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FOREIGN EXCHANGE
MARKETS

Foreign Exchange Market

The market where one currency is traded for

another is called foreign exchange market
Every international sale or purchase of
commodities, services or assets, there
corresponds an international sale or
purchase of currencies

Features of Foreign Exchange Market

Location: OTC Market banks and brokers

at a financial centre
Wholesale and Retail segments
Size : Daily turnover of over $3.98 trillion
24 hours market
Efficiency
Currencies traded

Most traded currencies by value

Rank

Currency

Symbol

% daily share( April

2010)

United States dollar

USD ($)

84.9%

Euro

EUR ()

39.1%

Japanese yen

JPY ()

19.0%

Pound sterling

GBP ()

12.9%

Australian dollar

AUD ($)

7.6%

Swiss franc

CHF (Fr)

6.4%

Canadian dollar

CAD ($)

5.3%

Hong Kong dollar

HKD ($)

2.4%

Swedish Krona

SEK (kr)

2.2%

10

New Zealand dollar

NZD ($)

1.6%

11

South Korean Won

KRW ()

1.5%

12

Singapore dollar

SGD ($)

1.4%

13

Norwegian Krone

NOK (kr)

1.3%

14

Mexican Peso

MXN ($)

1.3%

15

Indian rupee

INR ( )

0.9%
12.2%

Top 10 currency traders

% of overall volume, May 2011
Rank

Name

Market Share

Deutsche Bank

15.64%

Barclays Capital

10.75%

UBS AG

10.59%

Citi

8.88%

JP Morgan

6.43%

HSBC

6.26%

Royal Bank of Scotland

6.20%

Credit Suisse

4.80%

Goldman Sachs

4.13%

10

Morgan Stanley

3.64%

Foreign Exchange Market

Participants:

Corporates
Commercial banks
Exchange brokers
Central banks

Settlement of Transactions
SWIFT

Society for Worldwide Interbank Financial

Telecommunications
- a co-operative society owned by about
250
banks in Europe and North America
- registered in Brussels, Belgium

Settlement of Transactions
CHIPS :
Clearing House Interbank Payment Systeman electronic payment system owned by 12
private commercial banks constituting New
York Clearing House Association

CHAPS

:
Clearing House Automated Payment
System - London

Foreign Exchange Market

The foreign exchange market has two
segments
Spot Market
Forward Market

The rate at which one currency is traded for

another is called exchange rate

Spot Market

The exchange rate for immediate delivery

is called Spot Exchange Rate and is
denoted by S (.) e.g. S (Rs./$) = Rs.46.85/$

Here immediate delivery means delivery

after two business days

The market where the purchase and sale of

currencies is contracted for spot delivery is
called the Spot Market

Quotations at the FX Market

The quotes are usually made in the form of

buy and sell or bid and ask rates
Buy/ Bid

Exchange dealer is ready to buy

Sell/ Ask

Exchange dealer is ready to sell

Sometimes ask is also referred as offer price

Direct & Indirect Quotes

In case of direct quotes, a unit of foreign
currency is quoted in terms of domestic
currency

For example:
At Mumbai foreign exchange market , the
US dollar is quoted as:
USD 1 = Rs. 45.1525/1650
Spot (bid) = Rs. 45.1525/$
Spot
Rs. low:
45.1650/$
Rule(ask)
: =
Buy
Sell high

Direct & Indirect Quotes

In case of indirect quotes, a unit of
domestic currency is quoted in terms of
foreign currency

For example:
At Mumbai foreign exchange market , the
quotation are made as:
Rs. 100 = USD 2.0762/0767
Spot (bid) = $ 2.0767/Rs.100
Spot (ask) = $ 2.0762/ Rs.100

Rule : Buy high: Sell low

Direct & Indirect Quotes

Sometimes the quotes are made against

100
units of a currency instead of a unit of
the
currency

European quotes are indirect quotes

Indian quotes are direct quotes

Relationship between Bid/ Ask prices

When a bank quotes for a currency, it
simultaneously offers another currency in
lieu i.e. if it buys dollars for rupees, it is
simultaneously offering rupees for dollars
Thus, there are two sides of all quotes
S (x/bid y) = 1/ S (y/ask x) and S (x/ask y) = 1/
(y/bid x)
Where:

