notes on foreign exchange & international finance-iipm

8/12/2019 Notes on Foreign Exchange & International Finance-IIPM

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#iscellaneous Sources- F$+, (eposits 'o provide 9re Shipment in foreign %urrency or torediscount e+port bills.Short %erm $re(its :- %redit from the supplier up to ;@< days from shipment date at ratesprescribed by :&I..

Forfaiting- is the purchase of medium term claims of an e+porter on the foreign buyer withoutrecourse to the e+porter. 'his is a commercial source of finance and no cost such as insuranceetc. is involved.EXCHANGE ARITHMATIC & EXCHANGE RATES

5atural resources are not evenly distributed across the globe .What is available in plenty in onecountry is scarce in another. 'his was the genesis of the "lobal 'rade. Initially the trading termswere only barter, With traded items becoming more numerous and comple+ with the passage ofcenturies terms of trade shifted to more acceptable and universal store of value vi currency, 'hiswas the genesis of fore+ market. *n importer of goods and services in Japan would like to asseshis profits in terms of Japanese Aen whereas an )+porter in India would like to calculate thesame in India :upees. 2ut of this demand and supply dynamics emerges parity between the twocurrencies. 2f course this is a very broad term and various other factors contribute to a currencys

e+change value in terms of another currency such as inflation, interest rates etc are some of thefactors that impact e+change rates.)+change rate means the method of conversion of one currency into another. In suchconversions !oreign %urrency is always treated like a commodity and the home currency aspurchasing power. In other words the rate at which one currency is converted into anothercurrency is called the e+change rate .'he e+change rate can be >uoted in two ways -1. In(irect metho(: -* given no. of units of foreign currency per given units of local currency

e.g. :upees ;


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PURCHASE and SALE Transactions .- *ll purchase /sale transactions are not alike and henceattract different rates.'o illustrate, both outward remittance and payment of an import bill are sale transaction but workinvolved for the authoried dealer 3&ank4 in the two cases is not the same .In the first case thematter is relatively simple as he merely recovers the e>uivalent rupee amount and issues aremittance by way of ''/emand raft/mail 'ransfer. In case of import bill the work involved isnot simple. 'he bill has to be scrutinied, acknowledged, and presented to the drawees. !ollowup has to be done regarding payment and correspondence with the foreign bank. 9apers have tobe kept properly and safely and track of arrival of goods to be kept .'hus the work involved ismuch more as compared to a simple remittance. &anks would therefore like to be compensatedfor the additional work. 'his can be done by selling the currency a little costlier to the importer ascompared to the rate for the simple transactions.'hus other things being e>ual there would be two selling rates the first called the '' sellingrate3''S4 and the second &ill Selling rate 3&1S4.!or the reasons e+plained earlier the e+changerate >uoted for an e+port bill will be worse than one >uoted for an inward remittance .'here are two important aspects in a transactions involving sale or purchase of foreign currency3i4 rate for conversion and 3ii4 date of delivery i.e. the date on which a transaction is to becompleted.&anks normally come across different types of customer transactions 0 when bank agrees to sell

foreign e+change to one of its customers either the bank should have a purchase transactionfrom another customer or he will buy from another bank in the market. 'hus the bank whileac>uiring the foreign e+change from the market at market selling rate will charge the customer onthe market selling rate. 2n the other hand if a customer is offering to sell foreign e+change to thebank , bank should see the rate at which market will be buying foreign currency. 'hus the marketrates form the basis for banks for >uoting the rates to the customers.&anks have to work out buying and selling rates on the basis of a base rate which may bederived from the ongoing market rate. 2nce the bank has arrived at his base rate he marks it upto cover margin and profit. &anks in India are free to load e+change margins in their discretion forthe transactions sub8ect to compliance of ma+imum spreads and other provisions relating tocalculation of e+change rates.

Alication o! e"chan#e rates -;. Selling ,ates - A. %% Selling ratesa. 2utward remittance in foreign currency

Spread .;=E7 to .;E


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Spread .;=E7 to .;Eual to the ready/spot rate. 'his is so because the anticipated demand/ supplyand cost situation on a future date may not be the same. * commodity could be >uoted at ahigher 39remium4 or a lower 3discount4 rate for future deliveries.'he same situation holds good in foreign e+change transactions and forward rates would moreoften be at premium or at a discount rate as compared to spot rate.In a free market the rates will be based on the demand ( supply situation . * currency in e+cesssupply would tend to become cheaper and a scarce one would be costlier till a balance betweenthe demand and supply is struck.&esides given connection between e+change rates and funds cost in totally free market thepremium/discount on forwards would tend to e>ual the difference in interest rates in the twocurrencies.Example

*ssuming that the following rates are available in the market and there are no e+change controlor restriction on transfer of funds)$:2 interest rate - =.=E7 p.a.

$S ollars interest rate - ;.=E7 p.a.Spot rate )$: ; B $S ;.;;E

notes on foreign exchange & international finance-iipm

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