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(Exchange Rates, Forward Exchange Contracts, Currency Futures & Currency Options) One of the added uncertainties of conducting trade on an international basis is the fluctuation of in exchange rates among currencies. The relative value between the Indian Rupee and the foreign currency may change between the time the deal is made and the payment is received. A devaluation or rise in the foreign currency against the rupee causes either a windfall or loss to one party or the other involved in the transaction.

Terms and Concepts

International trade and the other transactions involving cross border flows of funds require the participants to enter the world of foreign exchange. Foreign exchange is defined as claims payable in a foreign country in a foreign currency. As a rule businesses and individuals operate using their own national currencies money recognized and legally acceptable for transactions with in the particular currency zone .

How The Exchange Rates are Quoted and Calculated ?

Direct Vs Indirect Quotation The exchange rates in India are quoted in a set pattern and before discussing the procedure of calculation of exchange rates it will be necessary to understand certain fundamental aspects involved in this regard. There are two systems of quotations as undera. Direct Quotation Where the price of foreign currency is quoted in terms of home or local currency. In this system variable units of home currency equivalent to a fixed unit of foreign currency is quoted. For Eg - US$1 = Rs.45.30 b. Indirect Quotation Where exchange rates are quoted in terms of variable units of foreign currency as equivalent to a fixed unit of home currency. For Eg. US$ 2.208 = Rs. 100 Inter Bank Rates and Merchant Rates Merchant rates are exchange rates to be applied for transactions with the public and are calculated in accordance with the guideline circulated by FEDAI. Inter Bank rates are for transactions amongst the authorized dealers themselves and depend upon the market conditions. Buying and Selling Rates Foreign exchange rates are always quoted as two way price i.e. a rate at which bank is willing to buy foreign currency (buying rate) and a rate at which the bank sells the foreign currency (selling rate). Banks do expect some profit to exchange operations and there is always some difference in buying and selling rates .All exchange rates by authorized dealers are quoted in terms of their capacity as buyer or seller. Spot and Forward Rates Spot rates are applicable on the day of transaction i.e. same day( transaction to be completed physically with in two working days) where as forward rates are the rates fixed in advance for a transaction which will mature at a specified date or during a specified period in future. Quotations for spot rates only are generally available and the customer have to enter in to specific contracts for forward rates.

Foreign Exchange Risk Management

Foreign Currency Exposure Exchange risk is logical sequence when conversions of currencies takes place i.e. switching over from one currency to another. From a Corporate entity point of view , currency exposure is the extent of vulnerability which will effect its profit and loses figures and Balance sheet resulting purely from the exchange rate movements. Hence in a Corporate business strategy, foreign exchange risk management assumes great significance. Foreign Currency Exposure can be divided in to three parts-

Economic Exposure Transaction Exposure Whenever there is a commitment to pay currency at a future date , any movement in the exchange rates will determine the domestic currency value of the transactions . Importers are subjected to transactions exposure. With liberalization process set in the country , the exchange market have been subjected to full interplay of market forces. The transaction exposure would still increase if a long term trade agreement with a country has been entered in to and therefore the corporate would be not in the position to switch over its trade flow. Translation Exposure - In case of domestic corporate with global operations they have to pay or receive money. Any large movement in exchange rate in either case would have its impact on domestic currency value of these transactions and if the exchange movements are wide and transactions are large it would have a serious impact on the financial position of the company. Between two Balance sheets dates , it may alter the net asset value and gearing ratio. In case of multinationals ,the reported profits of overseas subsidiaries can be effected by the change in the exchange rate at which profit figures are translated in to domestic currency.

Transaction Exposure Translation Exposure

Economic Exposure - In cross border trade , the strength of currency of competitors , relative cost and prices in each country which have a bearing on exchange rate and the structure of the business itself gives rise to economic exposure which may put the companies at a competitive disadvantage. Though this is not a direct foreign exchange risk exposure but the underlying economic factors may become a risk factor.

How to Cover the Foreign Exchange Risk?

