foreign exchange market and it's structure in india

F i E h M k t Foreign Exchange Market &

It’s Structure

Saturday, October 31, 2009

Nitin Kulkarni @ IF 2009 1

What is Foreign Exchange ?

• In narrow terms, Forex simply means foreign currency or money other than the domestic currency or money

• In Broader Terms, Forex MeansStudy of all the currencies of the different countries yHow they are exchanged or traded with each otherExchange rates and how they are setTh E h k tThe Exchange marketsThe Participants



Function of a Forex Department

Exports

Pre/post

Imports

Opening of LC

shipment Advance

Export

Advance bills

Bills for collection

Exchange DealingsRate Computation

Nostro / Vostro accountsForward Contracts

Guarantees,LC’S & bills for collection

Import loan and guarantees

Forward ContractsDerivatives

Exchange position and cover position

Remittances

Issue of DD,MT,TT

Statistics

Submission of returns, ,

Cheques,sale of Foreign currency notes,NR deposits

returns, collection of credit information



Foreign Exchange Market-World View• Globally, operations in the foreign exchange market started y, p g g

in a major way after the breakdown of the Bretton Woods system in 1971, which also marked the beginning of floating exchange rate regimes in several countriesfloating exchange rate regimes in several countries.

• Over the years, the foreign exchange market has emerged as the largest market in the worldas the largest market in the world.

• The decade of the 1990s witnessed a perceptible policy shift in many emerging markets towards reorientation of theirin many emerging markets towards reorientation of their financial markets in terms of new products and instruments, development of institutional and market infrastructure and realignment of regulatory structure consistent with the liberalised operational framework.



Foreign Exchange Market in India• The changing contours were mirrored in a rapid expansion g g

of foreign exchange market in terms of participants, transaction volumes, decline in transaction costs and more efficient mechanisms of risk transfer.

• The origin of the foreign exchange market in India could be traced to the year 1978 when banks in India were permittedtraced to the year 1978 when banks in India were permitted to undertake intra-day trade in foreign exchange.

• However, it was in the 1990s that the Indian foreign exchange market witnessed far reaching changes along with the shifts in the currency regime in India.



Foreign Exchange Management ActStructure of Forex Market in India

Foreign Exchange Management Act

Central Govt.

R.B.I.

Authorized Persons F.E.D.A.I.

Authorized Money Changes Authorized Dealers


Nitin Kulkarni @ IF 2009 6Full Fledged Restricted

Authorised Persons

Authorised Dealers

Commercial Banks -84

State Co-op Banks – 1

Financial institutions

FI -4

Factoring Agencies -5

Full Fledged Money Changers

Department of Post

Others

Th C kState Co-op Banks – 1

Urban Co-op Banks -2

Factoring Agencies -5UCB,FFMC

Thomos Cook India Ltd.

Activities

All Permissible current and capital account

Activities

Activities related to financing of

ActivitiesSale/Purchase of foreignexchange for

Activities

Specified non and capital account transactions

financing of international trade undertaken by these institutions

exchange for private andbusiness visits abroad

ptrade relatedcurrent account transactions



transactions

Authorised Persons

R t i t d A th i dAuthorised Dealers

Commercial Banks -84

State Co-op Banks – 1

Restricted Authorised Dealers

Category – I - FI

Full Fledged Money Changers

Department of PostState Co-op Banks – 1

Urban Co-op Banks -2ActivitiesActivities incidental to financing of international trade related activities undertaken by these

UCB,FFMC

Activities

All Permissible current and capital account

activities undertaken by these institutions.Category – II

ActivitiesSale/Purchase of foreignexchange forand capital account

transactions Upgraded FFMC, Selected UCB & RRB Thomos CookActivitiesPrivate Visits Business Travel

exchange for private andbusiness visits abroad



Private Visits, Business Travel

F.E.D.A.I

Foreign Exchange Dealer's Association of India (FEDAI) was set up in 1958 as an Association of banks dealing in foreign exchange in India (typically called Authorizedforeign exchange in India (typically called Authorized Dealers - ADs) as a self regulatory body and is incorporated under Section 25 of The Companies Act, 1956.

