FOREIGN EXCHANGE

MARKET
Prepared By
Ms.Navneet Kaur Bhatia
 FOREIGN EXCHANGE

• Foreign exchange is the mechanism by which the

currency of one country gets converted into the
currency of another country.

• Foreign exchange rate is simply the ratio of a unit

of currency of one country to a unit of currency of
another country at the time of sell or buy
transaction.
 Introduction
• FEM is the largest financial market in the world.
• Leading centers are London, NewYork, Paris,
Zurich, Tokyo, Milan and Frankfurt.
• Trading in FEM is usually done 24 hours.
• It includes coins, notes and bank deposits
and also a variety of highly liquid claims
denominated in foreign currency.
• It operates on very narrow spread.
 Characteristics of FEM
• FEM is described as an OTC market.
• Largest financial market in the world.
• 24 hours market.
• Operating throughout different time zones of the
globe.
• In India, it is open for the time banks are open for
their regular business.
• It is very efficient market having highly developed
communications network.
 Participants of FEM
• Corporates
• Commercial banks
• Exchange brokers; and
• Central banks
• Authorized Dealers
• Exchange Brokers
 Structure of FEM

Retail Wholesale

Bank & Central

Money Changer Inter-bank
Bank

Direct Indirect

Spot Forwards Derivatives

Merchandise Non-merchandise
 Trading
• Trading is generally done by telephone or telex
machine. Foreign exchange traders in each bank
usually operate out of a separate foreign exchange
trading room.
• Spot
• Forward
• Other derivatives
Banks earn spread and brokers earn
commission through FEM operations
 Different terms used in FEM
• Foreign Exchange Reserves (FER)
FER is the surplus money or capital that a country parks or
maintains in the foreign country in form of currency, bond
and other kind of securities.
• Transaction Costs
• The bid-ask spread-that is, the spread between bids and
asks rates for a currency is based on the breadth and depth
of the market for that currency as well as in the currency
volatility.
• Devaluation
• Depreciation
 Exchange Rate System

• The exchange rate systems can be classified according to

the degree by which exchange rates are controlled by the
government.
• Fixed exchange rate system- exchange rates are either
held constant or allowed to fluctuate only within the
prescribed boundaries stipulated by the central bank.
• Floating exchange rate system- the exchange rates are
determined by market forces without intervention by
governments.
Arbitrage
It is the exploitation of price differentials for risk less
guaranteed' profits.
Buying low in one market and selling high in the other market

• Financial Centre Arbitrage - This type of arbitrage ensures that the

dollar pound exchange rate quoted in New York will be the same as
that quoted in London and other financial centres.
• If the exchange rate is $1.61/£1 in New York but only $1.59/£1 in
London, it would be profitable for banks to buy pounds in London and
simultaneously sell them in New York and make a guaranteed 2 cents
on every pound bought and sold.
• The act of buying pounds in London will lead to depreciation of the
dollar in London, while selling pounds in New York will lead to an
appreciation of dollar in New York. Such a process continues until the
quoted in the two centers coincides at say $1.60/£1.
 Current Trends

• Foreign exchange reserves stood at USD 279.6 billion in

April 2010 from USD 251.7 billion April 2009. This
increase is subject to the recent surge in the foreign
investments inflows.
• USD: US Dollar EUR: Euro
• GBP: British Pound IEP: Irish Pound (Punt)
• JPY: Japanese Yen CHF: Swiss Franc
• CAD: Canadian Dollar AUD: Australian Dollar
• DEM: Deutschemark SEK: Swedish Kroner
• NLG: Dutch Guilder BEF: Belgian Franc
• FRF: French Franc DKK: Danish Kroner
• ESP: Spanish Peseta ITL: Italian Lira
• INR: Indian Rupee SAR: Saudi Riyal