FOREIGN EXCHANGE MARKETS

SCOPE

BROAD IDEA OF FEX SET-UP ROLE OF DEALING ROOM RETAIL & WHOLESALE MARKETS EXCHANGE CONTROLS COUNTER-PARTY RISK OPERATING IN WHOLESALE MARKET USING WHOLESALE MARKET TO PRICE PRODUCTS OBJECTIVE : TO UNDERSTAND PRICING OF RETAIL TRANSACTIONS

Exchange Rate of INR

Exchange Rate Arrangement :

Managed float with no pre-determined exchange rate path

Brief History :

Early Stages : 1947 to 77

Par value system & stable exchange rates Intra-day positions allowed Internal Control Guidelines Over-valued exchange rate Crisis of early 1990s

Formative Period : 1978 92

Exchange Rate of INR

Post-reform Period : 1992 onwards

Downward exchange rate adjustment by 9 & 11 % in July 91 Quasi market determined exchange rates ( LERMS ) Unified exchange Rates system in March 93 Current a/c convertibility since Aug 94 Sodhani Committee

Exchange rate of rupee against USD : 1947 to 2007

STRUCTURE OF FOREX MARKETS

Market Segments Market Players Sources of demand & supply Market instruments Trading Platforms Settlement of Transactions Market turnover

Market Segments :

On-shore and Off-shore markets Retail and wholesale markets Central and decentralized markets

OTC & Exchanges

Indian market is a decentralized multiple dealership market

SPOT and Derivative Segments

Market Segments :
Exporter $ Bank

Importer

Bank

Retail

Inter-bank

Market Players :

Authorized Dealers

Customers must necessarily buy or sell forex from/to an Authorized Dealer RBI under section 10(1) of FEMA authorizes

Banks ( category I ) Financial institutions ( category III ) FFMCs, RMCs, RRBs ( Category II )

Ads offer different products to Customers to suit their needs Large public and private sector companies from manufacturing & service sector Medium sized corporates and service providers SMEs Their requirements can range between a few thousand dollars to a few million dollars

Customers

Pricing Process

Q A

Protocol

R -- Request Q -- Quote A -- Accept

Retail Market :

PoS : interface between customer and bank ( AD )

Could be a branch or a separate center

Receives/pays forex and pays/receives Indian rupees Settles the transaction

PoS executes the transaction

Arranges for collection Sends out remittances ( SWIFT ) Uses correspondent network ( NOSTRO A/C ) Uses an appropriate exchange rate quoted by Treasury Ensures compliance with control regulations

Treasury quotes exchange rate and covers in interbank market Customers are necessarily required to go to an Authorized Dealer

Various types

Merchant Rates

Buying & Selling rates

Refer to what the bank does

Rates are quoted as INR equivalent of 1 unit of foreign currency

Japanese yen is exception quoted for 100 JPY

T.T and Bill Rates

Difference essentially arises from either

Banks being out of funds or Higher execution costs

Rates are also quoted for currency notes and traveler's cheques Buying rate is always less than Selling rate Between TT and Bill rate, the former is always better for the customer Rates differ from bank to bank & are negotiable

Example of settlements in retail market

1. Mr X goes to a bank to send a remittance of $ 5,000.- to his son in US SME Ltd. Has received an import consignment on collection basis for Euro 10,000.- and desires to take delivery of the B/L SmartSoft a software company had rendered some services to a Japanese company which in turn has sent a remittance of USD 3 mio mio through Bank of India Indtel is a large telecommunication company and wants to send an outward remittance for USD 10 mio favoring Arabsat towards bandwidth charges AutoComp Systems has executed an export order for supply of components to a British company amounting to GBP 1,000,000.- It has prepared all the documents including a bill of exchange drawn at 90 days from B/L date under a letter of credit and submitted the same to its bank for negotiation

2.

3.

5.

6.

Merchant Rates ( source : www.dcbl.com )

Merchant Rates ( source : www.abnamro.co.in)

How Banks Quote Rates

Banks selling rate for a customer is based on the rate at which they (banks ) can buy the forex from interbank market Banks buying rate for a customer is based on the rate at which they (banks ) can sell the forex in inter-bank market Acquisition and Disposal Rates Banks do not carry large risks on merchant business

Intermediation
1$ Exporter Bank

40 INR
41 INR 1$

COVER OPERATION
INTER-BANK

Intermediation
1$ Importer Bank

43 INR
42 INR 1$

COVER OPERATION
INTER-BANK

Intermediation

Bank is buying 1 $ from exporter at a rate of 40.00 INR

Bank is quoting this rate because it is able to sell the $ in inter-bank market at a rate of 41.00

Bank is selling 1 $ to the importer at a rate of 43.00 INR

Bank is quoting this rate because it is able to buy the $ in inter-bank market at a rate of 42.00