Covering the foreign exchange risk is term as hedging the risk. If the company does not want to hedge , it means it is taking a view that the future movements of exchange rates will move in its favor. Even if the company wants to adopt the policy of hedging everything , still economic exposure cannot be eliminated and this give rise to opportunity cost . If suppose the company hedged the exposure and if the spot rates moved in favor of the company due to shift in the economic factors between the date of invoice and conversion of currency , the company may lose out or incur and opportunity cost by hedging the exposure if the rates moved against. Corporate Managers specially companies operating in several; countries have the advantage of containing the exposures by their own management techniques by a. Opening foreign currency accounts where there are receivables payable in the same currency (our Foreign Exchange regulations permit opening of foreign currency A/Cs in certain cases). b. Netting group exposure and reduce the risk by currency switches between asset and liabilities. c. In case of manufacturing companies , switch the base of manufacturer so that cost and revenue are in the same currency.

Forward Exchange Contracts

This is usual hedge extended to customers. Banks offer forward exchange contracts both for sale and purchase transaction to customer with a maturity date for a fixed amount at a determined rate of the exchange at the outset. Normally contracts are entered in India for a period where the maturity period of the hedge does not exceed the maturity of the underlying transaction. The customer has the option to choose the currency of the hedge and tenor. The option forward contract are little more flexible in that the customer can exercise the option during the option period on any day. The disadvantages of the forward contract is that rate is locked in but where the transaction has a fixed maturity date , forward contract are handy. Even if the customer wants to cancel the contract , he can do so subject to cancelation charges and interest on outlay of funds incurred by the bank, if any . Hence in case of fixed forward exchange contracts also there is a certain amount of flexibility. As per current regulations in India , forward contracts involving rupee as one of the currencies , once cancelled shall not be re-booked although they can rolled over at ongoing rates on or before maturity. This restriction is not applicable to contracts covering export transactions which may be cancelled , re-booked, or rolled over at on going rate. Substitution of contracts for hedging trade transactions is also permissible subject to the satisfaction of the authorized dealer .

Currency Futures
A future contract is an agreement to buy or sell a standard quantity of specific financial instrument at a future rate and at an agreed priced. These are tailors made contracts and sold organized exchanges such Chicago international money market . A corporate can take a up a future contract which is opposite to its foreign currency transaction exposure . However the future reviewed on a daily basis based on spot rates therefore the value of the future contracts varies depending upon the agreed price. Hence the resultant spot will determine the loss or gain on the transaction exposure and can be counter acted by the resultant loss or gain , on the future contracts , Now the drawback of the future contracts are 1. Maturity rate 2. Contract size This may not precisely meet the requirements of corporate which may result in a residual exposure either in respect of maturity dates or the amount. Also the loss in value arising out of revaluation may have to be adjusted in the margin posted in the exchange rate therefore cash flow in the corporate may be effected.

Currency Option
Currency option gives the right but no obligation to the buyer of the option to sell(put option) or buy (call option) a specific amount of foreign currency at a pre- determined price called strike price. As stated above there are tailor made options which can be picked up over the counters of the banks. The buyer of a option to pay a price premium for conferring the above right by the option writer i.e. banks. In an American option , option can be exercised at any time with in the period of option. In case of European option , option can be exercised on the specified expiry date. As such American option is better , as it gives flexibility to exercise strike price. If a company believes that underlying exposure will result in a gain , currency option is useful and if the company insures against loss , the company has full hedge. As per current regulations in India , a resident is permitted to book and /or cancel freely a foreign currency option contract with an authorized dealer to hedge foreign exchange exposure arising out of his trade subject to the specified conditions. In case of contingent pre- transaction exposure , like projects abroad where the company has to bid for a large contract determined in foreign currency , the company at the bid stage will not know whether the currency exposure will arise or not. If the bid materializes , company will exercise the option if the spot rate moves adversely and will not exercise the option if spot rate is in favor. If the bid does not materializes , the option will be abandoned and sold back to the writer. Currency options are expensive then forward contracts as premium has to paid by the buyer .If option is not exercised and permitted to expire , the premium cost will be maximum or if it has still balance time-value some portion of premium can be retrieved. In India, RBI permits the contingent foreign exchange exposure arising out of submission of a tender bid in foreign exchange

for hedging.

