1. Foreign Exchange Market
Presented By
K.PRABHAKARAN
ASSISTANT PROFESSOR-FINANCE
RVS FACULTY OF MANAGEMENT
COIMBATORE

2. Foreign Exchange
• A foreign exchange transaction is an agreement
between a buyer and a seller that a given
amount of one currency is to be delivered at a
specified rate for some other currency.
• The foreign exchange market (forex, FX, or
currency market) is a form of exchange for the
global decentralized trading of international
currencies.

3. Foreign Exchange Definition
Import &
Export
Tourism,
Education,
etc
Forex
Transaction
Investment
Avenues
Abroad
Inter bank
Settlement

4. Features
Largest financial market in the
world with average daily
turnover of approximately $5
trillion
The forex market is greater
than the stock market. It is 75
times greater than the
combined volumes at New
York Stock Exchange
Dominated by large
Multinational banks, Central
banks, Hedge funds &
Currency Brokers
Round the clock market
starting from Sydney, Tokyo,
Honk Kong, Singapore,
Bahrain, London, New York.
Almost open 24hours x 5 days

5. Important facts about Indian Rupee
• Indian Rupee is partially convertible currency
Convertibility
Current Account
1. Imports & Exports
2. Tourism , employment,
study etc.
Capital Account
1. Investments and loans
2. Strict rules & regulations
• There is a maximum limit on conversion of Rupee
• India has floating Exchange rate with active participation of RBI
• INR is fast emerging as a major South East Asian Currency

6. Transactions
• Spot
– Immediate delivery is the basis
– Standard settlement is T+2 days
– USD-CAD is exception settles on T+1 day
• Forward
– Contract of exchange between two parties for a future date
– Any transaction settling more than T+2 days
Settlement date / Value date
• Trade date
• Trade date + 1
• Trade date + 2
• Trade date + 3 or any later date
Term Used
• Value cash
• Value Tom
• Spot
• Forward

7. Functions of FX Market
The foreign exchange market is the mechanism by
which participants:
– transfer purchasing power between countries;
– obtain or provide credit for international trade
transactions, and
– minimize exposure to the risks of exchange rate
changes.
7

8. Participants in Forex Market
• The major participants in the foreign exchange
market are central banks, like the U.S. Federal
Reserve and European Central Bank, large financial
institutions like commercial and investment banks,
multinational corporations, and investors of varying
shapes and sizes.
Participants at 2 Levels
1.
Wholesale Level (95%)
- major banks
2.
Retail Level
- business customers.

9. Indian Foreign Exchange Markets Participants

10. Factors Affecting Exchange Rates
•
•
•
•
•
•
•
•
•
•
•
Fundamental factors
Interest rates
Inflation rate
National Income
Exchange rate policy
Central Bank interventions
Balance of Payments
Government Intervention
Technical factors
Political factors
Speculation

11. Derivatives
• A derivative is a financial instrument whose
return is derived from the return on another
instrument.
• Derivative is a product whose value is derived
from the value of one or more basic variables,
called bases (underlying asset, index, or
reference rate), in a contractual manner. The
underlying asset can be equity, forex, commodity
or any other asset.

12. Basic Purpose Of Derivatives
• In derivatives transactions, one party’s loss is always
another party’s gain
• The main purpose of derivatives is to transfer risk from
one person or firm to another, that is, to provide
insurance
• If a farmer before planting can guarantee a certain
price he will receive, he is more likely to plant
• Derivatives improve overall performance of the
economy

13. Growth Drivers of Derivatives
• Increased volatility in financial markets
• Increased integration of national & international financial
markets
• Improvement in communication facilities & decrease in
transaction costs
• Development of sophisticated risk management tools providing
better risk management strategies
• Innovation in the derivatives market leading to higher returns,
reduced risk & reduced transaction cost compared with other
financial markets

14. Ways Derivatives are Used
• To hedge risks
• To speculate (take a view on the future direction
of the market)
• To lock in an arbitrage profit
• To change the nature of a liability
• To change the nature of an investment without
incurring the costs of selling one portfolio and
buying another

15. Actors in the Market
• There are three broad categories of market
participants:
• Hedgers
• Speculators
• Arbitrageurs
15

16. Actors in the Market
• Hedgers
Hedgers trade with an objective to minimize
the risk in trading or holding the underlying
securities. Hedgers willingly bear some costs
in order to achieve protection against
unfavorable price changes.