It's major activities include framing of rules governing the conduct of inter-bank foreign exchange business amongconduct of inter bank foreign exchange business among banks vis-à-vis public and liaison with RBI for reforms and development of Forex market.



Functions of F.E.D.A.I

• Guidelines and rules for the forex business

• Training of bank personnel in the areas of Forex business

Accreditation of brokers• Accreditation of brokers

• Advising / Assisting member banks in settling issuesAdvising / Assisting member banks in settling issues, matters in their dealings

• Represent member banks on Govt, R.B.I. and other bodies



Functions of F.E.D.A.I

• Announcement of daily and periodical rates to member banks

• Prescribing margin for calculating exchange rates for various merchant transactionsvarious merchant transactions

• Formulating code of conduct for dealers working in banks exchange brokers for dealing between each other



Members of F.E.D.A.I.• Public and private sector banksPublic and private sector banks

• Foreign banks g

• Co-operative banks

• Financial institutions such as EXIM bank, I.D.B.I.,I.F.C.I. and S I D B I and others such as Thomas Cook (I) Ltdand S.I.D.B.I. and others such as Thomas Cook (I) Ltd.

• As on May 2008 F.E.D.A.I. has 89 membersAs on May 2008 F.E.D.A.I. has 89 members



Authorized Dealers

Commercial Banks, Co-Op Banks & Financial Institutions

Category A Category –B Category CCategory –A

It can undertake all types of Forex

These are branches of the bank ,handling all

Category –C

These branches can undertake onlytypes of Forex

Transactions

Can set up dealing room to

types of Forex transactions and reporting to dealing room of their bank.

undertake only limited type of transactions like sale and dealing room to

handle such transactions

room of their bank.

These branches cannot undertake dealing room

purchase of foreign currency TC’s and Currency



dealing room operations

and Currency

Forex Market - Features• The Market Has No Physical Presence.y• It Is The Largest Market On The Planet “ Earth ”.• It Is Mostly Speculative In Nature.• It Is A 24 – Hour Market.• Some New York banks maintain 2 shifts (one arriving at

office at 3 am when London and Frankfurt are open)office at 3 am when London and Frankfurt are open). Large New York banks also have branches in Tokyo, Frankfurt, and London. Thus, they are in contact with all financial centers 24 hours.

• Daily Turn Over – 2.75 To 3.00 Trillion Dollar Per Day



24 Hour MarketMarket



Forex Market - Features• It Is A Market Connected By Advanced Communication• It Is A Market Connected By Advanced Communication

Channels Like S.W.I.F.T.• It Is An Extremely Active And Also An Unpredictable y p

Market.• The Market Is Truly Global As Trades Take Place Across

ContinentsContinents.• Most Deals Are On Spot Basis. • The Market Is Deep, Liquid And Efficient.p, q• Deals Are Screen Based.• Market Is Volatile Because Of Floating Nature Of

Exchange RatesExchange Rates



Foreign Exchange Market

Interbank Market-Whole sale MarketCentral Banks, Commercial Banks, Financial Institutions & Corporate (Union States)& Corporate (Union States)The Average Lot Size - USD 1 - 5 MnIndian Lot Size - USD 0.25 – 1.0 Mn

Retail MarketTouristsTouristsIndividual needs Forex in the form of TC, DraftsImporterExportersExporters The amount is small in this market



Wholesale Market

CorporatesBanks

Financial Intermediary Central Banks

HedgeFunds

Speculators(States)



