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International Foreign and Derivatives Market

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International Foreign and Derivatives Market

  1. 1. HELLO! Komal Gupta - 07 Kirti Dhanawade - 04 Mitali Sawant - 14 1
  2. 2. International Forex & Derivatives Market
  3. 3. Foreign Exchange Market 1 3
  4. 4. Foreign Exchange Market Features 1. Currencies are traded 2. World’s largest financial market 3. Most liquid among all the markets in the financial world. 4. No central marketplace for the exchange of currency 5. It is an OTC market. 6. It is open 24 hours a day, five days a week 7. Simultaneous purchase and sale of two currencies. 8. Foreign Exchange Rate. Major Currency Pairs • The major currency pairs that are traded include EUR/USD, USD/JPY, GBP/USD, and USD/CHF • The most popular forex market is the euro to US dollar exchange rate (EUR to USD), which trades the value of euros in US dollars. 4
  5. 5. Exchange Rate Quotations in Forex Market a
  6. 6. The two basic quotations are direct and indirect quotes. In direct quotation, the cost of one unit of foreign currency is given in units of local or home currency. In indirect quotations the cost of one unit of local or home currency is given in units of foreign currency. Exchange Rate Quotations 6 For example, consider EUR as the local currency. Then ◉ Direct Quote: 1 USD = 0.773407 EUR ◉ Indirect Quote: 1 EUR = 1.29303 USD
  7. 7. Exchange Rate Quotations Direct Quotation • Direct quotation is when the one unit of foreign currency is expressed in terms of domestic currency. • A lower exchange rate in a direct quote implies that the domestic currency is appreciating in value. • In a direct quotation, the foreign currency is the base currency and the domestic currency is the counter currency. • Example: USD to INR Indirect Quotation • Indirect quotation is when one unit of domestic currency us expressed in terms of foreign currency. • A lower exchange rate in an indirect quote indicates that the domestic currency is depreciating in value as it is worth a smaller amount of foreign currency. • In an indirect quotation, the domestic currency is the base and the foreign currency is the counter. • Example: INR to USD 7
  8. 8. Exchange Rate Types Floating and Fixed Exchange Rate • Exchange rates do not remain constant. • Exchange rates can be floating or fixed. • Floating exchange rate is when the currency rate is determined by market conditions. Most countries use a floating exchange rate. • Fix exchange rate is when some countries prefer to fix their domestic currency as against a dominant currency, such as the USD. Spot and Forward Exchange Rate • The spot exchange rate is the current exchange rate at any given point in time. • The forward exchange rate refers to the exchange rate that is stated and traded upon as of today but earmarked for payment and delivery at a future date. 8
  9. 9. “ Who determines the foreign exchange rate? 9
  11. 11. Answer The correct answer is option ‘1’. The indirect quote is the Canadian dollar (CAD) to US Dollar (USD) 11
  12. 12. Accounting Method in Forex Market b
  13. 13. Foreign Exchange Accounting 13 MEANING Foreign exchange accounting involves the recordation of transactions in currencies other than one’s functional currency. GAINS & LOSSES If there is a change in the expected exchange rate record a gain or loss in earnings in the period ACCOUNT Nostro, Vostro and Mirror
  14. 14. Accounts with Foreign Banks NOSTRO It means ‘our account with you’. It is an account maintained by a bank with its branch or another bank at overseas center and the account is maintained in foreign currency. VOSTRO It means ‘your account with us’. This account is maintained in rupees in the books of Indian banks. MIRROR Mirror Account is the reflection of NOSTRO Account in the books of the principal bank. This is maintained for reconciliation purpose and is maintained in both foreign currency and rupees. 14
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  17. 17. 17 THE PURCHASING POWER PARITY The purchasing power parity theory was propounded by Professor Gustav Cassel of Sweden. Rate of exchange between two countries depends upon the relative purchasing power of their respective currencies. EG: If a certain assortment of goods can be had for £1 in Britain and a similar assortment with Rs. 80 in India, then it is clear that the purchasing power of £ 1 in Britain is equal to the purchasing power of Rs. 80 in India. the rate of exchange, according to purchasing power parity theory, will be £1 = Rs. 80. In the USA one $ purchases a given collection of commodities. In India, same collection of goods cost 60 rupees. Then rate of exchange will tend to be $ 1 = 60 rupees. Now, suppose the price levels in the two countries remain the same exchange rate moves to $1=61 rupees.