17. Actors in the Market
• Speculators
Speculators use derivatives to bet on the
future direction of the markets. They take
calculated risks but the objective is to gain
when the prices move as per their
expectation.

18. Actors in the Market
• Arbitrageurs
Arbitrageurs try to make risk-less profit by
simultaneously entering into transactions in two
or more markets or two or more contracts.
For example, they try to benefit from
difference in currency rates in two different
markets. They also try to profit from taking a
position in the cash market and the futures
market.

19. Types of Derivatives
Futures: Buy or sell an asset at a date specified at
the price prevailing currently.
Options: Right to Buy or sell shares but not an
obligation to buy or sell.
Forwards: A Contract were settlement takes place
at the future date at current prevailing price on the
day the agreement has been made.
Swaps: Private agreements between 2 parties to
exchange Currencies in the future.

20. Futures
• Futures contracts are also agreements to buy or
sell an asset for a certain price at a future time.
• futures contracts are exchange traded and are
more standardized.
• They are standardized in terms of contract sizes,
trading parameters, settlement procedures and
are traded on a regulated exchange.
• The contract size is fixed and is referred to as lot
size.

21. Options
• A currency option provides the buyer with the
right but not the obligation, to buy or sell a set
amount of currency at an agreed exchange
rate, known as the “strike price” or the
“exercise price”.
• Strike price: agreed upon price for buying or
selling.

22. TYPES OF OPTIONS
• There are two basic types of options are American
& European options.
• American Option
American options are options contracts that can be
exercised at any time upto the expiration date.
Options on individual securities available at NSE are
American type of options.
• European Options
European options are options that can be exercised
only on the expiration date. All index options
traded at NSE are European Options.

23. TYPES OF OPTIONS
• Call option: A call option gives the option
buyer the right to buy an agreed amount of the
specified currency at the strike price.
• Put option: A put option gives the option buyer
the right to sell an agreed amount of the
specified currency at the strike price.

24. Forward Contracts
Forward contracts are agreements to exchange
currencies at an agreed rate on a specified future
date. The actual settlement date is more than
two working days after the deal date. Forward
contracts are bilateral contracts (privately
negotiated), traded outside a regulated stock
exchange and suffer from counter -party risks
and liquidity risks.

25. Swaps
A swap is the exchange of one set of cash flows for another on a
future date. In simple terms Swaps means exchange of obligation in two
different currencies.
Company A
Indian Company having
operations in USA
Company B
Agrees to pay $100000 over
next one year
US Company having
operations in India
Agrees to pay 6200000 Rs
over next one year
Obligation of $100000 over
next one year
Prevalent Exchange
Rate 1USD= 62 Rs
Obligation of Rs 6200000
over next one year
Both parties having similar obligation but susceptible to exchange rate risk. These two parties will
eliminate the risk by entering into a swap

26. Swap Transactions: Illustrations
Firm
Objective
Fixed interest
Floating interest rates
X
Fixed rate
10.75%
LIBOR +0.50%
Y
Floating rate
10.00%
LIBOR +0.25%
From the above table: Cost of borrowing → Firm Y < Firm X in both the markets. The difference is
called quality spread.
Fixed market
10.75% - 10.00%
= 0.75%
Floating Market
LIBOR +0.50% - (LIBOR +0.25%) =0.25%
Paid to counterparty
X
LIBOR
Y
10%
Received from
counter
party
10%
LIBOR
Swap Arrangement
X
Paid to Market
Net Cost
10%
LIBOR
LIBOR +0.50
10.50%
Savings
LIBOR + 0.25% Minus
LIBOR
10.75% Minus 10.50%
Fixed Rate 10.00%
Y
LIBOR
LIBOR + 0.50
Fixed Rate 10%
Market
Market

