PROJECT REPORT

ON

FOREX MARKET
BACHELOR OF MANAGEMENT STUDIES
SEMESTER V
(2016 - 2017)
Submitted
In partial fulfillment of the requirements for the award of degree of
TYBMS (Bachelor of Management Studies)
University of Mumbai
Submitted by

RITESH H KOLI
Under the guidance of
ASST. PROF. MRS. NAIRA BHATIA

S.I.C.E.S. DEGREE COLLEGE OF ARTS, SCIENCE AND

COMMERCE
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JAMBHUL PHATA, K.B.Rd., AMBARNATH (WEST), THANE 421505

2016-2017

CERTIFICATE
This is to certify that MR.RITESH KOLI of TYBMS, Semester - V (2016-2017) has
successfully completed the project on FOREX MARKET under the guidance of ASST.
PROF. MRS. NAIRA P. BHATIA.

_________________

________________

Asst. Prof. Ms. SUPARNA DUTTA

Prof. (Dr.) SATISH A. BHALERAO

(Coordinator)

(Principal)

_____________________________
Asst. Prof. Mrs. NAIRA BHATIA

______________________
EXTERNAL EXAMINER

(Project Guide)

DECLARATION

I, RITESH KOLI student of TYBMS Semester - V hereby declare that I have

completed the project on FOREX MARKET.
I further declare that the information imparted is true and fair to the best of my
knowledge.

(Signature)
RITESH KOLI

ROLL NO.- TMS-16005

ACKNOWLEDGEMENT

Preparing the project (FOREX MARKET) has given me extensive practical knowledge related
to the course.
I would first thank our Principal Prof. Dr. SATISH A. BHALERAO SIR, for his valuable
support in preparing this project.
I express my deep sense of gratitude to the Course Coordinator, Asst. Prof. Ms. Suparna Dutta
madam for the valuable guidance and support during my project work.
I am thankful to my Asst. Prof. Mrs. Naira Bhatia for providing me the guidance throughout
the course of this project. I am also thankful to her for patiently and critically evaluating the
content of this project.
I would like to take this opportunity to express my gratitude to all the staff of the library and the
computer lab for their support.

INTRODUCTION
Being the main force driving the global economic market, currency is no doubt an essential
element for a country. However, in order for all the countries with different currencies to trade
with one another, a system of exchange rate between their currencies is needed; this system is
formally known as foreign exchange or currency exchange.
In the early days, the system of currency exchange is supported solely by the gold amount held in
the vault of a country. However, this system is no longer appropriate now due to inflation and
hence, the value of ones currency nowadays is determined through the market forces alone. In
order to determine the value of a currencys exchange rate, two main types of system is used
which is floating currency and pegged currency.
For floating exchange rate, its value is determined by the supply and demand of the global
market where the supply and demand is bound by all these factors such as foreign investment,
inflation and ratios of import and export. Normally, this system is adopted by most of the
advance countries like for example UK, US and Canada. All of these countries have a similarity
where their market is well developed and stable in economic terms. These countries choose to
practice this system due to the reason where floating exchange rate is proven to be much more
efficient compared to the pegged exchange rate. The reason behind this is because for floating
exchange rate, the market itself will re-adjust the exchange rate real-time in order to portray the
actual inflation and other economic forces. However, every system has its own flaw and so does
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the floating exchange rate system. For instance, if a country suffers from economic instability
due to various reasons such as political issues, a floating exchange rate system will certainly
discourage investment due to the high risk of suffering from inflationary disaster or sudden slum
in exchange rate. Another form of exchange rate is known as pegged exchange rate. This is a
system where the value of the exchange rate is fixed by the government of a country and not the
supply and demand of the market. This system is called pegged exchange rate because the value
of a countrys currency is fixed to another countrys currency. As a result, the value of the pegged
currency will not fluctuate unlike the floating currency. The working principle behind this system
is slightly complicated where the government of a country will fixed the exchange rate of their
currency and when there is a demand for a certain currency resulting a rise in the exchange rate,
the government will have to release enough of that currency into the market in order to meet that
demand. However, there is a fatal flaw in this system where if the pegged exchange rate is not
controlled properly, panics may arise within the country and as a result of that, people will be
rushing to exchange their money into a more stable currency. When that happens, the sudden
overflow of that countrys currency into the market will decrease the value of their exchange rate
and in the end, their currency will be worthless. Due to this reason, only those under-developed
or developing countries will practice this method as a form to control the inflation rate. However,
the truth is, most of the countries do not fully practice the floating exchange rate or the pegged
exchange rate method in reality. Instead, they use a hybrid system known as floating peg.
Floating peg is the combination of the two main systems where one country will normally fixed
their exchange rate to the US Dollars and after that, they will constantly review their peg rate in
order to stay in line with the actual market value.
The Foreign exchange market, or commonly known as FOREX, is the largest and most prolific
financial market because each day, more than 1 trillion worth of currency exchange takes place
between investors, speculators and countries. From this, we can deduce that the actual
mechanism behind the world of foreign exchange is far more complicated than what we may
already know, and that, the information mentioned earlier is just the tip of an iceberg.

HISTORY
The foreign exchange market (fx or forex) as we know it today originated in 1973. However,
money has been around in one form or another since the time of Pharaohs. The Babylonians are
credited with the first use of paper bills and receipts, but Middle Eastern moneychangers were
the first currency traders who exchanged coins from one culture to another. During the middle
ages, the need for another form of currency besides coins emerged as the method of choice.
These paper bills represented transferable third-party payments of funds, making foreign
currency exchange trading much easier for merchants and traders and causing these regional
economies to flourish.
From the infantile stages of forex during the Middle Ages to WWI, the forex markets were
relatively stable and without much speculative activity. After WWI, the forex markets became
very volatile and speculative activity increased tenfold. Speculation in the forex market was not
looked on as favorable by most institutions and the public in general. The Great Depression and
the removal of the gold standard in 1931 created a serious lull in forex market activity. From
1931 until 1973, the forex market went through a series of changes. These changes greatly
affected the global economies at the time and speculation in the forex markets during these times
was little, if any.

