exchange rate mechanism 27th april 2012[1]

8/12/2019 Exchange Rate Mechanism 27th April 2012[1]

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K o t a k M a h i n d r a B a n k1

Exchange rate mechanism&

Forward contracts

K N VaradarajanHead Treasury OperationsKotak Bank

FEDAI Training (Indian Bank) April2012


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Rate of exchange

Price of one currency expressed in terms ofanother

FEDAI Training(Indian Bank)

April 2012


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Commodity currency

The currency being pricedUsually for a fixed number of units(Normally one)

Terms currencyThe price currency


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Direct & indirect quotes

DirectForeign currency unit fixed &Home currency varying1 USD - Rs.51.45

IndirectHome currency unit fixed &Foreign currency varying1 GBP = 1.5675 USD


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Two way quote

Bid and offer rates1 GBP = USD 1.5670/75Bid 1.5670 Offer 1.5675

Calling bank Quoting bank- Can buy at 1.5675 Will buy at 1.5670- Can sell at 1.5670 Will sell at 1.5675

Bid offer spread - difference between bid & offerPoints (pips) (last decimal place)


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Cross rate

Rate between two currencies derived via a thirdcurrency if1 $ = INR 51.451 $ = CHF 0.9600

1 CHF = 51.45-------- = 53.5937 or 53.590.9600


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Chain rule

Procedure for calculating cross rate

?INR = 1 CHFif 0.9600CHF = 1 USD

and 1 USD = INR 51.451 CHF = 1 x 1 x 51.45/0.9600

= INR 53.59


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Reciprocal rate

Procedure to change the terms in whichexchange rate is expressedif 1 Euro = USD 1.31701 USD = 1 Euro/ 1.3170

1 USD = Euro 0.7593


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Trending rates

Quoting bank move their prices to reflect change in theirwillingness to buy or sell

If market rates are1 Euro = USD 1.3170 / 75if a bank quotes

1 Euro - USD 1.3175 / 80the dealer indicates his intention to buy Euro as the dealer is

willing to buy EUR at 1.3175 when the whole market isbuying at 1.3170

Here is indicating to the market that he wants to buy EUR as

he expects the price of EUR to go up.


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Quality of a quote

Fast replyNarrow spreadDeal reasonable amount at rate quoted


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Reason to quote

Trend on the desired side

Spread benefitLet us say there are six dealers operating in our dealing room and wehave quoted to one of our top clients for direct import bill payment forUSD 24 Mio.

Each of the six dealers have been asked to buy USD from the market

when the USD INR Rate in the market is 1 USD = INR 51.50/51.Three dealers quoted this price to counterparty and the counterpartysold USD to the bank at 1 USD = INR 51.50Three dealers called other bank who quoted the same rate and boughtfrom them at 1 USD =INR 51.51

One of the question will arise when I quote what happens instead of

the counterparty selling to me but buys from me.We can trend the price. For example when the inter bank market quoteis 1 USD = INR 51.50/51 and if our quote is 1 USD = INR 51.5050/51which means that I buy USD at 51.5050 instead of others in the interbank market who are buying at 51.50. Even if we buy at 51.5050 it isbetter than buying at 51.51.It is better that we deal in our rates to get the spread benefit.


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Funds position

Net cash flow position in our NOSTRO accountsCash inflows and cash outflowsWhat are the expected in flowsWhat are the expected out flowsWhat is the expected closing balance?The expected closing balance should be suchthat we neither leave a huge balance in theaccount (since we do not get much benefit byway of interest) nor the account is over drawn

(since we will be charged overdraft interest athigh rates if the account is overdrawn)


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Net exchange position

Foreign currency purchased - foreign currencysold (all transactions where there are currencyconversions taking place)Long position (overbought)

-- gain if exchange rate rises-- loss if exchange rate fallsShort position (oversold)

-- gain if exchange rate falls

-- loss if exchange rate rises-- square-- fluctuations in exchange rate does not affect P&L