27. Types of Swaps
Interest Rate Swaps
Currency Swaps
Swapping only the interest
related cash flows between
the parties of the same
currency
Swapping both principal & interest
between the parties in two different
currencies
Swaptions:
• Options to buy or sell a swap. Two types receiver & payer swaptions.
•Receiver swaptions: received fixed and pay floating
•Payer swaptions: pay fixed receive floating

28. Key Points of Swaps
• Foreign exchange becomes necessary for import and export
• SDR is the monetary unit of IMF
• Dollar Index is weighted index to show the movement of dollar
against six major currencies. Euro, GBP, Yen, CHF,CAD and SKE
• Floating Exchange rate is where market forces determine price.
Most countries have adopted this.
• Fixed Exchange rate is where central authority fixes the rate.
• Market participants are Investors, Speculators. Hedgers,
Arbitrageurs

29. Spreads
• Spreads involve taking advantage of the price
difference between two different contracts of
the same commodity.
• Spreading is considered to be one of the most
conservative forms of trading in the futures
market, because it is much safer than the
trading of long / short futures contracts

30. FORWARD vs. FUTURE CONTRACT
Nature
Trading
Customised
OTC
Standardised Contract
Through Exchange only
Liquidity
Counter
Party
Less Liquid
Risk
Highly Liquid
Negligible
Settlement
Delivery
Offset or thro delivery
Margin
No Margin
Compulsorily needs to be paid
System
& perform
Not Marked to Marked to Market on Daily basis
Market
Mark to
Market

31. OTC vs ETF
Over The Counter
Exchange Traded Funds
Accessibility
Low
High
Price
Transparency
Low
High
Liquidity
Subject to credit limits
High
Agreements
Customized
Standard
Credit
Exposure
Yes
Mitigated through the
clearing corporation
Settlement
Physical Delivery
Net Settled in INR
Underlying
exposure
Required
Not required

32. Categories of Derivatives Traded In
India
• Commodities Derivatives
Ex: Gold Futures, Silver Futures, Crude oil Futures
• Equity Derivatives
Ex:Stock Future,Stock Options, Index Future, Index
Options
• Currency Derivatives
Ex:Currency Futures& Currency Options
• Interest Rate Derivatives
Ex: Interest Rate Futures

33. Recent Developments on Derivatives
Trading in India
Index Futures contracts introduced in June 2000.
Index Options introduced in June 2001.
Stock Options introduced in July 2001.
Commodity Futures contracts Introduced in
2003.
Currency Futures introduced in August 2008.
Interest rate Futures introduced in August 2009.
Currency Options introduced in October 2010.

34. Major Currencies of the World
US Dollar
Most widely used in the world,
also know as reserve currency
Vehicle currency as it is the most
liquid currency
Know as greenback in forex lingo
Euro
Common currency for 16
European nations
Emerged as the most traded in
recent times next to US dollar
Japanese Yen
Third most traded currency,
highly liquid
Large business volume between
Japan & USA in the primary
reason for the popularity of YEN
British Pound
Once heavily traded has lost to
dollar after second world war
Nick named Cable

35. Major Currencies of the World
•
The most traded currency pairs in the world are called the Majors , it includes following :
These currencies follow free floating method of valuation.
– Euro (EUR)
– US Dollar (USD)
– Japanese Yen (JPY)
– Pound Sterling (GBP)
– Australian Dollar (AUD)
Currency
Market Share %
– Canadian Dollar (CAD) and the
EURUSD
28
– Swiss Franc (CHF).
USDJPY
14
Market Share of Currency pairs in world market:
GBPUSD
9
AUDUSD
6
USDCHF
4
USDCAD
5
USD/Others
18
Others/ Others
16
TOTAL
100

