Oveview of Forex Markets,

Exchange Rate Mechanism

and Margin Matrix

STATE BANK ACADEMY, GURGAON

What do we mean by FOREX Market
Foreign Currency Exchange Market.
It involves trading one nations currency for the currency of
another nation.
It is the largest financial market in the world - $3.98 trillion
average daily turnover according to Bank for International
Settlements (BIS).
About 5 % turnover is transaction related and 95 % financial &
speculative.
Indias turnover is $ 31-32 billion per day
It operates virtually round the clock 24 hour a day, 5 days a
week from Monday to Friday : Trading begins in New Zealand
(Wellington), followed by Australia, Tokyo / Asia, the Middle
East, Europe and America (NY).
What do we mean by FOREX Market contd..
The daily volume is 10 times the average
daily turnover of global equity markets
More than 35 times the average daily
turnover of NYSE
Nearly $500 a day for every man, woman
and child on earth
An annual turnover more than 10 times
world GDP
What do we mean by FOREX Market contd
Structure:
- It is not centrally located.
- It is decentralised, over-the-counter (OTC) market,
also known as the inter-bank market.
- buyers and sellers conduct business linked by
telephones, computers, fax and any other instant
communication medium.
Contd.
Immediate impact due to fast communication
Hectic market, Very volatile quite often
According to BIS study, US dollar was involved in 88.7% of all spot
transactions, followed by the euro (37.2 %), the yen (20.3 %), and the
sterling (16.9 %)
London (34%), New York (16%) and Tokyo (6%) biggest markets in the
world. In that order, top 10 account for 80% of the transactions.
Just like any other exchange, forex market is driven by supply and
demand of a particular tool.
SPOT market accounts for about one third of daily turnover
Quite Efficient Market
Liquidity : all banks quote when asked for
Transparency : Rates quoted two way
Instant dissemination of information
Quite Efficient Market
Market Participants
Banks the inter bank market
Lowest spreads
The top tier inter bank market accounts for 53% of
transactions
Trades may be done on behalf of customers or by
proprietary trading desks, trading on the banks account
Commercial Companies
Those with businesses across borders
Rarely big enough to impact market
Market Participants (contd.)
Central Banks - Intervention
Very important players
Try to control money supply, inflation, interest rates
through currency markets push the exchange rate in a
particular direction
Try to resist high volatility
May not have to actually buy or sell to intervene just
an expression of concern about the currency can move
markets
Markets are usually stronger than the Central Bank and
can move against the Central Bank at times
Market Participants (contd.)
Investment management firms
Trade on behalf of their clients which might be companies,
pension funds or even HNIs
Hedge Funds
Aggressive speculators
Have ability to leverage their funds many times
George Soros controlled hedge fund hit Bank of England hard
when the Central Bank was trying to support the Sterling. The
fund made more that $1.1 billion during the transaction
Retail Brokers
Allow retail investors to bet on currencies
Very small players
Individuals
Forex Market in India

Merchant segment
Interbank segment
100 ADs operating in forex market
SBI, few large Indian banks and a few foreign banks
dominate the forex market
Market makers
- quote two way prices
- good price with narrow spreads
- efficiency & liquidity through spreads between buy
and sell rates.
( wide spreads and one way quotes illiquid market )
Forex Market in India

Daily Turnover in Indian forex

market
USD 3 bn in 199899
USD 12 bn in 2004-05
USD 25 bn in 2006-07
Merchant segment USD 7 bn
Interbank segment USD 18 bn
Present Size -- approx. USD 31-32
bn
CURRENT ACCOUNT

RECEIPTS PAYMENTS

SUPPLY OF DEMAND FOR

FOREX FOREX
For import of GOODS
From export of GOODS
For import of SERVICES
From export of SERVICES
PAYMENT OF PROFITS,
RECEIPT OF PROFITS,
DIVIDENDS, INTEREST,
DIVIDENDS, INTEREST,
ROYALTIES, ETC TO
ROYALTIES, ETC EARNED
FOREIGN COUNTRIES
ABROAD
CAPITAL ACCOUNT

INFLOWS FROM FOREIGN OUTFLOWS TO FOREIGN

COUNTRIES COUNTRIES

SUPPLY OF DEMAND FOR

FOREX
FOREX LENDINGS
BORROWINGS DIRECT INVESTMENT
DIRECT INVESTMENT PORTFOLIO INVESTMENT
PORTFOLIO INVESTMENT
Current Account Deficit / Surplus

Trade Surplus - Exports > Imports

Trade Deficit - Exports < Imports
Current Account Surplus: (Exports
+Inward Remittances) > (Imports +
Outward Remittances)
Current Account Deficit: (Exports +
Inward Remittances) < (Imports +
outward Remittances)
Current Account Deficit turns to surplus when:

Exports Imports
+ Inward Remittances + Outward Remittances
+ FII Inflows
> + FII outflows
 INTRODUCTION - INDIAN FOREX MARKETS

ALL TRANSACTIONS SHOULD CONFORM TO FEMA.