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Spot & forward rates

Value dates-- Date on which settlement takes place

Spot : second working day at both the centers

from the date of deal


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Forward rates

Obtained by adding/deducting disc/ premiumpointsPremium/disc governed by interest differentialsThe future price spread is wider than spot spreadDeduct disc point from price

Add premium points from priceDisc/premium in 2 way quoteLeft side higher than rightCommodity is at a discRight side higher than leftCommodity is at a premiumAscending order (add)Descending order (deduct) FEDAI Training

(Indian Bank)April 2012


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Forward difference

DiscountPremiumReflects the interest differentials in theinternational market


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Interest differential explained

6 m interest rate in USA = 5%6 m interest rate in UK = 6.5%if spot rate is 1 GBP - 1.6500 USDborrow in USD, deposit in UK

- borrow USD 1.65 million for 6 m- convert that into GBP 1 mio at 1.65- deposit GBP 1 mio for 6 m


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Interest payable in USD for 6 mon USD 1.65 mio at 5% 41250 $

Interest receivable in GBP for 6mon GBP 1 mio at 6.5% GBP 32500

After 6 monthsGBP 1 mio + int 32500 = USD 1.65 mio + int 41250

GBP 1032500 = USD 1691250Exchange rate is 1.6387GBP is at a discount of 113 points against USD


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Currency at higher rate of interest is at a discountCurrency at a lower interest rate is at a premium

In Indian context, the forward premium / discount

is mostly driven by demand and supply ratherthan the interest rate differential


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K o t a k M a h i n d r a B a n k

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Exchange rate structure

Concept of base rate & card rateBase rate : the rate prevailing in the inter bankmarketCard rate : The indicative rates for various typesof transactions


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T f t t d


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Types of rates quotedfor merchant transactions

TT sellingBill sellingT C sellingCurrency selling

TT buyingBill buyingCheck purchaseT C purchaseCurrency purchase


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Exchange margins

Transaction / customer specific

Application of margin :Margins for purchases to be deducted from base -

margins for sales to be added to base


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Swaps

Simultaneous purchase and sale of fixed amountfor different value datesLet us say the bank Buys USD 5 Mio value spot(the second working day) and simultaneouslysold USD 5 Mio value date one month later thistransaction is known as swap.Here the amounts bought and sold are the samebut the rates and value dates are different.


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Example # 1

Forward rate - Exports for USD/INR. Todays date is27 th April 2012.USD/INR spot = 51.40/41value date is 31.08.2012

premiums :May: 17/19June : 20/22July: 23/25

Aug :27/29What is forward rate if Bank wishes to keep 3 paisemargin ?Answer = Rs.51.64 FEDAI Training



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Example # 2

Forward rate - Imports for USD/INR. Todays date is

27th April 2012USD/INR spot = 51.40/41value date is 31.08.2012premiums :

May: 17/19June: 20/22July: 23/25Aug:27/29Sep: 31/33What is forward rate if Bank wishes to keep 5 paisemargin ?Answer = Rs. 51.75 FEDAI Training



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Example # 3

Forward rate - Imports for USD/INR.Today is 27th April 2012USD/INR spot = 51.40/41value date is 16.09.2012

premiums :May: 17/19 Aug 27 / 29June: 20/22 Sep 31 / 33July : 23/25What is forward rate if Bank wishes to keep 4 paisemargin ?Answer = Rs.51.76


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Example # 4

Cancellation of Forward contract Today is 27 th April 2012USD/INR spot = 51.40/41Contract earlier booked for exports (fordelivery30.08.2012) at 51.89 for USD 500,000What type of cancellation is this?premiums : (30 day/month)May:17/19 June: 20/22 July:23/25 Aug 27/29

What are cancellation charges, if the bank wishes tokeep 2 paisa margin?Answer = 17 paise , Rs.85,000/--Is it payable or recoverable?