  18. 18. 18 The value of the unit of one currency in terms of another currency is determined at any particular time by the market conditions of demand and supply. In the long run the exchange rate is determined by the relative values of the two currencies as indicated by their respective purchasing powers over goods and services. the rate of exchange tends to rest at the point which expresses equality between the respective purchasing powers of the two currencies This point is called the purchasing power parity. Exchange rates, under such a system, tend to be determined by the relative purchasing power parities of different currencies in different countries. If prices in India get doubled, prices in the USA remaining the same, the value of the rupee will be exactly halved. The new parity will be $ 1 = 120 rupees. This is because now 120 rupees will buy the same collection of commodities in India which 60 rupees did before.
  19. 19. 19 • The Absolute Version the rate of exchange should normally reflect the relation between the internal purchasing power of the different national currency units • The Relative Version The relative version of Cassel’s purchasing power parity theory attempts to explain the changes in the equilibrium rate of exchange between two currencies. It relates the changes in the equilibrium rate of exchange to changes in the purchasing power parities of currencies.
  20. 20. 20  This may be due to the fact that governments have either controlled prices or controlled exchange rates or imposed restrictions on import and export of goods.  the rate of exchange cannot reflect the purchasing power of goods in general  in India we may be able to get a dozen shirts washed with Rs. 40, but only 2 shirts with one dollar in the USA. Obviously, the purchasing power of one dollar in the USA is much less than the purchasing power of Rs. 40 in India.  This is due to the fact that dhobis do not form an article of international trade.  If dhobis entered into international trade and freely moved into the U.S.A., then in terms of clothes washed, the purchasing power of Rs. 40 may be equalized with the purchasing power of a dollar  it is very difficult to measure purchasing power of a currency Critisim
  21. 21. 21  Among the difficulties connected with index numbers • Different types of goods that enter into the calculation of index numbers; • Many goods which may enter into domestic trade may not figure in international trade; • Internationally traded goods also may not have the same prices in all the markets because of differences in transport costs.  According to Keynes, there are two basic defects in the purchasing power parity theory, namely: • It does not take into consideration the elasticity’s of reciprocal demand. • It ignores the influences of capital movements.  “By elasticity of reciprocal demand is meant the responsiveness of one country’s demand for another country’s exports with respect to price or income.”  As for price elasticity, generally speaking, greater the proportion of luxuries and semi-luxuries in the exports demanded, the more elastic will be the country’s demand for another country’s exports  when there is a greater number of alternative markets in which to buy and greater the capacity to produce the effective substitutes for goods imported.
  22. 22. 22 INTEREST RATE PARITY (IRP)  Interest Rate Parity (IRP) is a theory in which the differential between the interest rates of two countries remains equal to the differential calculated by using the forward exchange rate and the spot exchange rate techniques.  Interest rate parity connects interest, spot exchange, and foreign exchange rates.  It plays a crucial role in Forex markets.  IRP theory comes handy in analysing the relationship between the spot rate and a relevant forward (future) rate of currencies.  there will be no arbitrage in interest rate differentials between two different currencies and the differential will be reflected in the discount or premium for the forward exchange rate on the foreign exchange  The theory also stresses on the fact that the size of the forward premium or discount on a foreign currency is equal to the difference between the spot and forward interest rates of the countries in comparison.
  23. 23. 23 Covered Interest Rate Parity (CIRP)  Covered interest rate theory says that the difference between interest rates in two countries is nullified by the spot/forward currency premiums so that the investors could not earn an arbitrage profit. Example Assume Yahoo Inc., the U.S. based multinational, has to pay the European employees in Euro in a month's time. Yahoo Inc. can do this in many ways, one of which is given below − Yahoo can buy Euro forward a month (30 days) to lock in the exchange rate. Then it can invest this money in dollars for 30 days after which it must convert the dollars to Euro. This is known as covering, as now Yahoo Inc. will have no exchange rate fluctuation risk. Yahoo can also convert the dollars to Euro now at the spot exchange rate. Then it can invest the Euro money it has obtained in a European bond (in Euro) for 1 month (which will have an equivalently loan of Euro for 30 days). Then Yahoo can pay the obligation in Euro after one month.
  24. 24. 24  Uncovered Interest Rate Parity (UIP) Uncovered Interest Rate theory says that the expected appreciation (or depreciation) of a particular currency is nullified by lower (or higher) interest. In the given example of covered interest rate, the other method that Yahoo Inc. can implement is to invest the money in dollars and change it for Euro at the time of payment after one month. This method is known as uncovered, as the risk of exchange rate fluctuation is imminent in such transaction  Implications of IRP Theory If IRP theory holds, then it can negate the possibility of arbitrage. It means that even if investors invest in domestic or foreign currency, the ROI will be the same as if the investor had originally invested in the domestic currency. When domestic interest rate is below foreign interest rates, the foreign currency must trade at a forward discount. This is applicable for prevention of foreign currency arbitrage.
