INTERNATIONAL FINANCE - INTERNATIONAL FINANCIAL MANAGEMENT

1. Dr. Mohamed Kutty Kakkakunnan
Associate Professor
P.G. Dept. of Commerce
N A M College Kallikkandy
Kannur – Kerala – India

2. FOREIGN EXCHANGE RATES – DIFFERENT
CONCEPTS
The rate at which one currency is converted into
another currency
The price of one currency expressed in terms of
another currency
Two markets – exchange traded markets and over
the counter market (OTC market)
Exchange traded market, information related
with the transaction (rate, quantity) etc are
available to the public. Based on the rate, the
broker receives commission

3.  In an OTC, rates are generally displayed, but may not
be actual or real, it is only indicative
 In such situation banker is the price maker and quotes
two rates one for purchases and the other for sale -
known as two-way quote
1. Bid rate: rate at which currencies are bought
2. Ask rate: rate at which currencies are sold
 Profit : difference between bid and ask rates
 Generally quoted up to four decimals – but for
currencies whose base rate is 100 – quoted up to two
decimals
 RBI publishes reference rates – indicative only

4. Merchant and bank rate
Two-tiers in foreign exchange market
First-tier – banker and ultimate customer –
applicable rate merchant rates
Second tier – inter-bank transactions – inter-bank
rate
The market is known as inter-bank market
Inter-bank rates are generally quoted at four
decimals
Merchant rates are derived from interbank rates

5. Cross and Vehicle Currency
In the case of two countries, when direct
exchange of currencies is not possible, exchange
rate of these two countries is determined on the
basis of a third country, which is popular in these
two countries.
This third currency, which is used to determine
the exchange rate is called the vehicle currency
The rate determined with reference to the third
currency is called the synthetic rate or cross rate

6. Effective exchange rate
Deprecation and appreciation in the values of
currencies
A particular currency may depreciate in terms of
one currency and the same currency at the same
time may appreciate in terms of other currencies.
To understand how particular currency perform
an index will be calculate known as effective
exchange rate
Effective exchange rate is the measure of the
average value of a currency relative to two or
more other currencies

7. Steps involved in the calculation of effective exchange rates
1. Identify / select currencies of countries to be included in the
calculation. All currencies may be considered or few selected
currencies
2. Assign weights to these currencies on the basis of their
significance in foreign trade
 For assigning weights the following procedure is followed
• Suppose India has trade relation only with two countries-
Japan and US
Export to Japan - 4000, to US 6000
Import from Japan 3000, from US 7000
Weight to Japan (4000+3000) / (4000+30000)+ (6000+7000) =
0.35
Weight to US (6000+7000) / (6000 + 7000) + (4000+3000) = 0.65

8. 3. Find out the simple index number of the currencies
of these currencies P1/P0*100
4. Determine effective exchange rate
(index of country 1 x weight of the country) + (index
of country 2 x weight of the country)
By comparing the indices, it is possible to determine
real value changes in the home currency
Index base year 100 current year 113, then home
currency is depreciated by 13 points

9. CURRENCY ARBITRAGE
Arbitrage means buying and selling the same
security in different market to make profit by
taking advantage of the price differentials
Buying from the markets at lower prices
And selling the same in another market at
higher prices
Simultaneous sale or purchase of currency in
different markets to take advantage of
exchange rate differences