Spread
Ask and bid differential is called the spread
When quotes are direct :
Spread = Ask Bid
When quotes are indirect :
Spread = Bid Ask
Spread represents cost of transaction
It is represented by the percentage of spread
and is
given by:
1.[( Ask- Bid)/ Ask] x 100 when quotes are
direct

How BID and ASK rates are formed

Let c be one side average cost of transaction and
M be the mid rate, then the bid and ask rates are
given as:
S (bid) = M x ( 1-c) and
S (ask) = M x (1+c)
The mid rate is issued by the central banks of the
countries if convertibility conditions exist
Spread equals twice the one side average cost of
transaction

Determinants of Spread
The currency being traded
The volume of currency being traded
The nature of organisation making
quotes
Overall perception of the Dealer about
the
conditions of the economy and forex
market
Usually these spreads are regulated by

Factors Determining Spot Exchange Rates

Balance of Payments
Inflation
Interest Rates
Money Supply
National Income
Resource Discoveries
Capital Movements
Political Factors
Psychological Factors and Speculation
Technical and Market Factors

Forward Market

Forward contracts are bought and sold at

forward exchange rates
Hedging and speculation are the main
activities which pertain to forward
markets

Forward Exchange Rate

The exchange rates for delivery and
payment
at specified future dates are called
Forward
Exchange Rates and is denoted by F(.)

For example, 60 days F (Rs./$) : forward

rate
between rupees and dollar is the rate at
which

Forward Exchange Rate

Forward exchange rates are determined
by
forward demand and forward supply of
various currencies
A foreign currency is said to be at a
forward
premium if its future value exceeds its
present value in terms of domestic
currency
and it is said to be at discount if the

Quotations of Forward Rates

These rates are also quoted in the form
of
bid and ask rates and the spread also
depend on approximately the same
factors as
spot rates plus:
Rate of Interest
Demand and Supply
Speculation about Spot Rates and
Exchange Regulations

Quotations of Forward Rates

Payoffs in the case of a forward contract
Realised Rate
(Rs.)

Contracted
Rate (Rs.)

Unanticipated
Change

Profit/Loss
(Rs.)

46.5500

46.3500

-0.200 - 20,000.00

46.4500

46.3500

-0.100 - 10,000.00

46.3500

46.3500

0.000

0.00

46.2500

46.3500

0.100

10,000.00

46.1500

46.3500

0.200

20,000.00

Participants in the Forward Market

Traders
Arbitrageurs
Hedgers
Speculators
Banks
Governments

Cross Rates
The exchange rate which is obtained by cross
product of two exchange rates is called Cross Rate
Spot rate at Mumbai :S(Rs./$) = 31.2022/$
Spot rate at Frankfurt : S(Rs./DM) = 15.87 / DM
Then Cross Rate = S(DM/$) = DM 2.0983/$
This is the rate a Mumbai broker may expect the
Frankfurt price of dollar in terms of DM

Indian Forex Market

In Indian forex market, not all currencies
are
bought or sold
For non-traded currencies, the banks use
London, New York or Singapore markets
Exchange Market Segments:
1.
2.
3.

RBI and ADs( Commercial Banks)

Interbank market
Retail segment ADs with

Indian Forex Market

The rates quoted by authorised dealers

(ADs) are merchant rates at which trading
can take place in the Retail segment
Merchant rates are different than interbank rates and contain administrative
cost, cover for exchange fluctuation and
some profit on the transaction for the Bank

Types of Exchange Rates

Four types of rates are quoted:

1.
2.
3.
4.

TT( Telegraphic Transfer) rate

Bill rate
Currency notes
Travellers cheque rate

TT ( Telegraphic Transfer) rate

Transactions where TT rate is applied:

Issue/ Payment of demand drafts, mail

transfers, telegraphic transfers etc.

Foreign bill collected and amount

received in

nostro account

Cancellation of foreign exchange sold/

purchased earlier

Bill Rate
Rate applied for a foreign bill purchased or
payment
against import bill
Bill Buying rate: Basic rate (+ or -) Forward
Premium ( Discount) for
transit
period plus usance period

Exchange margin
Bill selling rate = TT selling rate + service

Indian Forex Market

In India, the official rate is determined by
the
RBI on the basis of the multi-currency
basket
The official buying and selling rates are
announced
FEDAI announces indicative free market
rate on
every business day

FEDAI Indicative Rates

11.30 am 22nd August 2011
USD

GBP

45.9350/9450

75.7150/7450

JPY

EUR

59.8500/9025

65.9900/66.0225