This means that the inter-bank market is quoting a rate 1 $ = 41.00 INR to buy $ and 1 $ = 42.00 INR to sell $

This is called a two-way price where a buying and selling price is simultaneously quoted

Market Instruments

Retail Market :

Ready Deals Inward & outward remittances Issuance of demand drafts in foreign currencies Negotiation / Discounting / Purchasing of foreign currency bills Export factoring Handling export and import bills on collection Opening letters of credit Handling bills under L/Cs

ADs also arrange for short term loans in foreign currency

FCNR(B) Loans PCFC Buyers credit

ADs also offer forward contracts & other derivatives

Retail Market

Settlement of Deals :

ADs settle the deals using their NOSTRO accounts for the foreign currency leg and a rupee account with them for the rupee leg SWIFT is widely used for messaging

Trading Platforms :

Physical interface Bilateral telephone conversations Inter-net based systems ATMS ?

Demand & Supply of forex

Demand for forex emanates from :

Imports Invisible payments

Travel, transportation, interest on borrowings etc.

Servicing of external borrowings including trade credits Outflows on a/c of NR deposits maturing and disinvestments by foreign investors

Supply of forex results from receipts on account of

Exports Invisibles

Travel, investment income, insurance, inward remittances from NRIs, software & service exports

Foreign Direct and Portfolio Investments NR deposits accepted by Indian banks External Commercial Borrowings by Indian companies

Demand & Supply of Forex

BRIEF RE-CAP

Retail Business of ADs

Handled by the PoS Counter-party Risk also managed by PoS Executed at a rate quoted by Dealing Room
Acquires risk from the customer business and covers that in the inter-bank market Finds out a cover rate adds margin and quotes to a customer Intermediation Function

Price Risk managed by the Dealing Room

Inter-bank Market :

Market between ADs OTC Market Telephonic and electronic communication between ADs - no physical interface Sometime brokers may also be involved Standardized Deal amounts and maturity

Surplus/Deficit that an individual AD may have from his operations in the retail market is cleared in this market
Market information vending firms like Bloomberg, Reuters etc serve a very useful purpose

Market Players :

ADs - Market-makers & Market-users International Banks Brokers :

They help the price discovery process in the inter-bank market Brokers can not cater to customers requirements Electronic broking systems are threatening to marginalize the voice brokers

Reserve Bank of India ?

Intervention

Market Instruments :

Inter-bank Market :

Currency symbols / codes ( ISO codes ) Outrights

Cash, Tom, SPOT deliveries Anything beyond SPOT Simultaneous sale and purchase for different maturities Foreign currency rupee swap Foreign currency rupee options Cross currency options Cross currency swaps Structures involving swaps and options

Forwards

Swaps

Other derivatives

Inter-bank Market

Trading Platforms :

Bilateral trades over telephone Electronic trading platforms such as

Reuter Dealing 3000 FXCLEAR FX Direct Reuters Market Data System

Settlement Process:

Deals with counter-party banks in India are mostly settled using clearing platform provided by CCIL Deals with overseas counter-party banks are settled using NOSTRO accounts in corresponding currencies

Demand & Supply of Forex

Turnover in Indian Fx Markets

RBIs Role

Market Turnover

Daily turnover in inter-bank market increased from $ 5 bio in 97/98 to $ 18 bio in 2005/06 This has increased further to $ 23 bio in 2006/07 Inter-bank to merchant turnover ratio has decreased from 5.2 in 97/98 to 2.6 in 2005/06 Mumbai alone accounts for more than 80% of the market turnover Turnover in India was 6.6 times the size of the Balance of Payments during 2005/06 as compared to 5.4 in 2000/01

CCIL Fx Clear System

CLEARCORP DEALING SYSTEMS(INDIA) LTD. MIS Report - FOREX DEALING SYSTEM (FX-CLEAR) USD/INR SPOT FOR 03 August,2007

Previous Close Open Price

40.4200 40.3900

Today's Close High Price

40.3475 40.3925 211

Net Change Low Price No. of Members

-0.0725 40.3250 63

Total Volume(Mn) 150.5 Number of Trades

Market Turnover

Market Turnover

Other EME Markets

TWO-WAY PRICE
1 USD = 40.50 / 40.51 INR
BASE CURRENCY
BID SPREAD

OFFERED ASK CURRENCY

DELIVERY DATE : CASH / TOM / SPOT / FORWARD STANDARD LOT : USD 1 MIO

MARKET MAKER & MARKET USER

TWO-WAY PRICE
1 EUR = 1.3700 / 1.3703 USD
BASE CURRENCY
BID SPREAD

OFFERED ASK CURRENCY

DELIVERY DATE : CASH / TOM / SPOT / FORWARD STANDARD LOT : USD 5 MIO

MARKET MAKER & MARKET USER

IMPORTANCE OF $

Preferred Vehicle currency Reserve currency Commodity and Debt prices Importance of $/INR Rate About 70 % of the transactions are denominated in $

TWO-WAY PRICE

MARKET PRACTICES

NO CENTRAL BANK RULES HIT ON THE PRICE ? THE RULE OF LEFT & RIGHT QUOTED PROMPTLY FOR STANDARD MARKET LOT NARROW SPREAD

PRICE CHANGE

WHAT IS A GOOD PRICE ?