It is possible to buy and sell money from different countries on the foreign exchange market called Forex. Forex currency traders can profit by taking advantage of the dips and swells in the foreign currency market. Capturing these differentials is easier in Forex currency trading than in other trading because the Forex market is open twenty-four hours a day, except for weekends, and it is global, so there are always buyers and sellers available. The traders can be diverse. They can be traders looking for short-term gains, such as day traders or slightly longer investment periods, or they can be foreign investors who are looking to hedge their investments with long term Forex trades. Forex currency trading is done in amounts of currency called lots, that are usually $100,000 each, and can be purchased on margin. Forex currency trading strategies can be based on technical analysis of the history of the currency price or it can be based on analysis of a particular countrys political climate, tax policy, jobless rate, inflation rate, and other factors of the country. There are many different systems of Forex currency trading. Forex currency trading is a huge market. Daily trading is estimated at between $1 trillion and $1.9 trillion dollars. Because the amount of money is so huge, its hard to imagine that the market can be manipulated the way a smaller market can be. Forex currency trading is also not overseen by one central agency like the Security Exchange Commission, and each country oversees the Forex currency trading activity within its own country. Recent News and Information:

XE - Currency Trading and Forex Tips What is currency trading? Learn about the basics of currency trading and the steps we recommend you take to start trading in the forex market. Forex Trading | Currency Trading | Forex Broker | Forex | FXCM Forex Trading - FXCM Inc. (NYSE:FXCM) is a leading online currency trading and CFD broker. Sign Up for a Free Forex Trading Practice Account. | Forex Software Online Forex Trading | Currency Trading | Swissquote Bank Forex Trading, Currency Trading: Trade Currencies at the best trading conditions. Swissquote Bank Forex offers Commission-free, tax-free, lowest forex spreads ... Forex, FX Trade, Currency Trading, Forex Trading Strategies from ... CNBCs Money in Motion Currency Trading brings you insight and strategies from some of the biggest names in the world of forex. Our job is simple: to teach ... Foreign Currency Trading Investing and Exchanging Foreign ... Forex on Demand is the comprehensive step-by-step guide to foreign currency trading. Master the world of online currency trading using our educational guides, charts ... Exchange rate - Wikipedia, the free encyclopedia In finance, an exchange rate (also known as the foreign-exchange rate, forex rate or FX rate) between two currencies is the rate at which one currency will be ... Foreign exchange market - Wikipedia, the free encyclopedia The foreign exchange market (forex, FX, or currency market) is a global, worldwide decentralized over-the-counter financial market for trading currencies.

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Foreign exchange market

From Wikipedia, the free encyclopedia

Jump to: navigation, search "Forex" redirects here. For the football club, see FC Forex Braov. Foreign exchange
Exchange rates Currency band Exchange rate Exchange rate regime Fixed exchange rate Floating exchange rate Linked exchange rate Markets Foreign exchange market Futures exchange Retail forex Products Currency Currency future Non-deliverable forward Forex swap Currency swap Foreign exchange option Historical agreements Bretton Woods Conference Smithsonian Agreement Plaza Accord Louvre Accord See also Bureau de change / currency exchange (office) Safe-haven currency

The foreign exchange market (forex, FX, or currency market) is a global, worldwide decentralized over-the-counter financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and

sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies.[1] The primary purpose of the foreign exchange is to assist international trade and investment, by allowing businesses to convert one currency to another currency. For example, it permits a US business to import British goods and pay Pound Sterling, even though the business's income is in US dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation on the change in interest rates in two currencies.[2] In a typical foreign exchange transaction, a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market began forming during the 1970s after three decades of government restrictions on foreign exchange transactions (the Bretton Woods system of monetary management established the rules for commercial and financial relations among the worlds major industrial states after World War II), when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system. The foreign exchange market is unique because of

its huge trading volume representing the largest asset class in the world leading to high liquidity; its geographical dispersion; its continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday; the variety of factors that affect exchange rates; the low margins of relative profit compared with other markets of fixed income; and the use of leverage to enhance profit and loss margins and with respect to account size.

As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding currency intervention by central banks. According to the Bank for International Settlements,[3] as of April 2010, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume as of April 2007. Some firms specializing on foreign exchange market had put the average daily turnover in excess of US$4 trillion.[4] The $3.98 trillion break-down is as follows:

$1.490 trillion in spot transactions $475 billion in outright forwards $1.765 trillion in foreign exchange swaps $43 billion currency swaps $207 billion in options and other products

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