Funds

Direct Quotes - SpotExchange Rates

Direct Quotes - SpotUSD / INR

base currency

Friday 10th 2007- NY Closing

Friday 21st August 2009- NY Closing1 USD = 48 6050 INR Closing

1 USD = 40.6400 INR1 USD = 118.4800 JPY1 GBP = 2.0234 USD

1€ = 1 3697 USD

1 USD = 48.6050 INR1 USD = 94.3820 JPY1 GBP = 1.6508 USD

1€ = 1.4326 USD 1€ = 1.3697 USD€ 3 6 US1 USD = 1.0583 CHF1 USD = 1.0812 CAD1 AUD = 0.8348 USD



Quoted currency1 USD = 6.8313 CNY

Indirect QuotesExchange Rates

Indirect Quotes

INR / USD

b base currency

100 INR = 2.5 USD



Types of Exchange Rate• Floating Rate – A completely floating exchange rate is

one whose level is determined exclusively by underlying balance of supply and demand for the currenciesbalance of supply and demand for the currencies involved with no outside intervention i.e. Cable, Euro/$

• Fixed Rate – A fixed exchange rate is one in which case the government guarantees a stable price for foreign currency This achieved through interventions by centralcurrency. This achieved through interventions by central bank whenever exchange rate varies from a stated % from fixed rate i.e. Kuwaiti Dinar



Types of Exchange Rate

• Managed Float – It is a system where the authorities manipulate the exchange rate to suit their own p gobjectives, sometimes intervening to fix the rate sometimes staying on the sidelines. This type of compromise is known as a Managed or Dirty floatcompromise is known as a Managed or Dirty float i.e. Chinese Yuan, Indian Rupee ,(Yen )



Forex Terms• SWIFT-Society for world wide Interbank Financial

Telecommunication. It is replaces paper by electronic fund transfer by secure SWIFT Codes ,thereby reduces Transaction costs. It is supported by 6500 professional organizations throughout the world

• CHIPS-Clearing House for Interbank Payment system is a US Based electronic payment system

• CHAPS-Clearing House for Automated payment system is a UK based electronic payment system



SWIFT Codes

USD United States Dollar

INR Indian Rupee

JPY Japanese Yen

GBP Great Britain Pound

CHF Swiss Franc



Forex Terms• Reuters- Reuter is a London based organization• Reuters- Reuter is a London based organization

established in the year 1851.First Electronic trading screen which gives real time quotes was established in the year 1973 by Reutersthe year 1973 by Reuters

• Telrate- Telrate is an American organization established in 1969 to deal in screen based trading for foreign exchange

• Fedwire – The transactions at NY-Forex market ultimately get settled through Fedwire.It is a communication network that links the computers of aboutcommunication network that links the computers of about 7000 banks to the computers of Federal Reserve Banks



Foreign Currency Accounts

• Nostro Account

Nostro account is an account maintained by a bank in IndiaNostro account is an account maintained by a bank in India with a bank abroad i.e.S.B.I. may maintain an account with Citi-Bank New York or with HSBC in London ,for $ operations and £ operations respectively. While corresponding with the Citi or HSBC SBI would refer its account with former two as Nostro account means ourits account with former two as Nostro account, means our account with you. All foreign exchange transactions are routed through Nostro accounts.



Foreign Currency Accounts

• Vostro Account

A foreign bank may open rupee account with an IndianA foreign bank may open rupee account with an Indian bank. while corresponding with the foreign bank maintaining an account with it, the Indian bank would refer to the account as Vostro account meaning your account with us .Bank of Baharin and Kuwait may open an account with State Bank of India and draw drafts on the accountwith State Bank of India and draw drafts on the account.On presentation of drafts, the Indian bank would pay to the debit of the foreign bank’s account with it. For exchange control purposes such accounts are known as “non-resident bank accounts”