PayableFEDAI Training



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Example # 5

Booking of Cross currency forward contract -Todays date is 27 th April 2012USD/INR spot = 51.28/30 GBP/USD =1.5490/92for exports (90 days from bill of lading date which is16 th April 2012) for GBP 500,000

USD /INRpremiums cross currency fwdsMay: 31/33 1 month 31/30

June : 54/56 2 month 54/53July : 75/77 3 month 82/81What rate do you quote for the transaction?


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Example # 5 (Contd)

What rate can he sell his GBP spot?1GBP=USD 1.5490But he is getting his GBP on 16/07/12 (90 days fromB/L date) . Hence he has to sell forward for16/07/12.Is GBP in premium / Discount?Forward rate 3 month is 82/81 points.It is in discount.

1.5490(-) 0.0082 = USD 1.5408Now he has sold GBP and got USD and has to sellUSD against INR


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Example # 5 (Contd)What rate can he sell his USD against INR spot?

1USD = INR 51.28But he is getting his USD only on 16/07/12. Hencehe has to sell forward for 16/07/12.Is USD in premia / Discount?

Rates for June is 54/56 and for July 75/77.It is in Premium.How much of premium to be passed on.Rs.0.6450

How was this arrived? How is it different from theGBP/USD quoteHe can sell his USD at Rs.51.925Final rate for GBP = 1.5408 X 51.925= Rs.80.01(apply chain rule)


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Practically.

Normally customers complainRate is not favorableOther banks offer better rate ( ! )

How do we cross check this information?

Can we offer products below our cost price?

Does any other industry offer such fine rates?


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FORWARD CONTRACTSRBI 2011 -12 /379 Master circular on Risk Management and Interbank Dealings

updated as on 31 st Jan 2012

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Booking of Forward contracts

Contracted exposuresEnsure that an exposure existsUnderlying to be submitted to bank within 15 days

What if not submittedEconomic Exposures.

Cash settled.No rebooking if cancelled.

Maturity of the hedge does not exceed the maturityof the underlying transactionCurrency and hedge of the tenor left to the choiceof the customerIf hedge currency is different from that of theunderlying exposure the risk management policyof the corporate approved by their Board mustpermit such type of hedging.


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Contracted exposures

If he exact amount is not ascertainable the contractcan be booked on the basis of a reasonableestimateForeign currency loans and bonds hedgingpermitted only after approval is accorded by RBIEEFC balances can be hedged but such contractscan only be rolled and not cancelled.Cancellation and re booking

Forward contracts booked by residents irrespectiveof type and tenor of the underlying exposure, oncecancelled cannot be rebooked.Non INR forwards can be rebooked only if thecorporate has submitted the exposure information

Substitution of contracts permitted on beingsatisfied with the circumstances


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Booking of forward contracts

PROBABLE EXPOSURES BASED ONPAST PERFORMANCE.Last three years turn over or last years turn over whichever is higher.Limits computed separately for imports / exporttransactionsContracts booked during the current financial year (April Mar) and outstanding contracts at any point of time shouldnot exceed

Eligible limit i.e. the average of the previous three financialyears actual export turnover or the previous years actualexport turn over which ever is higher for exports25% of the eligible limit i.e. the average of the previous threefinancial years actual import turnover or the previous yearsactual import turn over which ever is higher for imports.


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Probable exposures

All forward contracts booked under probableexposures both by exporters and importers (from16 th Dec 2011) will be on fully deliverable basis.If cancelled gains cannot be passed on to thecustomer.Aggregate of overdue bills shall not exceed 10%of the export turn over.Limits once utilized cannot be reinstated eitheron cancellation or on maturity of the contracts.AD must initiate appropriate systems forvalidating the PP limit at pre deal stageMonthly report to RBI limits granted and utilisedby their constituents. 36


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Certificate requirements

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K kM h i d B k

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THANK YOU

FEDAI Training (Indian Bank) April2012

exchange rate mechanism 27th april 2012[1]

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