1944 Bretton Woods Accord is established to help stabilize the global economy after World
War II.
1971 Smithsonian Agreement established to allow for greater fluctuation band for currencies.
1972 European Joint Float established as the European community tried to move away from its
dependency on the U.S. dollar.
1973 Smithsonian Agreement and European Joint Float failed and signified the official switch to
a free-floating system.
1978 The European Monetary System was introduced so other countries could try to gain
independence from the U.S. dollar.
1978 Free-floating system officially mandated by the IMF.
1993 European Monetary System fails making way for a world-wide free-floating system.

SUMMARY

The foreign exchange market is the mechanism by which a person of firm transfers
purchasing power from one country to another, obtains or provides credit for

international trade transactions, and minimizes exposure to foreign exchange risk.

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.
A foreign exchange rate is the price of a foreign currency. A foreign exchange quotation

or quote is a statement of willingness to buy or sell at an announced rate.

The foreign exchange market consists of two tiers: the interbank or wholesale market,
and the client or retail market. Participants include banks and nonbank foreign exchange
dealers, individuals and firms conducting commercial and investment transactions,
speculators and arbitragers, central banks and treasuries, and foreign exchange brokers.
Transactions are effectuated either on a spot basis or on a forward or swap basis. A spot

transaction is for an (almost) immediate value date while a forward transaction is for a

value date somewhere in the future.

Quotations can be classified either as European and American terms or as direct and
indirect quotes.
In the real world, quotations include a bid-ask spread. A bid is the exchange rate in one
currency at which a dealer will buy another currency. An ask is the exchange rate at
which a dealer will sell the other currency. The spread is the difference between the bid
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price and the ask price. This spread reflects the existence of commissions and transaction

costs.
A cross rate is an exchange rate between two currencies, calculated from their common
relationship with a third currency.

General Features
Foreign exchange market is described as an OTC (Over the counter) market as there is no
physical place where the participants meet to execute their deals. It is more an informal
arrangement among the banks and brokers operating in a financing centre purchasing and selling
currencies, connected to each other by telecommunications like telex, telephone and a satellite
communication network, SWIFT. The term foreign exchange market is used to refer to the
wholesale a segment of the market, where the dealings take place among the banks. The retail
segment refers to the dealings take place between banks and their customers. The retail segment
refers to the dealings take place between banks and their customers. The retail segment is
situated at a large number of places. They can be considered not as foreign exchange markets,
but as the counters of such markets. The leading foreign exchange market in India is Mumbai,
Calcutta, Chennai and Delhi is other centers accounting for bulk of the exchange dealings in
India. The policy of Reserve Bank has been to decentralize exchanges operations and develop
broader based exchange markets. As a result of the efforts of Reserve Bank Cochin, Bangalore,
Ahmadabad and Goa have emerged as new centre of foreign exchange market.

Size of the Market

Foreign exchange market is the largest financial market with a daily turnover of over USD 2
trillion. Foreign exchange markets were primarily developed to facilitate settlement of debts
arising out of international trade. But these markets have developed on their own so much so that
a turnover of about 3 days in the foreign exchange market is equivalent to the magnitude of
world trade in goods and services. The largest foreign exchange market is London followed by
New York, Tokyo, Zurich and Frankfurt. The business in foreign exchange markets in India has
shown a steady increase as a consequence of increase in the volume of foreign trade of the
country, improvement in the communications systems and greater access to the international
exchange markets. Still the volume of transactions in these markets amounting to about USD 2
billion per day does not compete favorably with any well developed foreign exchange market of
international repute. The reasons are not far to seek. Rupee is not an internationally traded
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currency and is not in great demand. Much of the external trade of the country is designated in
leading currencies of the world, Viz., US dollar, pound sterling, Euro, Japanese yen and Swiss
franc. Incidentally, these are the currencies that are traded actively in the foreign exchange
market in India.

24 Hours Market
The markets are situated throughout the different time zones of the globe in such a way that
when one market is closing the other is beginning its operations. Thus at any point of time one
market or the other is open. Therefore, it is stated that foreign exchange market is functioning
throughout 24 hours of the day. However, a specific market will function only during the
business hours. Some of the banks having international network and having centralized control
of funds management may keep their foreign exchange department in the key centre open
throughout to keep up with developments at other centers during their normal working hours . In
India, the market is open for the time the banks are open for their regular banking business. No
transactions take place on Saturdays.
Efficiency
Developments in communication have largely contributed to the efficiency of the market. The
participants keep abreast of current happenings by access to such services like Dow Jones
Telerate and Teuter. Any significant development in any market is almost instantaneously
received by the other market situated at a far off place and thus has global impact. This makes
the foreign exchange market very efficient as if the functioning under one roof.

Currencies Traded
In most markets, US dollar is the vehicle currency, Viz., the currency used to denominate
international transactions. This is despite the fact that with currencies like Euro and Yen gaining
larger share, the share of US dollar in the total turnover is shrinking.

Physical Markets
In few centers like Paris and Brussels, foreign exchange business takes place at a fixed place,
such as the local stock exchange buildings. At these physical markets, the banks meet and in the
presence of the representative of the central bank and on the basis of bargains, fix rates for a
number of major currencies. This practice is called fixing. The rates thus fixed are used to
execute customer orders previously placed with the banks. An advantage claimed for this
procedure is that exchange rate for commercial transactions will be market determined, not
influenced by any one bank. However, it is observed that the large banks attending such meetings
with large commercial orders backing up, tend to influence the rates.

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 Participants
The participants in the foreign exchange market comprise;
(i)
(ii)

Commercial banks

(iii)

Exchange brokers

(iv)

(i)

Corporates

Central banks

Corporates: The business houses, international investors, and multinational

corporations may operate in the market to meet their genuine trade or investment
requirements. They may also buy or sell currencies with a view to speculate or trade in
currencies to the extent permitted by the exchange control regulations. They operate by
placing orders with the commercial banks. The deals between banks and their clients
form the retail segment of foreign exchange market. In India the foreign Exchange
Management (Possession and Retention of Foreign Currency) Regulations, 2000 permits
retention, by resident, of foreign currency up to USD 2,000. Foreign Currency
Management (Realisation, Repatriation and Surrender of Foreign Exchange) Regulations,
2000 requires a resident in India who receives foreign exchange to surrender it to an
authorized dealer: (a) Within seven days of receipt in case of receipt by way of
remuneration, settlement of lawful obligations, income on assets held abroad, inheritance,
settlement or gift: and (b) Within ninety days in all other cases. Any person who acquires
foreign exchange but could not use it for the purpose or for any other permitted purpose
is required to surrender the unutilized foreign exchange to authorized dealers within sixty
days from the date of acquisition. In case the foreign exchange was acquired for travel
abroad, the unspent foreign exchange should be surrendered within ninety days from the
date of return to India when the foreign exchange is in the form of foreign currency notes
and coins and within 180 days in case of travellers cheques. Similarly, if a resident
required foreign exchange for an approved purpose, he should obtain from and authorized
dealer.