36. Currencies Derivatives in NSE
•
•
•
•
US Dollar
Euro
Japanese yen
Pound

37. Product Specifications: NSE Traded
Currency Futures
Category
Description
Trading Hours
9:00 am to 5:00 pm
(Monday to Friday on all
business days)
Contract Months
o
Order driven market
o
Revised methodology of
computation and
dissemination of Reference
rate: Rates will be polled in a
5 minute window from
11:45 AM to 12:15 PM
chosen randomly
o
Expiry at 12:15PM
12 near calendar months
Last Trading Day
Final Settlement
Day
Settlement
Holiday
Calendar
Two business days prior to
last business day of the
month.
Last working day of the
month
INR cash settled at RBI
reference rate
Mumbai-Interbank

38. Features of Currency Pairs
USD-INR
Quotation
Contract Size
Calendar
Spread
Margin
EUR-INR
GBP-INR
JPY-INR
Rate of
exchange
between 1 USD
and INR
(USDINR)
Rate of exchange
between 1 EURO
and INR (EUR-INR)
Rate of
exchange
between 1 GBP
and INR (GBPINR)
Rate of
exchange
between 100
JPY and INR
(JPY-INR)
USD 1000
EURO 1000
GBP 1000
JPY 100000
Rs. 400 for a
spread of 1
month; Rs 500
for a spread
of 2 months, Rs
800 for a spread
of 3 months
Rs.700 for spread
of 1 month
Rs.1000 for
spread of 2
months
Rs.1500 for
spread of 3
months or more
Rs.1500 for
Rs.600 for
spread of 1
spread
month
of 1 month
Rs.1800 for
Rs.1000 for
spread of 2
spread of 2
months
months
Rs.2000 for
Rs.1500 for
spread of 3
spread of 3
months or more months or more

39. Product Specifications: Exchange Traded Currency Options
Category
Description
Type of Option
Premium Styled European Call and Put Options
Trading Hours
9:00 am to 5:00 pm
(Monday to Friday on all business days)
Permitted Lot Size
One lot denotes $ 1000
Tick Size
0.25 paisa or INR 0.0025
Contracts Available
Three serial monthly contracts followed by three quarterly contracts of
the cycle March/June/September/December
Last Trading Day
Two business days prior to last business day of the month
Final Settlement
Day
Last working day of the contract month (Excluding Saturdays)
Settlement
INR cash settled at RBI reference rate
Holiday Calendar
Mumbai-Interbank

40. Trading Strategies – Directional views
View: INR will depreciate against USD, caused by India’s
sharply rising import bill and poor FII equity flows
Trade:
USDINR 31 Dec
contract : 63.50
Current Spot rate (08 Nov 13): 62.70
Buy 1 Dec contract : Value Rs. 63.50 (USD 1000 *63.50)
Hold contract to expiry: RBI fixing rate – 64.00
Economic return : Profit, Rupees 500 (64.00 – 63.50)

41. Long position in Futures
Speculative long positions in currency futures market means buying futures contract
without any exposure in the cash market
Illustration On 1st November 2013 mr X a currency trader expects that dollar will
strengthen against the rupee in the coming months. He decides to go long and buys one
December USD-INR contract at 63.50 & he wants to hold the contract till expiry. The
market moves as his anticipation and the Dollar strengthens against the rupee and the
RBI reference rate moves to USD-INR 65.50 on 31st December.
Date
Contract
Rate
!st November 2013
USD-INR December
Futures
63.50
27th December 2013 USD-INR December
Futures
65.50
Profit = Sell – Buy Price x lot size
Profit = ( 63.50 – 65.50) x 1000
Profit = Rs 2000