ONLY AUTHORISED DEALERS /AUTHORISED MONEY CHANGERS

ALLOWED TO BUY/SELL IN THE MARKET.

AS ON AUGUST 2007 -
AN AMOUNT OF USD 1100 BILLION WAS
OUTSTANDING IN THE BALANCE SHEETS OF INDIAN BANKS 84
% FORWARDS AND REST OPTIONS.

INTEREST RATE DERIVATIVE MARKET SIZE - DAILY RUPEE SWAP

MARKET IS WORTH USD 4 BILLION (INR 16,000 CRORE ) PER DAY
CCIL DATA AUGUST 2007
 SHORTCOMINGS OF INDIAN FOREX
MARKET
Turnover has gone up but still small size - USD
3 billion per day in 1998-99 to USD 31-32 billion
per day at present.
Very few players - RBI , Banks , Corporates,
Brokers
Forward market active upto 1 year.
Not fully integrated with money mkt.
Derivative market in growing stage.
Exchange control - being liberalised.
RECENT DEVELOPMENTS
As far as the Indian foreign exchange market is
concerned, during the last five years the sources of
supply and demand have changed significantly with
large transactions emanating from capital account
unlike in the past when current account transactions
dominated the foreign exchange market.
EXCHANGE RATE MECHANISM

Exchange Rate is the conversion rate of

one currency in terms of another
currency.
 Measuring
Exchange Rate Movements

An exchange rate measures the value of one currency in

units of another currency.
An exchange rate represents the price of a currency,
which is determined by the demand for that currency
relative to the supply for that currency.
When a currency declines in value, it is said to
depreciate. When it increases in value, it is said to
appreciate.
On the days when some currencies appreciate while
others depreciate against a particular currency, that
currency is said to be mixed in trading.
CONVERSION CAN BE ON ACCOUNT OF
Export Receivables
Import Payables
Disbursal of Forex Loan
Repayment of Forex Loan
Foreign Investment
WHY DO WE NEED EXCHANGE RATES

International Business requires cross border payments.

Different countries have different currencies.
Importer / Exporter requires payment in their respective
currencies.
Corporate require for converting their ECB/FCCB/ADR/GDR
proceeds to meet their domestic requirements.
Corporate require for repayment of ECB, redemption of FCCB or
to meet any other debt obligation in foreign currency.
Exchange Rates

Exchange rate codes are expressed in 6 letter

currency codes.

eg. USD / CHF ; GBP/USD ; EUR / USD ;

USD / INR ;

In the first place is base currency code ;

quotations are expressed in units of the
second currency against one unit of the first
currency.
Now Let us know

Currency Codes :
Each currency bears its three-
letter ISO code , developed by the
International Standardisation
Organisation

eg. USD; CHF; GBP; EUR;

AUD; INR; etc.
Exchange Rate Quotes

Direct and Indirect Rates

Buying and Selling Rates
Bid and Ask / Offered Rates
Spot and Forward Rates
Direct Rates

System of expressing exchange rate of 1 unit of foreign currency

in units of home currency e.g. USD / INR = 46.60 would be a
direct exchange rate for the US dollar in India.
1 GBP = 67.75 INR In India
1 USD = 105.60 JPY In Japan
Fixed Component foreign currency
Most currencies are quoted against 1 USD i.e. quoted DIRECT.
(India has adopted the direct quotation system effective from
06.08.1993).
Indirect Rates
System of expressing exchange rate of a unit of local
currency in units of foreign currency e.g. EUR / USD =
1.2748 would be the corresponding indirect quotation in
France for the US dollar.
1 GBP = 1.4850 USD In Britain
1 AUD = 0.5450 USD In Australia
Fixed Component domestic currency
EUR/USD, GBP/USD, AUD/USD, NZD/USD are quoted in
units of US dollars against 1 unit of home currency i.e.
quoted INDIRECT.
Buying Rates