(ii)

Commercial Banks are the major players in the market. They buy and sell currencies
for their clients. They may also operate on their own. When a bank enters a market to
correct excess or sale or purchase position in a foreign currency arising from its various
deals with its customers, it is said to do a cover operation. Such transactions constitute
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hardly 5% of the total transactions done by a large bank. A major portion of the volume is
accounted buy trading in currencies indulged by the bank to gain from exchange
movements. For transactions involving large volumes, banks may deal directly among
themselves. For smaller transactions, the intermediation of foreign exchange brokers may
be sought.

(iii)

Exchange brokers facilitate deal between banks. In the absence of exchange brokers,
banks have to contact each other for quotes. If there are 150 banks at a centre, for
obtaining the best quote for a single currency, a dealer may have to contact 149 banks.
Exchange brokers ensure that the most favorable quotation is obtained and at low cost in
terms of time and money. The bank may leave with the broker the limit up to which and
the rate at which it wishes to buy or sell the foreign currency concerned. From the intends
from other banks, the broker will be able to match the requirements of both. The names
of the counter parties are revealed to the banks only when the deal is acceptable to them.
Till then anonymity is maintained. Exchange brokers tend to specialize in certain exotic
currencies, but they also handle all major currencies.

(iv)

Central Banks : In India, banks may deal directly or through recognized exchange
brokers. Accredited exchange brokers are permitted to contract exchange business on
behalf of authorized dealers in foreign exchange only upon the understanding that they
will conform to the rates, rules and conditions laid down by the FEDAI. All contracts
must bear the clause subject to the Rules and Regulations of the Foreign Exchanges
Dealers Association of India. Central Bank may intervene in the market to influence the
exchange rate and change it from that would result only from private supplies and
demands. The central bank may transact in the market on its own for the above purpose.
Or, it may do so on behalf of the government when it buys or sell bonds and settles other
transactions which may involve foreign exchange payments and receipts. In India,
authorized dealers have recourse to Reserve Bank to sell/buy US dollars to the extent the
latter is prepared to transact in the currency at the given point of time. Reserve Bank will
not ordinarily buy/sell any other currency from/to authorized dealers. The contract can be
entered into on any working day of the dealing room of Reserve Bank. No transaction is
entered into on Saturdays. The value date for spot as well as forward delivery should be
in conformity with the national and international practice in this regard. Reserve Bank of
India does not enter into the market in the ordinary course, where the exchanges rates are
moving in a detrimental way due to speculative forces, the Reserve Bank may intervene
in the market either directly or through the State Bank of India.

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Why the foreign Exchange Market is Unique?

Its huge trading volume representing the largest asset class in the world leading to high
liquidity;

Its geographical dispersion;

Its continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT
on Sunday until 22:00 GMT Friday;

The variety of factors that affect exchange rates;

The low margins of relative profit compared with other markets of fixed income; and

The use of leverage to enhance profit and loss margins and with respect to account size.

As such, it has been referred to as the market closest to the ideal of perfect competition,
not withstanding currency intervention by central banks. According to the Bank for
International Settlements, as of April 2010, average daily turnover in global foreign
exchange markets is estimated at $3.98 trillion, a growth of approximately 20% over the
$3.21 trillion daily volume as of April 2007. Some firms specializing on foreign
exchange market had put the average daily turnover in excess of US$4 trillion.

The $3.98 trillion break-down is as follows:

$1.490 trillion in spot transactions
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$475 billion in outright forwards

$1.765 trillion in foreign exchange swaps
$43 billion currency swaps
$207 billion in options and other product.

ADVANTAGES AND DISADVANTAGES OF FOREIGN

EXCHANGE MARKET:
Advantages

The forex market is extremely liquid, hence its rapidly growing popularity. Currencies
may be converted when bought or sold without causing too much movement in the price
and keeping losses to a minimum.

As there is no central bank, trading can take place anywhere in the world and operates on
a 24-hour basis apart from weekends.

An investor needs only small amounts of capital compared with other investments. Forex
trading is outstanding in this regard.

It is an unregulated market, meaning that there is no trade commission over seeing

transactions and there are no restrictions on trade.

In common with futures, forex is traded using a good faith deposit rather than a loan.
The interest rate spread is an attractive advantage.

Disadvantages

The major risk is that one counter party fails to deliver the currency involved in a very
large transaction. In theory at least, such a failure could bring ruin to the forex market as
a whole.
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Investors need a lot of capital to make good profits because the profit margins on smallscale trades are very low.

Various participants Of foreign Exchange Market:

Governments: Governments have requirements for foreign currency, such as paying
staff salaries and local bills for embassies abroad, or for arraigning a foreign currency credit line,
most often in dollars, for industrial or agricultural development in the third world, interest on
which ,as well as the capital sum, must periodically be paid. Foreign exchange rates concern
governments because changes affect the value of product and financial instruments, which
affects the health of a nations markets and financial systems.
Banks: There are different types of banks, all of which engage in the foreign exchange market to
greater or lesser extent. Some work to signal desired movement in the market without causing
overt change, while some aggressively manage their reserves by making speculative risks. The
vast majority, however, use their knowledge and expertise is assessing market trends for
speculative gain for their clients
Brokering Houses: These exist primarily to bring buyer and seller together at a mutually agreed
price. The broker is not allowed to take a position and must act purely as a liaison. Brokers
receive a commission from both sides of the transaction, which varies according to currency
handled. The use of human brokers has decreased due mostly to the rise of the interbank
electronic brokerage systems
International Monetary Market: The International Monetary Market (IMM) in Chicago trades
currencies for relatively small contract amounts for only four specific maturities a year.
Originally designed for the small investor, the IMM has grown since the early 1970s, and the
major banks, who once dismissed the IMM, have found that it pays to keep in touch with its
developments, as it is often a market leader

