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UNIT II

FOREIGN EXCHANGE MARKET

THE FOREIGN EXCHANGE MARKET:


The foreign exchange market is the market in which currencies of various countries
are bought and sold against each other. It is the informal arrangements among the banks and
brokers operating in financial center purchasing and selling currencies connected to each other
by telecommunication like telephones, satellite communication network.
It is divided into 2 segments:
1. The retail market for foreign exchange deals with transactions involving travelers and
tourists exchanging one currency for another in the form of currency notes or travelers
cheques.
2. The wholesale market often referred to as the interbank market is entirely different and
the participants in this market are commercial banks, corporations and central banks.

COMPONENTS OF FOREIGN EXCHANGE MARKET:


There are 3 major components of Foreign Exchange Market:
i.

Transaction between public and foreign: In this the purchase of foreign currency from
public and sale of foreign currency to the public.

ii.

Transaction between the banks: In this transactions are taken between branches of the
domestic banks, between the agents banks abroad.

iii.

Transaction between banks and central banks: The transactions are taken between the
banks and their central banks like RBI to the local banks.

FOREIGN EXCHANGE MARKET PLAYERS:


The Reserve bank of India has the authority to administer foreign exchange in
India. The commercial banks, cooperative banks and some selected financial Institutions has
been authorized to deal in foreign exchange by Reserve bank of India are known as Authorized
Dealers. An authorized dealer should follow the directions and instructions given by RBI from
time-to- time. The most important player of foreign exchange market is FEDAI.
Foreign Exchange Dealers Associations of India (FEDAI):
FEDAI was established in 1958 as an Association of all Authorized dealers in
India. It has its headquarters at Mumbai. The affairs of FEDAI are managed by a managing
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committee at the head office and respect local committee at local offices. The committees are
represented equally by banks incorporated in India and outside India. The principal functions of
FEDAI are as follows:
1. To frame rules for conducting of foreign Exchange business in India.
2. To coordinate with RBI in proper administration of exchange control.
3. To provide information likely to be of interest to its number.
EXCHANGE RATE:
The exchange rate is the rate at which one currency is converted into another
currency. The rate of Exchange for a currency is known as Quotations in the foreign Exchange
Market. There are two types of quotations:
i.

Direct quotations: Direct quotations are represented directly and no calculations are
needed for representing.

ii.

Indirect quotation: In indirect quotation it is not directly represented but it undergoes


the calculations.
Quotations:

USD1 = Rs.64.2781/2991
Purchase price

Sales price

INSTRUMENTS USED FOR CONVERSION:


A number of instruments are used for the effective conversion of a currency into
another. The following are the different instruments:
1. Telegraphic Transfer (TT): TT is a transfer of money by telegrams or fax from one
center to another in a foreign currency. It is a method used by banks with their own codes
and corresponding relations with bank abroad for transmission of funds.
2. Mail Transfer (MT): It is a method in which cash is paid to 3 rd party sent by mail by
bank to its branch or corresponding abroad.
3. Bills of Exchange: It is an unconditional order in writing address by one person to
another requesting the person to whom it is addressed to pay a certain sum on demand or
within specified date.
4. Drafts and cheques: Draft is a pay order issued by a bank on its own branch or
corresponding bank abroad. It is an immediate payable (on spot). But there is always a
time laps in the transit in the payment in case of cheques.
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PROBLEMS IN EXCHANGE:
Banks deals with exchange of currency. To deal with it there are 3 types of foreign
exchange accounts.
i.

Nostro A/c: is an account maintained by bank in India with a foreign bank. Indian bank
would refer its bank A/c with the foreigner as Nostro A/c.
Meaning: Our A/c with you (punch line)

ii.

Vostro A/c: Foreign bank may open a rupee A/c with an Indian bank. Indian bank would
refer to the vostro A/c.
Meaning: Your A/c with us (punch line)

iii.

Loro A/c: People bank of India is having an A/c with bank of America, Newyork.
Meaning: Their A/c with you (punch line)
Example: SBI having A/c with foreign bank

TYPES OF EXCHANGE RATE:


The exchange rates are of 2 types: 1) Spot/Ready Exchange rate
2) Forward Exchange rate
1) Spot/Ready Exchange rate: In merchant business in which the contract with the customer to
buy or sell foreign exchange is agreed to and executed on the same day.
2) Forward Exchange rate: In such case the payments are paid in future for the contracts which
is agreed today.
PARAMETERS:
To buy and sell we exchange the currencies of domestic and foreign currency.
Foreign Exchange Transactions
Purchase (Bid/buy)
(To acquire foreign currencies we
have to pay Home currency)
Example:

Sales (Ask)
(To acquire Home currencies we
have to pay Foreign currency)
USD1 = Rs.64.2781/2991
Purchase price

Sales price

BUYING AND SELLING RATES


TT (Telegraphic transfer) Buying rate
Buying rates

2 types
Bills buying rate
TT selling rate

Selling rate

2 types
Bills selling rate

TT Buying Rate:
This is the rate applied when the transactions does not involve any delaying realization of
foreign exchange by the bank. The rate is calculated by deducting the exchange margin.
Exchange Margin: Charges for banks for exchange i.e., brokerage charges.
TT Buying rate

0.025% to 0.080%

Bills buying rate

0.125% to 0.150%

TT selling rate

0.125% to 0.150%

Bills selling rate

0.175% to 0.200%

Buying rates
Selling rate