42. Short position in Futures
Speculative short positions in currency futures market means selling futures contract
without any exposure in the cash market
Illustration
On 1st November 2013 mr A a currency trader expects that dollar will weaken
against the rupee in the coming months. He decides to go short and sells one December
USD-INR contract at 66.50 & he wants to hold the contract till expiry. The market moves
as his anticipation and the Dollar depreciates against the rupee and the RBI reference
rate moves to USD-INR 64.50 on 31st December. Mr A decides to square his position and
makes a profit of Rs 2000 (65.50 – 63.50x 1000).
Date
Contract
Rate
1 st November 2013 USD-INR December
Futures
66.50
27th December 2013 USD-INR December
Futures
64.50
Profit = Buy – Sell Price x lot size
Profit = ( 66.50 – 64.50) x 1000
Profit = Rs 2000

43. Hedging using Currency Futures
Hedging means taking a long positions in futures market that is opposite to the
position in the physical market in order to reduce risk associated with exchange rates.
The overall portfolio of a hedger consists of the following two positions:
• Underlying Position
•Hedging position which is totally opposite to underlying positions
Types of Hedge
Long Hedge
Underlying Positions : short in foreign
currency
Hedging Positions: Long in Currency futures
Short Hedge
Underlying Positions : Long in foreign
currency
Hedging Positions: Short in Currency futures

44. Arbitrage
Arbitrage can potentially exist between, currency futures, OTC forwards and
the non-deliverable forwards traded offshore
An arbitrage can be executed by an entity having access to any two of the
above
Corporate entities with an underlying exposure, can straddle both markets
Sell 1st month in currency futures
Buy 1 month forward in OTC markets
This scenario can exist when currency futures are trading higher than
forwards which will also be governed by interest rate differentials and USD
supply with banks
Restricted access to the OTC and NDF markets could translate to the
arbitrage gap not closing

45. Trading

46. Clearing, Settlement & Risk
Management
Mark to Market:
•
Online real time calculation
•
Maximum 75% of total deposit allowed to be lost
•
Warning given at 60%, 75% and 90% of breaching this limit
•
On utilizing the 75% limit member is suspended
Position Limit:
•
To avoid huge built up of positions
•
Monitored at day end
•
Monitored at both client level and member level
•
Violation of limits used for further surveillance
•
CM accountable for TM violation
•
TM accountable for Client violation
Limits:
•
Client level = 10 million USD or 6% of all open positions whichever is higher
•
Exchange disseminates warning when 3% crossed for any client
•
Non Bank Member = 50 Million USD or 15%
•
Bank Member = 100 million USD or 15%
•
Clearing member = no separate limits

47. Clearing, Settlement & Risk
Management
•
•
•
•
Clearing Corporation (CC) undertakes clearing & settlement
Acts as legal counter party to all trades
This is called NOVATION
Guarantees financial settlement
Clearing & Settlement includes:
1. Clearing
2. Settlement
3. Risk Management
Clearing Entities:
Clearing Members = TCM and PCM clear trades. For each additional TM under them they
have to bring additional deposit
Clearing Banks = Used for Funds settlement
Each member required to open an account with Clearing Bank

48. Clearing and Settlement -MTM
• Daily marked to market(MTM) Settlement
• Netted MTM settlement on T+1
• End of day open positions MTM @ daily
settlement price(DSP)
• Through clearing member’s settlement
account

49. FOREIGN EXCHANGE MANAGEMENT
ACT-1999
• The Foreign Exchange Management Act (FEMA)
was an act passed in the winter session of
Parliament in 1999 which replaced Foreign
Exchange Regulation Act.
• FEMA has brought a new management regime of
Foreign Exchange consistent with the emerging
framework of the World Trade Organisation
(WTO).

50. BROAD STRUCTURE OF FEMA
• It mainly deals with matters pertaining to foreign
exchange
• All current account transactions are free However,
Central government can impose restrictions by issuing
rules. S.3
• Capital accounts transactions are permitted to the extent
specified by RBI regulations s.6
• RBI controls management of foreign exchange
• Since it cannot directly deal with foreign exchange it
authorises” authorised persons ” to deal in foreign
exchange according to RBI Regulations s.10
• RBI issues directions to such persons u/s.11
• These directions are issued through AP(DIR) circulars.
Authorised Persons (Directions)