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Money Managers: These tend to be large New York commission houses that are often very
aggressive players in the foreign exchange market. While they act on behalf of their clients, they
also deal on their own account and are not limited to one time zone, but deal around the world
through their agents.
Corporations: Corporations are the actual end-users of the foreign exchange market. With the
exception only of the central banks, corporate players are the ones who affect supply and
demand. Since the corporations come to the market to offset currency exposure they permanently
change the liquidity of the currencies being dealt with.
Retail Clients: This includes smaller companies, hedge funds, companies specializing in
investment services linked by foreign currency funds or equities, fixed income brokers, the
financing of aid programs by registered worldwide charities and private individuals. Retail
investors trade foreign exchange using highly leveraged margin accounts. The amount of their
trading in total volume and in individual trade amounts is dwarfed by the corporations andinter
bank markets.
Central Bank:External value of the domestic currency is controlled and assigned by central
bank of

every county. Each country has a central or apex bank. For example In India Reserve
Bank of Indians the central Bank

Commercial Bank :Commercial banks are the one which has the most number of branches.
With its wide branch network the Commercial banks buy the foreign exchange and sell it to the
importers. These banks are the most active among the market players and also provide services
like converting currency from one to another.
Exchange Brokers: Services of brokers are used to some extent, Forex market has some
practices and tradition depending on this the residing in other countries are utilised.Local brokers
can conduct Forex transactions as per the rules and regulations of the Forex governing body
of their respective country.

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Overseas Forex market: The Forex market operates all around the clock and the market day
initiates with Tokyo and followed by Bahrain Singapore, India, Frankfurt, Paris, London, New
York, and
Sydney before things are back with Tokyo the next day.
Speculators: In order to make profit on the account of favourable exchange rate, speculators buy
foreign currency if it is expected to appreciate and sell foreign currency if it is expected to
depreciate. They follow the practice of delaying covering exposures and not offering a cover till
the time cash flow is materialized.
Other financial institutions involved in the foreign exchange market include:
Stock brokers Commodity
Firms Insurance
Companies Charities
Private Institutions
Private Individuals

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Characteristics Of Foreign Exchange Market

Changing Wealth
The ratios between the currencies of two countries are exchange rates in forex. If one currency
loss its value in the market and at the same time the value of the another currency increases this
causes the fluctuations in the exchange rate in foreign exchange market. For Example, over 20
years ago a single US dollar bought 360 Japanese Yen, whereas at present1 US dollar buys 110
Japanese Yen; this explains that the Japanese Yen has risen in value ,and the US dollar has
decreased in value (relative to the Yen). This is said to be a shift in wealth, as a fixed amount of
Japanese Yen can now purchase many more goods than two decades ago

No Centralized Market
The foreign exchange market does not have a centralized market like a stock exchange. Brokers
in the foreign exchange market are not approved by a governing agency. Business network and
operation market of foreign exchange takes place without any unification in transaction. Foreign
exchange currency trading has been reformed into a non-formal and global network organization
it consists of advanced information system. Trader of forex should not be a member of any
organisation.

Circulation work
Foreign exchange market has member from all the countries, each country has different geo
graphical positions so forex operates all around the clock on working days (i.e.) Monday to
Friday every week. Because the time in Australia is different than in European countries, this
kind of 24 hours operation, free from any time is an ideal environment for investors.
For instance, a trader may buy the Japanese Yen in the morning at the New York market, and in
the night if the Japanese Yen rises in the Hong Kong market, the trader can sell in the Hong
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Kong market. more number of opportunities are available for the forex traders. In FOREX
market most trading takes place in only a few currencies; the U.S. Dollar ($), European
Currency Unit (), Japanese Yen (), British Pound Sterling (), Swiss Franc (Sf), Canadian
Dollar (Can$), and to a lesser extent, the Australian and New Zealand Dollars

Financial Instruments of foreign exchange market

Spot Market
Spot market involves the quickest transaction in the foreign exchange market. This involves
immediate payment at the current exchange rate is called as spot rate. The spot market accounts
for 1/3rdof all the currency exchange, trades in Federal Reserve that takes place within two days
of the agreement. The traders open to the volatility of the currency market, which can raise or
lower the price between the agreement and the trade.

Futures Market
These kind transactions involve future payment and future delivery at an agreed exchange rate.
Future market contracts are standardized, it is non-negotiable and the elements of the agreement
are set. It also takes the volatility of the currency market, specifically the spot market, out of the
equation. This type of market is popular for Steady return on their investment that is done on
large currency transactions.

Forward Market
The terms are negotiable between the two parties. The terms can be changes according to the
needs of the participants. It allows for more flexibility. Two entities swap currency for an agreed
amount of time, and then return the currency at the end of the contract.

Swap Transactions
In swap two parties are involves where they exchange the currencies for certain time and agree to
reserve the transaction at a later date. Swap is the most commonly used forward

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transaction. In swap transaction it is not traded through the exchange and there is no
standardization. Until the transaction is completed the deposit is required to hold the position.