1. T.T. Buying Rate

2. Bill Buying Rate
3. DD Buying Rate
4. TC Buying Rate
5. Currency Notes Buying Rates
6. Others
 Selling Rates

1. T.T. Selling Rate

2.Bill Selling Rate
3.Travellers Cheques Selling Rate
4.Currency Notes Selling Rate
 Others
Bank buys a currency from exporter at buy rate
Bank sells a currency to importer at sell rate
Sell rate is kept higher than buy rate
The difference is profit to the Bank
All currencies bought have to be sold
All currencies sold are bought back
This matching of sale and purchase is called cover
operation.
Customers not always available for sale / purchase
Banks deal among themselves inter bank market
This is wholesale market for currencies.
Bid and Ask / Offered Rates
Interbank market quotes bid and ask rate for currencies.
Bid rate is the rate at which market is willing to buy a currency by
selling other
Ask rate is the rate at which market is willing to sell a currency for other
e.g. Bid Ask
1 USD INR 46.60 INR 46.61
i.e. market is willing to buy 1 USD at INR 46.60 and sell at 46.61
- Quoted like 46.60/61 or more often 60/61

- Although, banks trade (buy & sell) in currencies at the domestic inter-
bank market and the international exchange market, their bread and
butter transactions are the merchant (customer) transactions.
Spot and Forward Rates
Cash When settlement is done on the same day; it is
a cash transaction
Tom When settlement is done on next working day;
it is a Tom transaction
Spot Settlement of funds in foreign market normally
takes place after two working days. Rates quoted are
on spot basis.
Forward - When the settlement is done beyond the
spot date
 Value Date
Every forex transaction involves exchange of two currencies by the
counter parties to the transaction. The date on which the two
currencies involved in an exchange transaction change hands i.e. when
the nostro account is credited in case of a purchase and debited in case
of a sale, is the value date.
Exchange normally takes place two working days after deal date and is
called spot date.
When settlement is done on next working day; it is a Tom transaction
When settlement is done on the same day; it is a Cash transaction
When the settlement date is beyond the spot date, it is called a forward
transaction.
Spot, Tom and Cash transactions are called ready transactions.
Value Date - Time Scale
Time Scale

Cash Tom Spot Forward Maturities

Cash Deal is done today for delivery Today

Tom Deal is done today for delivery Tomorrow

Spot Deal is done today for delivery on 2nd Business Day

Forward Deal is done today for delivery beyond Spot Date

 Eligible Value Date
To be an eligible value date, a value date must be a
business day in the home countries of the currencies
involved in the transaction.
 Calculation of forward rate
Customer wants to book one year forward say USD 1
million for export
Interest rate scenario: USD 4%, INR 7%; INR/USD Spot: Rs
45
Bank borrows USD 1 mio @ 4% & sells USD 1 mio value
spot @ Rs 45/ to market
i.e. Bank buys INR 45 mio value spot
Bank borrows USD 1 mio @4% while it places Rs 45 mio @
7%
After 1 year
USD 1,000,000 INR 45,000,000
Int paid 40,000 Int recd 3,150,000
Total 1,040,000 48,150,000
Effective rate after one year 48,150,000/1,040,000=46.30
Types of Settlement in Forex market
- Value date contd..

Forward Rates Rules of Value Date:

1)Value date of 1M Forward Contract will
be the spot date in the next month i.e.
deal struck on 24th January 2010 will
have to be settled on 26th February 2010
2) If 26th Feb 2010 is holiday ( say
Saturday or Sunday ) settlement day
will be Monday
( 28 Feb10).
Types of Settlement in Forex market
- Value date contd..

Forward Rates Rules of Value

Date:

3) Rule of No Change of the Month

also applies i.e. if the deal date is
28.03.2010 , the settlement date has
to be 30.04.2010 but if 30.04.2010 is
Sunday, it has to be settled on
28.04.2010
 CALCULATION OF EXCHANGE RATES
FORWARD PURCHASE RATE (EXPORT TXN)

A CUSTOMER WANTS TO TAKE A FWD CONTRACT

FOR USD 250,000 FOR ITS EXPORT PROCEEDS TO BE
RECEIVED ON 30-11-10; CUSTOMER REQUESTS ON
18-07-10 TO BOOK A FORWARD COVER FOR THE
AMOUNT FOR VALUE 30-11-10
SPOT INR/USD RATE BID ASK
1USD = 46.67 46.68
FORWARD PREMIUM 0.25 0.26
(I.E INTEREST RATE
DIFFERENTIAL UPTO
30-11-10; relative Fwd Diff. Points)
 CALCULATION OF EXCHANGE RATES
THE FORWARD PURCHASE RATE IS