  25. 25. 25 If a foreign currency does not have a forward discount or when the forward discount is not large enough to offset the interest rate advantage, arbitrage opportunity is available for the domestic investors. So, domestic investors can sometimes benefit from foreign investment. When domestic rates exceed foreign interest rates, the foreign currency must trade at a forward premium. This is again to offset prevention of domestic country arbitrage. When the foreign currency does not have a forward premium or when the forward premium is not large enough to nullify the domestic country advantage, an arbitrage opportunity will be available for the foreign investors. So, the foreign investors can gain profit by investing in the domestic market.
  26. 26. 26 Foreign Exchange Risk  Foreign exchange risk refers to the losses that an international financial transaction may incur due to currency fluctuations.  Also known as currency risk, FX risk and exchange-rate risk  it describes the possibility that an investment’s value may decrease due to changes in the relative value of the involved currencies.  Foreign exchange risk arises when a company engages in financial transactions denominated in a currency other than the currency where that company is based.  Any appreciation/depreciation of the base currency or the depreciation/appreciation of the denominated currency will affect the cash flows emanating from that transaction  Foreign exchange risk can also affect investors, who trade in international markets, and businesses engaged in the import/export of products or services to multiple countries.
  27. 27. 27 Fluctuations in the exchange rate could adversely affect this conversion resulting in a lower than expected amount. An import/export business exposes itself to foreign exchange risk by having account payables and receivables affected by currency exchange rates. This risk originates when a contract between two parties specifies exact prices for goods or services, as well as delivery dates. If a currency’s value fluctuates between when the contract is signed and the delivery date, it could cause a loss for one of the parties. There are three types of foreign exchange risk: Economic risk: Also called forecast risk, refers to when a company’s market value is continuously impacted by an unavoidable exposure to currency fluctuations.
  28. 28. 28 Transaction risk This is the risk that a company faces when it's buying a product from a company located in another country. The price of the product will be denominated in the selling company's currency. If the selling company's currency were to appreciate versus the buying company's currency then the company doing the buying will have to make a larger payment in its base currency to meet the contracted price. Translation risk A parent company owning a subsidiary in another country could face losses when the subsidiary's financial statements, which will be denominated in that country's currency, have to be translated back to the parent company's currency.
  29. 29. Derivatives Market 2
  30. 30. 30 WHATIS DERIVATIVE Market? “
  31. 31. METHOD SETTLEMENT OF FUND 31 T+0 : The National Stock Exchange (NSE) has introduced a same-day settlement scheme ‘T+0’, under which members can save on additional margins if the payments for trades are made before the opening of the next trading session. T+1: The adoption of T+1 would mean shortening the settlement cycle from two business days to one for U.S. equities. Key benefits including increased efficiency and reduction in margin risk and volatility have supported the push for a shorter settlement cycle as outlined in our previous article on T+1.
  32. 32. 32 T+2 / SPOT SETTLEMENT: • This type of settlement is carried out immediately following the rolling settlement principle of “SPOT SETTLEMENT”. • All equity/stock settlements in India happen on a T+2 basis. • The new market-wide “T+2” settlement cycle, most securities transactions will now settle in two business days of their transaction date. For example: if you sell shares of ABC stock on Monday, the transaction will settle on Wednesday. That means that if you have a securities certificate, you may need to deliver your securities certificate to your broker-dealer earlier or through different means than you do today. If you hold your securities with your broker-dealer, your broker-dealer will deliver the securities on your behalf one day earlier.