One way Quotes - SpotExchange Rates

One way Quotes - Spot Big Figure

Big Figure

1 USD = 48.85 INRPips

1 USD = 93.8150 JPY1 USD = 93.8150 JPY

Big Figure

Pips

1 GBP = 1.6250 USD

g g


Nitin Kulkarni @ IF 2009 29Pips

Exchange Rates

Two-way Quotes - Spot

Offer

Bank sells USDCorporate buys USD

USD / INR = 48.38/ 40

Offer

Bid

Bank buys USD Spread=Offer-BidCorporate sells USD

p

=2 Paise /USD



Quotes – SpotBOB ask Quote (USD/INR 5) to BOIBOB ask Quote (USD/INR 5) to BOI

Offer/Ask

BOI sells USDBOB buys USD

USD / INR = 48.38/ 40

Offer/Ask

Bid

BOI buys USD Spread=Offer-BidBOB sells USD

p

=2 Paise /USD

BOB says Your’s 5 USD,BOI



y ,

Foreign Exchange Transaction

BOB CITI CITI

BOB’s Nostro. a/c Dr

SWI

CITICHI

FEDW

CITI

CITI a/c Dr $5 mnSells 5 mn $

IFT

IPS

WIRE AMEX

C a/c $5

Amex a/c Cr $5 Mn

BOI AMEX E AMEX

BOI’s Nostro.BOI s Nostro. a/c Cr



Basis for Merchant Rates

• When the bank buys FE from the customer, it expects to sell the same in the interbank market at a better rate and thus make a profit out of the deal In the interbankthus make a profit out of the deal. In the interbank market, the bank will accept the rate as dictated by the market.

• It can,therefore,sell foreign exchange in the market at the market buying rate for the currency concerned Thusthe market buying rate for the currency concerned. Thus the interbank buying rate forms the basis for quotation of buying rate by the bank to its customer.



Basis for Merchant Rates

• When the bank sells FE to the customer, it meets the commitment by purchasing the required foreign

h f th i t b k k t It i FEexchange from the interbank market. It can acquire FE from the market at the market selling rate.Therefore,the interbank selling rate forms the basis for quotation of selling rate to the customer by the bank.

Th i t b k t th b i f hi h th b k• The interbank rate on the basis of which the bank quotes its merchant rate is known as base rate



Merchant Buying Rates

Interbank Market Rate 48.3800/4000Bank first sell

to Market

Market will buy at 48.3800

Bank will $ sell high to market at Market b i tBank

Bank will deduct their margin and give quote to customer

buying rate hence buy $ low from customer

C stomer

Customer wants to sells FE

(Applicable rate will be



Customer (Applicable rate will be 48.3800 less margin)

Merchant Selling Rates

Interbank Market Rate 48.3800/4000Bank first buys

from Market

Market will sell at 48.4000

Bank will buy low from market atBank

Bank will add their margin and give quote to customer

market at market selling rate and sell to customer at hi h t

C stomer

Customer wants to

buy FE

higher rate

( Applicable rate will be



Customer ( Applicable rate will be 48.4000 plus margin)

Cross Currency Rates

• We know that USD being the currency of intervention only USD/INR exchange rate is available in the Indian F M k t d h t f ith ll thForex Market and exchange rates of rupee with all other foreign currencies are derived from this rate

• Suppose MBT earned £ 1mio in Briton ,now they want toSuppose MBT earned £ 1mio in Briton ,now they want to remit the same to India then first they have to sell these £ 1mio in London against the $ and those $ will be sold in Mumbai against INRin Mumbai against INR

• Suppose London quotes1£=1.6000 USD and Mumbai quotes 1$= 48.8000 INRq



Chain Rule

How Many INR = 1£ ?

If 1£ = 1.6000 $

A d if 1$ 48 8000 INRAnd if 1$ = 48.8000 INR

Then 1£ = 1.6000 $ = (1$ *1.6000)=48.8000*1.6000 INRHence 1£ = 78.0800 INR



Chain Rule

How Many INR = 1 CAD $ ?

If 1.0880 CAD $ = 1 $


$ $Then 1.0880 CAD $ = 1 $ = 48.8000 INRThen

1 CAD $ =48.8000/1.0880=44.8530 INR



$

Chain Rule

How Many INR = ¥100 ?

If 93.10 ¥ = 1 $


$Then 93.10 ¥ = 1 $ = 48.8300 INRThen

¥100 =48.8300/93.10*100=52.44 INR