Settlement of Transactions
Foreign exchange markets make extensive use of the latest developments in telecommunications
for transmitting as well settling foreign exchange transaction, Banks use the exclusive network
SWIFT to communicate messages and settle the transactions at electronic clearing houses such as
CHIPS at New York.
SWIFT: SWIFT is a acronym for Society for Worldwide Interbank Financial
Telecommunications, a co operative society owned by about 250 banks in Europe and North
America and registered as a co operative society in Brussels, Belgium. It is a
communications network for international financial market transactions linking effectively
more than 25,000 financial institutions throughout the world who have been allotted bank
identified codes. The messages are transmitted from country to country via central
interconnected operating centers located in Brussels, Amsterdam and Culpeper, Virginia. The
member countries are connected to the centre through regional processors in each country.
The local banks in each country reach the regional processors through the national net works.
The SWIFY System enables the member banks to transact among themselves quickly (i)
international payments (ii) Statements (iii) other messages connected with international
banking. Transmission of messages takes place within seconds, and therefore this method is
economical as well as time saving. Selected banks in India have become members of SWIFT.
The regional processing centre is situated at Mumbai.
The SWIFT provides following advantages for the local banking community:
1. Provides a reliable (time tested) method of sending and receiving messages from a vast
number of banks in a large number of locations around the world.
2. Reliability and accuracy is further enhanced by the built in authentication facilities, which has
only to be exchanged with each counterparty before they can be activated or further
communications.
3. Message relay is instantaneous enabling the counterparty to respond immediately, if not
prevented by time differences.
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4. Access is available t a vast number of banks global for launching new cross border initiatives.
5. Since communication in SWIFT is to be done using structure formats for various types of
banking transactions, the matter to be conveyed will be very clear and there will not be any
ambiguity of any sort for the received to revert for clarifications. This is mainly because the
formats are used all over the world on a standardized basis for conducting all types of banking
transactions. This makes the responses and execution very efficient at the receiving banks end
thereby contributing immensely to quality service being provided to the customers of both banks
(sending and receiving).
6. Usage of SWIFT structure formats for message transmission to counterparties will entail the
generation of local banks internal records using at least minimum level of automation. This will
accelerate the local banks internal automation activities, since the maximum utilization of
SWIFT a significant internal automation level is required.

CHIPS:
CHIPS stands for Clearing House Interbank Payment System. It is an electronic payment system
owned by 12 private commercial banks constituting the New York Clearing House Association.
A CHIP began its operations in 1971 and has grown to be the worlds largest payment system.
Foreign exchange and Euro dollar transactions are settled through CHIPS. It provides the
mechanism for settlement every day of payment and receipts of numerous dollar transactions
among member banks at New York, without the need for physical exchange of cheques/funds for
each such transaction. The functioning of CHIPS arrangement is explained below with a
hypothetical transaction: Bank of India, maintaining a dollar account with Amex Bank, New
York, sells USD 1 million to Canara Bank, maintaining dollar account with Citibank.
1. Bank of India intimate Amex Bank debuts the account of Bank through SWIFT to debit its
account and transfer USD 1 million to Citibank for credit of current account of Canara Bank.
2. Amex Bank debits the account of Bank of India with USD 1 million and sends the equivalent
of electronic cheques to CHIPS for crediting the account of Citibank. The transfer is effected the
same day.
3. Numerous such transactions are reported to CHIPS by member banks and transfer effected at
CHIPS. By about 4.30 p.m, eastern time, the net position of each member is arrived at and funds
made available at Fedwire for use by the bank concerned by 6.00 p.m. eastern time.
4. Citibank which receives the credit intimates Canara Bank through SWIFT.
It may be noted that settlement of transactions in the New York foreign exchange market takes
place in two stages, First clearance at CHIPS and arriving at the net position for each bank.
Second, transfer of fedfunds for the net position. The real balances are held by banks only with
Federal Reserve Banks (Fedfunds) and the transaction is complete only when Fedfunds are
22

transferred. CHIPS help in expediting the reconciliation and reducing the number of entries that
pass through Fedwire.

CHAPS
CHAPS is an arrangement similar to CHIPS that exists in London. CHAPS stands for Clearing
House Automated Payment System. Fedwire The transactions at New York foreign exchange
market ultimately get settled through Fedwire. It is a communication network that links the
computers of about 7000 banks to the computers of federal Reserve Banks. The fedwire funds
transfer system, operate by the Federal Reserve Bank, are used primarily for domestic payments,
bank to bank and third party transfers such as interbank overnight funds sales and purchases and
settlement transactions. Corporate to corporate payments can also be made, but they should be
effected through banks. Fed guarantees settlement on all payments sent to receivers even if the
sender fails.

Functions of the Foreign Exchange Market

23

The foreign exchange market is the mechanism by which a person of firm transfers purchasing
power form one country to another, obtains or provides credit for international trade transactions,
and minimizes exposure to foreign exchange risk.
Transfer of Purchasing Power
Transfer of one country to another and from one national currency to another is called the
transfer of purchasing power. International transactions normally involve different people from
countries with different national currencies. Credit instruments and bank drafts are used to
transfer the purchasing power this is one of the important function in forex. In forex the
transaction can only be done in one currency.
Provision of credit for foreign trade
The forex takes time to move the goods from a seller to buyer so the transaction must be
financed. Foreign exchange market provides credit to the traders. Credit facility is need by
exporters when the goods are transited. Goods some on the other need credit facility when this
kind of special credit facility is used the forex exchange department is extended to finance the
foreign trade
Foreign Exchange Dealers
Foreign exchange dealers, deal both with interbank and client market. The profit of the dealers is
there buying at a bid price and sells it at a high price. Worldwide competitions among dealers
narrows the spread between bid and ask and so contributes to making the foreign exchange
market efficient in the same sense as securities markets. Dealers in the foreign exchange
departments of large international banks often function as market makers. They stand willing to
buy and sell those currencies in which they specialize by maintaining an inventory position in
those currencies.
Minimizing Foreign Exchange Risk
The foreign exchange market provides "hedging" facilities for transferring foreign exchange
risk to someone else.

Types of Foreign Exchange Rates

24

(i)

Floating Rates

Floating rates is one of the primary reasons for fluctuation of currency in foreign exchange
market. This is one of the most important commonly and main type of exchange rate. Under this
market force all the economies of developed countries allow there currency to flow freely. When
the value of the currency becomes low it makes the imports more and the exports are cheaper, so
the countries domestic goods and services are demanded more in foreign buyers. The country can
withstand the fluctuation only if the economy is strong.
When the countrys economy is able to meet the demand then it can adjust between the
foreign trade and domestic trade automatically.
(ii)

Fixed Rates

Fixed exchange rates are used to attract the foreign investments and to promote foreign trade.
This type of rates is used only by small developed countries. By Fixed exchange rates the
country assures the investors for the stable and constant value of investment in the country. A
monetary policy of the country becomes ineffective. In this type the exchange rates the imports
become expensive. The exchange value of the currency does not move. This normally reduces
the countrys currency against foreign currencies.
(iii)

Pegged Rates

This rate is between the floating rate and the fixed rate. Pegged rates appropriate more
for developed country. A country allows its currency to fluctuation to some extend for a adjusted
central value. Pegged allow some adjustments and stability. No artificial rates are found in fixed
and floating exchange rates. Pegged can fix the economic problem by itself and provide
growth opportunity also. When a fixed value is not maintains by the country it cant follow
the fixed exchange rate.