LET US DO AN EXERCISE

TWO-WAY PRICE

USING THE MARKET

AT WHAT PRICE DO I BUY ? AT WHAT PRICE DO I SELL ? I MUST DO AT MARKET RATE & NOT AS PER MY WISH OR DESIRE SPREAD GOES AGAINST ME !

LET US DO AN EXERCISE ! MAKING THE MARKET

BENEFITS & RESPONSIBILITIES

NON-USD / INR RATES

COMBINING USD/INR RATE WITH USD/NON-USD RATE MUST REMEMBER MARKET PRACTICE

QUOTING CONVENTIONS

WHEN USD AS BASE CURRENCY IN ONE & OFFERED CURRENCY IN OTHER,

BID*BID ; ASK*ASK

WHEN USD AS BASE CURRENCY IN BOTH QUOTES TO BE COMBINED

BID/ASK ; ASK/BID

LET US DO AN EXERCISE

COVER OPERATION

WE NOW FAMILIAR WITH THE INDIAN & INTERNATIONAL FOREX MARKET PRICE INFORMATION PRICING FOREX PRODUCTS USING THIS INFORMATION IS VERY EASY A STEP-WISE APPROACH HELPS

UNDERSTAND TRANSACTION DECIDE WHETHER TO BUY FROM OR SELL TO I.BANK MARKET SELECT APPROPRIATE RATE DECIDE MARGIN LOAD MARGIN & QUOTE RATE

STEP-WISE APPROACH : STEP 1 : STEP 2 : IS IT A FC BUYING OR SELLING TRANSACTION ? WHICH CURRENCY IS TO BE BOUGHT FROM CUSTOMER ? AGAINST WHICH CURRENCY ? IN INTER-BANK MARKET THE CURRENCY BOUGHT FROM CUSTOMER WOULD HAVE TO BE SOLD. WHAT IS THE MATURITY ? YOU NOW KNOW ---* WHICH CURRENCY TO SELL * AGAINST WHICH CURRENCY * FOR WHAT MATURITY WORK OUT THE RATE AT WHICH YOU WOULD BE ABLE TO DO THE TRANSACTION IN INTERBANK MARKET. DECIDE THE MARGIN TRANSACTION SIZE EXECUTION COSTS RISK PREMIUM CUSTOMER RELATIONSHIP LOAD MARGIN & QUOTE * BE VERY SPECIFIC * IS IT AN INDICIATION ? * IS IT A FIRM PRICE ? * IT WILL BE FIRM FOR HOW LONG ? * FOR WHAT AMOUNT THE PRICE IS GOOD ?

STEP 3 :

STEP 4 : STEP 5 :

STEP 6 :

STEP 7 :

STEP 7 :

EXERCISE ON CUSTOMER RATES

Idea Cellular desires to remit USD 500,000.- value SPOT. Pune center reports an inward remittance for USD 10,000.value SPOT for Mr. X IBM( India) in Gurgaon wants a forward contract for USD 7 mio to cover inward remittance that it plans to bring sometime in Oct, 07. Mr. & Mrs. Y are traveling to Japan and want T/Cs for USD 5,000.- each and currency notes of $ 250.-`` Maruti Udyog Ltd are remitting JPY 100 mio today towards royalty payment.

MARGIN ON CUSTOMER RATES

FUNCTION OF

COST OF EXECUTION PROFIT EXPECTATION RISK PREMIUM

MARGIN RANGE 0.01 % TO 0.30 % WHAT IS RISK PREMIUM ?

MARKET LOT GETTING COVER FOR EXOTIC CURRENCIES ODD MATURITIES

State Bank Story ( www.statebankofindia.com )

Profit for the year : Rs 4,541 cr. Other Income : Rs 5,769 cr Income on foerx( Schedule 14 ) : Rs 373 cr ( v/s 1,001 cr for 05/06 )

PRICING CUSTOMER PRODUCTS

STEP 1 :

DECIDE WHETHER YOU ARE REQUIRED TO BUY FROM OR SELL TO CUSTOMER

FIND OUT THE RATE FROM THE MARKET AT WHICH YOU CAN COVER YOURSELF LOAD THE CUSTOMER MARGIN AND QUOTE A RATE TO THE CUSTOMER YOU MAY OR MAY NOT ACTUALLY COVER

STEP 2 :

STEP 3 :

STEP 4 :