solving four α,β1,β2,β3.

α = -3.517 β1 = -8.18 β2 = -8.65 β3 = 8.08

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2002 - 2005

α = -3.884 + 0.565 β1 -1.116 β2 - 0.551 β3 -0.05 = -0.074 β1 + 0.013 β2 - 0.063 β3 -0.072 = -0.254 β1 + 0.135 β2 - 0.120 β3

-0.133 = -0.413 β1 + 0.225 β2 - 0.188 β3

Now, we have four equations and four unknowns. So, solving four α,β1,β2,β3.

α = -4.187 β1 = -8.14 β2 = -8.13 β3 = 8.67

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Model Parameters

YEAR α β1 β2 β31994-97 -5.180 -8.54 -8.12 10.61998-01 -3.517 -8.18 -8.65 8.082002-05 -4.187 -8.14 -8.13 8.67

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COMPARISON OF INDIA’S GNP WITH EX.RATE

GNP

0

5000

10000

15000

20000

25000

30000

35000

40000

YEAR

GNP

EX. RATE

0

10

20

30

40

50

60

YEAR

EX. RATE

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RESERCH FINDINGS

&CONCLUSIONS

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CONCLUSION

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Bibliography

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BOOKS

International Financial Management- Eun / Resnick

BULLETIN

Bulletin of rbi (Reserve Bank of India)

WEBSITES

www.economagic.comwww.imf.comwww.economicsurvey.comwww.oanda.comwww.rbi.org

SEARCH ENGINE

www.google.comwww.yahoo.com

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