Factors affecting Movement of Exchange Rates

25

Aside from factors such as interest rates and inflation ,exchange rate is one of the most important
determinants of a country's relative level of economic health. Exchange rates play a vital role in a
country's level of trade, which is critical to every free market economy in the world. For this
reason, exchange rates are among the most watched ,analyzed and governmentally manipulated
economic measures. But exchange rates matter on a smaller scale as well: they impact the real
return of an investor's portfolio. Here we look at some of the major forces behind exchange rate
movements. Before we look at these forces, we should sketch out how exchange rate movements
affect a nation's trading relationships with other nations. A higher currency makes a country's
exports more expensive and imports cheaper in foreign markets; a lower currency makes a
country's exports cheaper and its imports more expensive in foreign markets. A higher exchange
rate can be expected to lower the country's balance of trade, while a lower exchange rate would
increase it. Numerous factors determine exchange rates, and all are related to the trading
relationship between two countries. Remember, exchange rates are relative, and are expressed as
a comparison of the currencies of two countries. The following are some of the principal
determinants of the exchange rate between two countries. Note that these factors are in no
particular order; like many aspects of economics ,the relative importance of these factors is
subject to much debate.
Differentials in Inflation
As a general rule, a country with a consistently lower inflation rate exhibits a rising currency
value, as its purchasing power increases relative to other currencies. During the last half of the
twentieth century, the countries with low inflation included Japan ,Germany and Switzerland,
while the U.S. and Canada achieved low inflation only later. Those countries with higher
inflation typically see depreciation in their currency in relation to the currencies of their trading
partners. This is also usually accompanied by higher interest rates.
Differentials in Interest Rates
Interest rates, inflation and exchange rates are all highly correlated. By manipulating interest
rates, central banks exert influence over both inflation and exchange rates, and changing interest
rates impact inflation and currency values. Higher interest rates offer lenders in an economy a
higher return relative to other countries. Therefore, higher interest rates attract foreign capital and
cause the exchange rate to rise. The impact of higher interest rates is mitigated, however, if

26

inflation in the country is much higher than in others, or if additional factors serve to drive the
currency down. The opposite relationship exists for decreasing interest rates - that is, lower
interest rates tend to decrease exchange rates.
Current-Account Deficits
The current account is the balance of trade between a country and its trading partners, reflecting
all payments between countries for goods, services, interest and dividends. A deficit in the
current account shows the country is spending more on foreign trade than it is earning, and that it
is borrowing capital from foreign sources to make up the deficit. In other words, the country
requires more foreign currency than it receives through sales of exports, and it supplies more of
its own currency than foreigners demand for its products. The excess demand for foreign
currency lowers the country's exchange rate until domestic goods and services are cheap enough
for foreigners, and foreign assets are too expensive to generate sales for domestic interests.
Public Debt
Countries will engage in large-scale deficit financing to pay for public sector project sand
governmental funding. While such activity stimulates the domestic economy ,nations with large
public deficits and debts are less attractive to foreign investors. The reason? A large debt
encourages inflation, and if inflation is high, the debt will be serviced and ultimately paid off
with cheaper real dollars in the future.
In the worst case scenario, a government may print money to pay part of a large debt, but
increasing the money supply inevitably causes inflation. Moreover, if a government is not able to
service its deficit through domestic means (selling domestic bonds, increasing the money
supply), then it must increase the supply of securities for sale to foreigners, thereby lowering
their prices. Finally, a large debt may prove worrisome to foreigners if they believe the country
risks defaulting on its obligations. Foreigners will be less willing to own securities denominated
in that currency if the risk of default is great. For this reason, the country's debt rating (as
determined by Moody's or Standard& Poor's, for example) is a crucial determinant of its
exchange rate

Terms of Trade
27

Trade of goods and services between countries is the major reason for the demand and supply of
foreign currencies. A ratio comparing export prices to import prices, the terms of trade is related
to current accounts and the balance of payments. If the price of a country's exports rises by a
greater rate than that of its imports, its terms of trade have favorably improved. Increasing terms
of trade shows greater demand for the country's exports. This, in turn, results in rising revenues
from exports, which provides increased demand for the country's currency (and an increase in the
currency's value). If the price of exports rises by a smaller rate than that of its imports, the
currency's value will decrease in relation to its trading partners. This is a typical case for
underdeveloped countries which rely on imports for development needs. The current account
balance(deficit or surplus) thus reflects the strength and weakness of the domestic currency.
6. Fundamental Factors viz. Political Stability and Economic Performance
Fundamental factors include all such events that affect the basic economic and fiscal policies of
the concerned government. These factors normally affect the long-term exchange rates of any
currency. On short-term basis on many occasions, these factors are found to be rather inactive
unless the market attention has turned to fundamentals. However, in the long run exchange rates
of all the currencies are linked to fundamental causes. The fundamental factors are basic
economic policies followed by the government in relation to inflation, balance of payment
position, unemployment ,capacity utilization, trends in import and export, etc. Normally, other
things remaining constant the currencies of the countries that follow the sound economic policies
will always be stronger. Similar for the countries which are having balance of payment surplus,
the exchange rate will always be favourable. Conversely, for countries facing balance of payment
deficit, the exchange rate will be adverse. Continuous and ever growing deficit in balance of
payment indicates over valuation of the currency concerned and the dis-equilibrium created can
be remedied through devaluation. Foreign investors inevitably seek out stable countries with
strong economic performance in which to invest their capital. A country with such positive
attributes will draw investment funds away from other countries perceived to have more political
and economic risk. Political turmoil, for example, can cause a loss of confidence in a currency
and a movement of capital to the currencies of more stable countries.