SPOT RATE (BID) = 46.67

+ FWD PREM(BID) = 0.25
- I.B MARGIN = 0.04
FINAL RATE = 46.88

PLS NOTE THAT IN CASE OF FORWARD CONTRACT NO

ACCOUNTING ENTRY IS PASSED ON DATE OF TXN.
ACCOUNTING ENTRY IS PASSED ONLY ON THE DATE OF
SETTLEMENT OR CANCELLATION
 CALCULATION OF EXCHANGE RATES
FORWARD SALE RATE (IMPORT TXN)

A CUSTOMER WANTS TO TAKE A FWD CONTRACT

FOR USD 250,000 FOR ITS IMPORT REMITTANCE TO
BE REMITTED ON 30-11-10 CUSTOMER REQUESTS ON
18-07-10 TO BOOK A FORWARD COVER FOR THE
AMOUNT FOR VALUE 30-11-10
CURRENT RATE BID ASK
1USD = 46.67 46.68
FORWARD PREMIUM 0.25 0.26
(I.E INTT RATE
DIFFERENTIAL UPTO
30-11-10)
 CALCULATION OF EXCHANGE RATES
THE FORWARD SALE RATE IS

SPOT RATE (ASK) = 46.68

+ FWD PREM(ASK) = 0.26
+ I.B MARGIN = 0.07
FINAL RATE = 47.01

PLS NOTE THAT IN CASE OF FORWARD CONTRACT NO

ACCOUNTING ENTRY IS PASSED ON DATE OF TXN.
ACCOUNTING ENTRY IS PASSED ONLY ON THE DATE OF
SETTLEMENT OR CANCELLATION
 Inter Bank Deal

SBTM: USD/INR 2
CIBY: 60/61
SBTM: MINE
CIBY: OK DONE
SBTM: To reconfirm at 46.61 I buy USD 2 mio
My USD to SBI N York chipsuid 230542
value 25/08/10
CIBY: All agreed. My INR to Citi Mumbai
Tx deal n bifn.
FORWARD PREMIUM
Forward Bid / Ask Forward Rate
SPOT 47.10/12
October 2010 14/16 47.24/28
November 2010 16/18 47.26/30
December 2010 18/20 47.28/32
January 2011 21/23 47.31/35
February 2011 25/27 47.35/39
March 2011 27/29 47.37/41
April 2011 29/31 47.39/43
May 2011 31/33 47.41/45
June 2011 33/35 47.43/47

July 2011 37/39 47.47/51

August 2011 41/43 47.51/55
September 2011 43/45 47.53/47.57
 Others

Competitive Rates
Competitive Rates for Small Value Transactions
Rounding off rupee equivalent of foreign currency
amounts
Buy Rates : Market Bid Margin
Sell Rates : Market Offer + Margin
MARGIN MATRIX

i) FOREX Category

RATINGS CREDIT RATING % of Companys Forex

business with us

A SB1/SBTL1
SB2/SBTL2 50-100
SB3/SBTL3 100

B SB2/SBTL2 <50
SB3/SBTL3 50-100
SB4/SBTL4 100

C SB3/SBTL3 <50
SB4/SBTL4 50-100
SB5/SBTL5 100

D SB4/SBTL4 <50
SB5/SBTL5 50-100

E SB5/SBTL5 <50
ii) Margin Matrix in paise if the highest credit spread charged is 12 paise (Different margins for different size of transactions)

Transaction <0.025 0.025-2.0 2.0-5.0 >5

Amount in
Million USD

A 0 0 0 0

B 2.5 1.5 1 0.25

C 4.75 3 2 0.5

D 7.25 4.25 3 0.75

E 12 7.25 4.75 1.25

F CARD RATES

The above margins are the minimum that are to be charged for customers. Branches should strive to quote higher margins as they will impact the
branch profitability directly and at the same time, give some scope to the customers to negotiate rates.
AUTHORITY STRUCTURE
GROUP ASSESSMENT OF APPROVAL BY
CATEGORY
CAG R.M. BR HEAD

MCG R.M. BR HEAD

DGM(MCGRO)
NBG BR HEAD AGM/DGM

DGM BR DIV MGR/RM/ DGM

DESK OFFICIAL
FACTORS INFLUENCING EXCHANGE RATES

Balance of Payment
Interest rates and inflation
Central Bank Intervention
Economic Growth Rate
Political Stability / Fiscal Policy
Speculation
Demand and Supply
Force-major events
 3% 20%

Trade related
spot
43%
options
25% swaps
NDF
9%

SBI GLOBAL MARKETS 50