Foreign exchange

Meaning of Foreign
Exchange
The term Foreign exchange implies two things:
a)foreign currency and
b) exchange rate
Foreign exchange generally refers to foreign
currency, eg for india it is dollar, euro, yen, etc &
the other part of foreign exchange is exchange rate
which is the price of one currency in terms of the
other currency.
Forex is the international market for the free trade of
currencies. Traders place orders to buy one currency
with another currency.

 According
to Hartly Withers,
Foreign exchange is the art and science
of international monetary exchange
The forex market is the worlds
largest financial market. Over $4
trillion dollars worth of currency are
traded each day. The amount of
money traded in a week is bigger
than the entire annual GDP of the
United States!
The main currency used for forex

Foreign exchange market

Foreign exchange market is that market in
which national currencies are traded for one
another..
The major participants in this market are
commercial
banks,
forex
brokers,
and
authorized
dealers
and
the
monetary
authorities.
Besides, transfer of funds form one country to
another , speculation is an important
dimension of foreign exchange market.
Its where money in one currency is exchanged
for another

Advantages of Forex
market
Its already the worlds largest market and its still
growing quickly
It makes extensive use of information technology
making it available to everyone
Traders can profit from both strong and weak
economies
Trader can place very short-term orders which are
prohibited in some other markets
The market is not regulated
Brokerage commissions are very low or non-existent
The market is open 24 hours a day during weekdays

Terms related to Foreign Exchange

Foreign exchange reserves- holdings of other countries' currencies
Foreign exchange controls- controls imposed by a government on the
purchase/sale of foreign currencies
Retail foreign exchange platform- speculative trading of foreign exchange by
individuals using electronic trading platforms
Foreign exchange risk- arises from the change in price of one currency against
another
International trade- the exchange of goods and services across national
boundaries
Foreign exchange company- a broker that offers currency exchange and
international payments
Bureau de change- a business whose customers exchange one currency for
another
Currency pair- the quotation of the relative value of a currency unit against
the unit of another currency in the foreign exchange market
Digital currency exchanger- market makers which exchange fiat currency for
electronic money

Exchange rate
According to haines, Exchange rate is
the price of the currency of a country can
be exchanged for the number of units of
currency of another country.
Exchange rate is that rate at which one
unit of currency of a country can be
exchanged for the number of units of
currency of another country.
Its the the price for which one currency is
exchanged for another

Factors influencing
Exchange Rates
As with any market, the forex market is driven by supply and demand:
If buyers exceed sellers, prices go up
If sellers outnumber buyers, prices go down
The following factors can influence exchange rates:
National economic performance
Central bank policy
Interest rates
Trade balances imports and exports
Political factors such as elections and policy changes
Market sentiment expectations and rumours
Unforeseen events terrorism and natural disasters
Despite all these factors, the global forex market is more stable than
stock markets; exchange rates change slowly and by small amounts.

Types of exchange rates

Fixed and Floating exchange rates

Fixed exchange rate is the official rate set by the
monetary authorities of the Governance for one
or more currencies.
Under floating exchange rate, the value of the
currency is decided by supply and

factors

demand

Direct and indirect

exchange rates
Direct method - Under this, a given number
of units of local currency per unit of foreign
currency is quoted. They are designated as
direct/certain rates because the rupee cost of
single foreign currency unit can be obtained
directly. Direct quotation is also called home
currency quotation.
Indirect method Under this, a given number
of units of foreign currency per unit of local
currency is quoted. Indirect quotation is also
called foreign currency quotation

Buying and selling

Exchange rates are quoted as two way quotes
for purchase
and for sale
transactions by the Bank

Spot and forward

The delivery under a foreign exchange
transaction can be settled in one of the following
ways
Ready or cash To be settled on the same day
Tom To be settled on the day next to the
date of transaction
Spot To be settled on the second working
day from the date of contract
Forward To be settled at a date farther than
the spot date

Theories of exchange rate

determination
Meaning:
Theories which determine the prices
of forex rate considering inflation,
interest rate, and elasticity of price
etc..
Methods:
a)Long run theory
b)Short run theory

Long Run Theory of Exchange rate

Determination:

This are the theories which predominately take into

account the fundamental changes of economy.
Here fundamental changes refers to the change which are
going to change the economic performance of the
economy Purchasing powfor all times to come.
Types of theory:
Purchasing power parity.
1) Absoulte purchasing power parity.
2) Relative purchasing power parity.
Interest Rate parity
1) Covered Interest Rate parity
2) UnCovered Interest Rate parity

Short Run theory of exchange rate

determination
This theories are based more on
current information or immediate
performance of economic variables.
This theories try to take into account
the short run factor which may be
eliminated in the long run.

Purchasing power parity theory

Founder Swedish economist Gustav Cassel in
1918.
Meaning : According to this theory ,the price
levels and the changes in these price levels in
different countries determine the exchanges
rates of these countries currencies.
The basic principle of this theory is that the
exchange rates between various currencies
reflect the purchasing power of these currencies
.This theory is based law of one price.

Absolute form of PPP Theory

If the law of one price were to hold
good for each and every commodity
then the theory is termed as
Absolute form of PPP Theory.
This theory describes the link
between the spot exchange rate and
price levels at a particular point of
time

Relative form of PPP

This theory describes the link between the
changes in spot exchange rate and in the
price levels over a period of time.
According to this theory ,changes in spot
rates over a period of time reflect the
changes in the price level over the same
period in the concerned economies.
This theory relaxes three assumptions of
PPP ie Absences of transportation cost
,transaction costs and tarriffs.

Interest Rate Parity Theory

Definition :
The process that ensures that the annualized
forward premium or discount equals the
interest rate differential on equivalent
securities in two currencies.
International Fisher effect:
Expected Rate of change = Interest rate of
the exchange rate differential
Interest Rate = Real Interest Expected
Differential Rate + inflation rate

Modern theory: demand &

supply theory
The most satisfactory explanation of the
determination of the rate of exchange is
that a free exchange rate tends to be
such as to equate the demand and supply
of foreign exchange..
The intersection of supply curve and
demand curve gives the equilibrium price
Modern theory also called balance of
payments theory of foreign exchange

Foreign Exchange Risk

Exposure to exchange rate movement.

Any sale or purchase of foreign currency
entails foreign exchange risk.
Foreign exchange transaction affects the
net asset or net liability position of the
buyer/seller.
Carrying net assets or net liability
position in any currency gives rise to
exchange risk.

Risk management
Controlling losses
You could control your losses, by mental stop or hard
stop. Mental stop means that you already set you limit
of your loss. A hard stop is your initiative to stop when
you think you must to stop it.
Using correct lot size
As a beginning just use smaller lots you could stay
flexible and logic than emotions while you trade.
Tracking overall exposure
sample: you go to short on EUR/USD and long on
USD/CHF, you exposed two times for USD in the same
direction. If USD goes down , you have a double dose of
pain. So, keep your overall exposure limited, it keeps
you for the long haul for trading
The bottom line
Trading is about opportunities, you must take action

Thank You!!!