Political and Psychological factors

28

Political and psychological factors are believed to have an influence on exchange rates. Many
currencies have a tradition of behaving in a particular way for e.g. Swiss Franc as a refuge
currency. The US Dollar is also considered a safer haven currency whenever there is a political
crisis anywhere in the world.
Speculation
Speculation or the anticipation of the market participants many a times is the prime reason for
exchange rate movements. The total foreign exchange turnover worldwide is many times the
actual goods and services related turnover indicating the grip of speculators over the market.
Those speculators anticipate the events even before the actual data is out and position themselves
accordingly in order to take advantage when the actual data confirms the anticipations. The
initial positioning and final profit taking make exchange rates volatile. These speculators many
times concentrate only on one factor affecting the exchange rate and as a result the market
psychology tends to concentrate only on that factor neglecting all other factors that have equal
bearing on the exchange rate movement. Under these circumstances even when all other factors
may indicate negative impact on the exchange rate of the currency if the one factor that the
market is concentrating comes out positive the currency strengthens.
Capital Movement
The phenomenon of capital movement affecting the exchange rate has a very recent origin. Huge
surplus of petroleum exporting countries due to sudden spurt in the oil prices could not be
utilized by these countries for home consumption entirely and needed to be invested elsewhere
productively. Movement of these petro dollars, started
affecting the exchange rates of various currencies. Capital tended to move from lower yielding to
higher yielding currencies and as a result the exchange rates moved. International investments in
the form of Foreign direct investment (FDI) and Foreign institutional investments (FII) have
become the most important factors affecting the
exchange rate in todays open world economy. Countries which attract large capital
inflows through foreign investments, will witness an appreciation in its domestic currency as its
demand rises. Outflow of capital would mean a depreciation of domestic currency.

Intervention
29

Exchange rates are also influenced in no small measure by expectation of changes in regulation
relating to exchange markets and official intervention. Official intervention can smoothen an
otherwise disorderly market but it is also the experience that if the authorities attempt halfheartedly to counter the market sentiments through intervention in the market, ultimately more
steep and sudden exchange rate swings can occur. In the second quarter of 1985 the movement of
exchange rates of major currencies reflected the change in the US policy in favour of coordinated exchange market intervention as a measure to bring down the value of dollar.
Stock Exchange Operations
Stock exchange operations in foreign securities, debentures, stocks and shares, influence the
demand and supply of related currencies, thus influencing their exchange rate.
Political Factors
Political scenario of the country ultimately decides the strength of the country. Stable efficient
government at the centre will encourage positive development in the country, creating successful
investor confidence and a good image in the international market. An economy with a strong,
positive image will obviously have a strong domestic currency. This is the reason why
speculations rise considerably during the parliament elections, with various predictions of the
future government and its policies. In 1998,the Indian rupee depreciated against the dollar due to
the American sanctions after India conducted the Pokharan nuclear test.
Others
The turnover of the market is not entirely trade related and hence the funds placed at the disposal
of foreign exchange dealers by various banks, the amount which the dealers can raise in various
ways, banks' attitude towards keeping open position during the course of a day, at the end of the
day, on the eve of weekends and holidays ,window dressing operations as at the end of the half
year to year, end of the month considerations to cover operations for the returns that the banks
have to submit the central monetary authorities etc. - all affect the exchange rate movement of
the currencies. Value of a currency is thus not a simple result of its demand and supply, but a
complex mix of multiple factors influencing the demand and supply.
30

Players in Foreign Exchange Market

A key goal of exchange rate economics is to understand currency returns. Exchange rates
like asset prices more generally move in response to new information about their fundamental
value. Over the past decade microstructure research has revealed that this price discovery
process involves different categories of market participants. Each participants distinct role is
determined by (a) whether the agent is a liquidity maker or taker, and (b) the extent to which the
agent is informed. The original FX market participants were traders in goods and services.
Currencies came into existence because they solved the problem of the coincidence of wants
with respect to goods. Most countries have their own currencies so international trade in goods
requires trade in currencies. The motives for currency exchange have expanded over the
centuries to include speculation, hedging, and arbitrage with the list of key players expanding
accordingly. Beyond importers and exporters, the major categories of market participants now
include asset managers, dealers, central banks, small individual (retail) traders, and most recently
high-frequency traders. The Forex over the counter market is formed by different participants
with varying needs and interests that trade directly with each other. These participants can be
divided in two groups: the interbank market and the retail market.
The Interbank Market
The interbank market designates Forex transactions that occur between central banks,
commercial banks and financial institutions.
Central Banks
National central banks (such as the US Fed, the ECB, R.B.I.)play an important role in the Forex
market. As principal monetary authority, their role consists in achieving price stability and
economic growth. Their main purpose is to provide adequate trading conditions. To do so, they
regulate the entire money supply in the economy by setting interest rates and reserve
requirements. They also manage the country's foreign exchange reserves that they can use in
order to influence market conditions and exchange rates. Central banks intervene in economic or
financial imbalance in the foreign exchange market. Central banks are also responsible for
stabilizing the forex market. They do this by balancing the country's foreign exchange reserves.
31

In addition, they also have official target rates for the currencies that they are handling. Because
of this role, central banks are sometimes jokingly referred to as circus performers because of the
daily balancing act that they have to perform. Their intervention in the foreign exchange market
is not to earn profit from foreign currency trading.

Commercial Banks
Traditionally known as a savings and lending institution, banks are certainly one of the major
players in forex market. They are the natural players in foreign exchange as all other participants
must deal with them. Foreign exchange currency trading began as an added service to deposits
and loans offered by commercial banks. Banks are usually involved in both large quantities of
speculative trading and also daily commercial turnover. The really big and well-established
banks trade in the billions of dollars in foreign currencies every day. Commercial banks provide
liquidity to the Forex market due to the trading volume they handle every day. Some of this
trading represents foreign currency conversions on behalf of customers' needs while some is
carried out by the banks' proprietary trading desk for speculative purpose. The profitability
of foreign exchange trading is a perfect characteristic for banks to be involved.
Financial Institutions
Financial institutions such as money managers, investment funds, pension funds and brokerage
companies trade foreign currencies as part of their obligations to seek the best investment
opportunities for their clients. For example, a manager of an international equity portfolio will
have to engage in currency trading in order to buy and sell foreign stocks.
The Retail Market
The retail market designates transactions made by smaller speculators and investors .These
transactions are executed through Forex brokers who act as a mediator between the retail market
and the interbank market. The participants of the retail market are investment firms, hedge funds,
corporations and individuals / retail forex brokers and speculators.

