Index

Sr. No. Topics Page No.s

1. Foreign Exchange Market 02

2. Foreign Exchange Rate 03

3. Determinants of Foreign Exchange Rates 04

4. Exchange Quotation 06

5. Direct Quotation (Home Currency) 08

6. Indirect Quotation (Foreign Currency) 09

7. Conclusion 10

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 Foreign Exchange Market
Introduction:
 Today no country is self sufficient in its demand and supply of goods
and services and factors of production such as labour and capital are
seen moving freely across the national frontiers.
 All the countries trade in goods and services, borrow and lend, invest
and accept investments with other countries with nominal or full
control to govern the currency flow and trade.
 Since different countries have their own currencies (with different
purchasing power), the settlement of payments cannot be made with
the currency of one country.
Meaning:
 The Foreign Exchange market is a decentralized world-wide market;
the participants in the market include central banks, commercial
banks, brokers, corporations and individuals.
 The central banks monitor both market movements and sentiments
and intervene according to government policy and prevailing
situation.

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Functioning:
 International economic and commercial relations between countries
involve exchange of goods and services and payment for these
exchanges.
 The payments lead to conversion of one currency into another.
 Each country has its financial system and its own currency and
financial assets.
 Exchanges between the money and financial assets of one country for
money or financial assets of another country constitute international
financial transactions.
 These transactions are put through the foreign exchange market.

Exchange Rate:
 It is the price of one country in terms of another. The rate varies from
time to time depending upon the supply of and demands for foreign
exchange in the inter-bank, which is based on the transactions in the
market segment.
 The rate of exchange between two currencies is the amount of one
currency that will be exchanged for one unit of another currency.
 The exchange rate of a currency appreciates if the general demand for
that currency at any moment exceeds the current supplier.
 It is worth noting that the exchange rates of active currencies fluctuate
every 4 seconds.
 You would have come across the data on buying and selling exchange
rate in newspapers and T.V.

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 The selling rate is the rate at which the bank sells a foreign currency
against the local currency.
 The buying rate is the rate at which the bank buys a foreign currency
against the local currency.
 The margin between the buying and selling rate constitute the
exchange profit for the bank.
 Exchange Rates commonly quoted by banks or an authorized dealer as
two way rates- the bid price and the offer price.
1. The price at which a dealer is buying a foreign currency is
called as ‘Bid Price’.
2. The price at which a dealer is selling a given currency is called
as ‘Offer Price’. It is also called ‘Ask Price’.
3. The difference between bid price and the offer price is called
‘Spread’. This represents the margin of foreign exchange
dealer.
 Illustration: The exchange rate of 1 U.S dollar against Rupees in the
spot market as follows:

Buying Selling
1 U.S Dollar
Rs. 42.22 Rs 42.64

  The buying price i.e. Rs. 42.22 is the bid price and selling price
of Rs 42.64 is the offer price.
 The difference between the bid price and the offer price i.e.
Rs. 42.22 - Rs 42.64 = Re 0.42. It is called Spread.

Determinants of Foreign Exchange Rates:

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1. Purchasing Power (Inflation):
 The relative inflation rates of different countries will have impact
on their currency exchange rates.

2. Interest Rates:
 The relative interest rates and expected changes in interest rates
also influence exchange rates.
 The domestic economic policies influence domestic interest rates.
 The domestic interest rates are an important factor influencing the
Foreign Exchange Market.

3. Balance of Payment Position:

 Continuous adverse balance of payment leads to depreciation in
home country’s currency exchange rate.
 It creates pressure for buying on the foreign currency against its
own currency.
 Then, the country’s own currency exchange rate will fall.

4. Government Intervention:
 Sometimes the government exerts lot of pressure on exchange rates
by involving in direct selling and buying and impose restrictions
on currency dealings, currency movements and by their taxation
and monetary policies.
 All will affect the exchange rates.

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 5. Market Expectation:
 The market expectations of a country keep on fluctuating which
creates an impact on the supply and demand for currencies which
influence the rate of exchange.

6. Overseas Investment:
 Suppose foreign investment in India from US, increases the supply
of US, putting downward pressure on US, investment in India by
US individuals or companies will tend to strengthen the rupee.

7. Speculation:
 Speculators, including the treasury managers of international bank
influence movement exchange rate by buying and selling in the
expectation of making positive return by correctly forecasting
movement and exchange rates and by exploiting any market
inefficiencies.

Exchange Quotation:
Illustration:
 If 1$ can be exchanged for Rs 46/- the rate of exchange between
dollars and rupees is 1$ = Rs 46/-
 When the rate of exchange is quoted as so many rupees per dollar
it is know as the ‘dollar rate’.
 When it is quoted as dollar as rupees, it is know as ‘rupee rate’.
Exchange
Quotation

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Direct Quotation or Indirect Quotation or
Home Currency Foreign Currency
 The quotation in which exchange rate is expressed as the price per
unit of foreign currency is known as ‘Home Currency’ or ‘Direct
Quotation’.
 The number of units of foreign currency is kept constant and
changing the value in terms of rupees will make any change in the
exchange rate.
 The quotation in which the unit of home currency is kept constant
and the exchange rate is expressed as so many units of foreign
currency is known as ‘Foreign Currency Quotation’ or ‘Indirect
Quotation’
 Under this system, changing the number of units of foreign
currency in exchange will effect any change.

Exchange
Quotation

Direct Indirect

Variable Unit Variable Unit

Home Currency Foreign Currency

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 Direct Quotation (Home Currency):
 The prime motive of any trader is to make profit. He earns profit
by purchasing the commodity at a lower price and selling it at a
higher price.
 In foreign exchange too, the banker buys the foreign currency at a
lesser price and sells it at a higher price. Example: It may buy US
dollar at Rs 45/- and sell at Rs 46/-
 Thus in Direct Quotation, the principle adopted by the banker is to
buy at a lower price and sell at a higher price. This principle is
stated in the form of a maxim: “Buy low; Sell high.”

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 Direct Quotation

Buy Low Sell High

For a fixed
Pay lesser units Receive
unit of
of more home home
foreign
currency currency
currency

Indirect Quotation (Foreign Currency):

 This refers to the quantity that a trader purchases and sells instead
of the variation in price. For a fixed amount of investment, he
would acquire more units of the commodity when he sells.
 Illustration: When a banana seller gets 50 bananas for Rs 100
from his supplier and for the same amount of Rs 100 if he sells 40
bananas, he would incur a profit. The same principle can be
applied to a foreign exchange quotation.
 In Direct Quotation, it is the commodity of the trade, i.e. the
foreign currency, which is varying in accordance with the change
in exchange rates,

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  For a fixed unit of home currency, the bank would like to acquire
more units of foreign currency while buying and part with lesser
units of foreign currency while selling.
 The difference between the selling rate and buying rate is the
banks profit margin.

Indirect Quotation

Buy High Sell Low

For a fixed
Acquire more Part with Lesser
unit of
units of foreign units of foreign
home
currency currency
currency

Conclusion:
 The Central Banking authority in India, that is the Reserve Bank of
India, should play a more positive role in developing markets by
entering the exchange markets at all centres from time to time.
 In the years to come, the foreign exchange market is likely to play
a pivotal role in strengthening the Indian financial System and
accelerate the process of economic development.

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 Thank you

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