UNIT 3-Foreign Exchange Market

Foreign Exchange Market

It is the market where foreign currencies are
bought & sold. It broadly comprises of:
Customer Market
Interbank Market.

Customer market
It comprises of transactions between banks
(authorized dealers) and their customers. Such
transactions are of two types, viz., Ready
delivery & Forward delivery.

Interbank Market

It comprises of:
Transactions between different banks in the
same center/country.
Transactions between banks in a country and
their correspondents and overseas branches.
Transactions of the central bank of one country
with central banks of other countries.

 Interbank foreign exchange dealings are of four

types:
Cash- same day delivery
Tom- delivery on immediately succeeding
working day
Spot- delivery on second successive working day
Forward- delivery beyond second successive
working day

Features of FEM
It is market where foreign currencies are
brought and sold.
Eg: If an Indian importer import goods from
USA and has to make payment in US dollar ,it
will approach FEM to buy US dollar for rupees.
An exporter converts the export proceeds
obtained in foreign currency into its own
currency.

 It is the over the counter market.

It consist of trading desk at major agencies
dealing in foreign exchange throughout the
world connected by telephone,telex etc
Transaction are normally oral followed by
written communication.

Foreign Exchange Rates & Quotations

Different sets of exchange rates are applied for various
types of foreign exchange transactions as under:
(1) TT Selling Rate:- It is applicable for all clean
remittances outside India i.e., the bank undertakes only
currency transfers by way of issuance of DD(demand
draft), MT(money transfer), TT(telegraphic transfer),
etc in terms of foreign currency.
The bank does not perform any other function such as
handling documents.

 TT Selling Rate = Base Rate + Exchange Margin

Base rate is the Interbank selling rate. Exchange
margin is the profit margin that may load subject
to the conditions specified by FEDAI(
Foreign Exchange Dealers' Association
of
India)

 #Apart from accepting deposits and lending

money, Banks also carry out, on behalf of their
customers the act of transfer of money - both
domestic and foreign.- from one place to another.
This activity is known as "remittance business" .
Banks issue Demand Drafts, Banker's Cheques,
Money Orders etc. for transferring the money.
Banks also have the facility of quick transfer of
money also know as Telegraphic Transfer or Tele
Cash Orders.

 (2) Bill Selling Rate: It is applied for all outward remittances in

respect of import bills payable in India. This rate
is a little worse than TT Selling Rate as the bank
has to handle documents relating to the
transaction.

 Bill Selling Rate = TT selling rate + Exchange

Margin
Forward Bill Selling Rate = Forward TT Selling
Rate + Exchange Margin
Forward TT Selling Rate = Interbank Spot
Selling Rate + Forward Premium/ - Forward
Discount + Exchange Margin

 Ex.- A wishes to buy pounds 2 months forward to

settle a sight bill. The market rates are: Spot
selling: Rs.55.60 2 months: 15 Paise discount ,
Exchange margin is 0.125% for TT selling and
0.15% for bill selling .
Forward TT selling rate = (55.60-0.15) 1.00125 =
Rs.55.52 ,
Forward Bill Selling Rate = 55.52 (1.0015) =
Rs.55.60

 (3) TT Buying Rate:- It is applied for all clean

foreign inward remittances which are payable in
India. For e.g., a TT issued by a bank in Australia
for USD 10,000 drawn on OBC, New Delhi will
be converted into rupees at TT buying rate as the
bank in Australia would have already paid the
USD in OBC branch at New York.

 TT Buying Rate = Base Rate Exchange Margin

 (4) Bill Buying Rate:- It is applied for purchase/

discounting of export bills resulting in foreign
remittance to India after realization. It is worse
than TT buying rate as there is delay between the
AD paying the exporter and itself getting paid on
presentation of bill to the foreign importer. Also,
interest is recovered from the exporter for such
period.

 Bills are of two types:

Sight/ demand bills- delay involved in such bill
is only the transit period.
Time/ usance bills:- delay involved is transit
period plus the usance period i.e. the credit
period allowed to the importer.

 Bill Buying Rate = Base Rate + Forward

Premium / - Forward Discount - Exchange
Margin.
NOTE: The forward premium / discount
is for transit + usance period; in case of
forward bill buying, it is for transit + usance +
forward periods.

 (5) Cross Rates:- It is an exchange rate between

two foreign currencies; for eg., in India, FFR/ $,
DM /$ are cross rates. A cross rate may be used
to ascertain the price of a foreign currency in
terms of INR for which direct quotations are not
available.

 If, FFR 7.05 = $ 1

And, Rs.44.53 = $ 1
Then, Rs. (44.53/7.05) = FFR 1
Or, Rs.6.32 = FFR 1

 (6) Spot Rate:- It is the prevailing market rate on

the day of transaction.
(7) Forward Rate:- It is the rate fixed in advance
for a transaction which will mature at a specified
date or specified period in future. It is at a
premium / discount to spot rate.

 In case of direct quotes,

Forward Rate = Spot Rate + Forward Premium/Forward Discount

Types of Quotations:
1. Direct Quotation:- It is the home currency
price of one unit of foreign currency.
Eg., Rs.44 = $1
2. Indirect Quotation:- It is the foreign currency
price of one unit of home currency. E.g.- Re.1 =
$1/44 = $.0227
Direct quote = 1/ Indirect quote, and vice versa.

 3. Bid / Offer:- Bid is the purchase price of a

currency quoted .
Whereas, offer ( or ask rate) is the selling price
of a currency quoted. Bid for one currency is
simultaneously an offer for another currency.
For instance,
$1 = Rs.44.50/44.55
offer

bid

 An authorized dealer gains by keeping his offer

for a currency higher than his bid for that
currency.
Thus, his spread = offer bid.
Two-way quote: Rs 44.50 is bid for $1; at
the same time $ 1 is offer for Rs.44.50 or,
$.02 is offer for Re.1