  33. 33. 33 Forward settlement This settlement is applicable when you agree to settle the trade later at a future date which could be T+5 or T+7. • Features • Terms • Guarantee • Interest Rates • Target Customers
  34. 34. 34 MESSEGING CENTER FOR PAYMENT CHIPS : (THE CLEARING HOUSE INTERBANK PAYMENTS SYSTEM) MISSION The Clearing House is committed to being the premier private-sector payments Enterprise • Providing efficient, safe and sound payment systems to help our Owners and customers be successful • Leveraging the collective voice of our Owners to shape the future of the payments industry • Taking positions on critical legal, regulatory and litigation issues of common interest to our members PAYMENTS • Wire, ACH, Image Exchange, Check • 48 million transactions for $1.9 trillion per day FORUMS • Legal/Regulatory, Strategic Payments • Highly respected and effective
  35. 35. 35 CHIPS is a leader in large value U.S. dollar clearing for both international and domestic payments CLEARING HOUSE INTERBANK PAYMENTS SYSTEM Benefits: • Real-time, multilateral netting with Payment Finality • Standardization • Over 94% straight-through processing rate • Direct access to international marketplace • Maximizes liquidity - $1 turns over 525 times • Contingency capability for Fedwire Outstanding resiliency, reliability, customer satisfaction Value-added services: • Web-based management tools • Global processing hours • Remittance Information Delivery • Universal Identification numbers (UID)
  36. 36. 36 CHIPS HISTORY • 1984 Bilateral Limits • 1986 Debit Caps • 1990 End of Day Settlement Finality • 1992 New Payment Formats • 1997 Enhanced End of Day Settlement Finality • 2001 CHIPS Finality – Intraday Payment Finality • 2003 Intraday Supplemental Funding and Web Enablement • 2005 TCP/IP Network
  37. 37. 37 Here’s how it works: – Bank funds a special CHIPS account at the FRBNY (Federal Reserve Bank of New York.) – From 9:00 p.m. (previous day) to 5:00 p.m. (current business day) participants send payments to CHIPS – CHIPS continuously searches the payments queue to match, net, and release payments – A payment is final (settled) when it is released by CHIPS CHIPS FINALITY
  38. 38. 38 Society For Worldwide Interbank Financial Telecommunications SWIFT • SWIFT is a member-owned cooperative through which the financial world conducts its business operations with speed, certainty and confidence. • More than 10,500 financial institutions and corporations in 215 countries trust them every day to exchange millions of standardized financial messages. • This activity involves the secure exchange of proprietary data while ensuring its confidentiality and integrity. • SWIFT is neither a Financial Institution nor a payment system: SWIFT is solely a carrier of messages • SWIFT enables its customers to automate and standardize financial transactions, thereby lowering costs, reducing operational risk and eliminating inefficiencies from their operations. By using SWIFT customers can also create new business opportunities and revenue streams. • SWIFT has its headquarters in Belgium and has offices in the world's major financial centers and developing markets. • SWIFT does not hold funds, nor does it manage accounts on behalf of customers, nor does it store financial information on an on-going basis.
  39. 39. 39 • Forty square meters of office space in the center of Brussels, a handful of people and an ambitious idea. • Supported by 239 banks in 15 countries, • The Society for Worldwide Interbank Financial Telecommunication (SWIFT) starts the mission of “CREATING A SHARED WORLDWIDE DATA PROCESSING AND COMMUNICATIONS LINK AND A COMMON LANGUAGE FOR INTERNATIONAL FINANCIAL TRANSACTIONS”. • Carl Reuters kiöld is SWIFT’s first Chief Executive Officer.  1976 — First operating centers open  1977 — SWIFT goes live  1979 — Opening of North American operating center  1980 — First Asian countries connect  1985 — Satellite communication enhances services  1991 — Smithsonian recognizes SWIFT History of SWIFT
  40. 40. 40 WHATISSWIFT&WHYITISUSE? • SWIFT stands for Society for Worldwide Inter bank Financial Telecommunication. It is a service for sending and receiving money. • It comprises of a worldwide network where messages related to financial transactions is being exchanged among banks and other financial institutions electronically. • The transaction mainly depends on international standards and through a unique code provided to each bank known as the Swift Code.
  41. 41. 41  Why to prefer Bank Swift for money transfer?  It is a safe and reliable way to send and receive money worldwide.  It has no upper limit for the transaction amount.  You are allowed to issue money transfers in all major foreign currencies.  It processes the transaction very fast.  It issues money transfers on a periodic basis with the help of standing instruction.  The fees differ with the amount.  How can we transfer my money?  In order to send or receive money with Bank, you will need to have a bank account with us.  For sending out money, you must have the Beneficiary full name, Bank Address and Swift and Beneficiary Account Number.
  42. 42. 42  How does the SWIFT system work? • Swift payments are payments done through the network. • Swift assigns each bank an eight- or 11-character long code, known as the bank identifier. • It is similar to the IFSC code used for domestic interbank transfers, with Swift being used for international transfers. For example, if someone in India wants to send money to a person in the US, they would need the latter’s bank account number and the Swift code of the destination bank. The Swift code lets the US bank know of the transfer in real-time and eases its clearing.
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  44. 44. THANK YOU! 44