32

 Investment Firms
Investment management firms commonly manage huge accounts on behalf of their clients such
as endowments and pension funds. Sometimes, these investments require the exchange of foreign
currencies so they have to facilitate these transactions through the use of the foreign exchange
market. These situations exist because there are basically no limitations to the nationalities of
customers that an investment firm can attract. Therefore, investment managers with an
international equity portfolio, needs to purchase and sell several pairs of foreign currencies to
pay for foreign securities purchases.
Hedge Funds
Hedge funds are private investment funds that speculate in various assets classes using leverage.
Macro Hedge Funds pursue trading opportunities in the Forex Market. They design and execute
trades after conducting a macroeconomic analysis that reviews the challenges affecting acountry
and its currency. Due to their large amounts of liquidity and their aggressive strategies, they are a
major contributor to the dynamics of Forex Market.
Corporations
They represent the companies that are engaged in import/export activities with foreign
counterparts. Their primary business requires them to purchase and sell foreign currencies in
exchange for goods, exposing them to currency risks. Through the Forex market, they convert
currencies and hedge themselves against future fluctuations. Initially, they were not interested in
foreign exchange trading, but the trend of companies going international and tight competition
amongst them made them think twice
Individuals / Retail Forex Brokers
Individual traders or investors trade Forex on their own capital in order to profit from speculation
on future exchange rates .They mainly operate through Forex platforms that offer tight spreads,
immediate execution and highly leveraged margin accounts. These can be individuals or groups
of individuals. They handle a fraction of the total volume of the entire forex market, but do not
let that fool you. A single retail forex broker estimate retail volume of between 25 to 50 billion
dollars each day. Their volume is estimated to make up 2% of the total market volume.
33

 Speculators
A person, who trades in currencies with a higher than average risk in return for higher than
average profit potential. These are the individuals or private investors who purchase and sell
foreign currencies and profit through fluctuations on their price. Speculators are a "hardy" bunch
simply because they are more adept at handling and maybe even sidestepping risks that
regular investors would prefer not to be involved with. Speculators take large risks, especially
with respect to anticipating future price movements, in the hope of making quick large gains.
Speculators are risk-taking investors with expertise in the market(s) in which they are trading and
will usually use highly leveraged investments such as futures and options.

Trading characteristics
Most traded currencies by value
Currency distribution of global foreign exchange market
turnover

Ran
k

ISO
Currency

4217 code
(symbol)

United States
dollar

% daily
share
(April
2013)

USD ($)

87.0%

Euro

EUR ()

33.4%

Japanese yen

JPY ()

23.0%

GBP ()

11.8%

Pound
sterling

34

Australian
dollar

Swiss franc

Canadian
dollar

AUD ($)

8.6%

CHF (Fr)

5.2%

CAD ($)

4.6%

Mexican peso

MXN ($)

2.5%

Chinese yuan

CNY ()

2.2%

NZD ($)

2.0%

SEK (kr)

1.8%

RUB ()

1.6%

HKD ($)

1.4%

NOK (kr)

1.4%

SGD ($)

1.4%

TRY ()

1.3%

10

11

12

13

14

15

16

New Zealand
dollar

Swedish
krona

Russian ruble

Hong Kong
dollar

Norwegian
krone

Singapore
dollar

Turkish lira

35

17

18

South Korean
won

South African
rand

KRW ()

1.2%

ZAR (R)

1.1%

19

Brazilian real

BRL (R$)

1.1%

20

Indian rupee

INR ()

1.0%

Other

6.3%

Total

200%

FOREIGN EXCHANGE RISK

36

Foreign exchange risk (also known as exchange rate risk or currency risk) is a financial risk
posed by an exposure to unanticipated changes in the exchange rate between two currencies.
Investors and multinational businesses exporting or importing goods and services or making
foreign investments throughout the global economy are faced with an exchange rate risk which
can have severe financial consequences if not managed appropriately. Many businesses were
unconcerned with and did not manage foreign exchange risk under the Bretton Woods system of
international monetary order. It wasn't until the onset of floating exchange rates following the
collapse of the Bretton Woods system that firms perceived an increasing risk from exchange rate
fluctuations and began trading an increasing volume of financial derivatives in an effort to hedge
their exposure. The outbreak of currency crises in the 1990s and early 2000s, such as the
Mexican peso crisis, Asian currency crisis, 1998 Russian financial crisis, and the Argentine peso
crisis, substantial losses from foreign exchange have led firms to pay closer attention to foreign
exchange risk.
MANAGEMENT
Managers of multinational firms employ a number of foreign exchange hedging strategies in
order to protect against exchange rate risk. Transaction exposure is often managed either with the
use of the money markets, foreign exchange derivatives such as forward contracts, futures
contracts, options, and swaps, or with operational techniques such as currency invoicing, leading
and lagging of receipts and payments, and exposure netting.
Firms may exercise alternative strategies to financial hedging for managing their economic or
operating exposure, by carefully selecting production sites with a mind for lowering costs, using
a policy of flexible sourcing in its supply chain management, diversifying its export market
across a greater number of countries, or by implementing strong research and development
activities and differentiating its products in pursuit of greater inelasticity and less foreign
exchange risk exposure.
Translation exposure is largely dependent on the accounting standards of the home country and
the translation methods required by those standards. For example, the United States Federal
Accounting Standards Board specifies when and where to use certain methods such as the
temporal method and current rate method. Firms can manage translation exposure by performing
37

a balance sheet hedge. Since translation exposure arises from discrepancies between net assets
and net liabilities on a balance sheet solely from exchange rate differences. Following this logic,
a firm could acquire an appropriate amount of exposed assets or liabilities to balance any
outstanding discrepancy. Foreign exchange derivatives may also be used to hedge against
translation exposure.
MEASUREMENT
If foreign exchange markets are efficient such that purchasing power parity, interest rate parity,
and the international Fisher effect hold true, a firm or investor needn't protect against foreign
exchange risk due to an indifference toward international investment decisions. A deviation from
one or more of the three international parity conditions generally needs to occur for an exposure
to foreign exchange risk.
Financial risk is most commonly measured in terms of the variance or standard deviation of a
variable such as percentage returns or rates of change. In foreign exchange, a relevant factor
would be the rate of change of the spot exchange rate between currencies. Variance represents
exchange rate risk by the spread of exchange rates, whereas standard deviation represents
exchange rate risk by the amount exchange rates deviate, on average, from the mean exchange
rate in a probability distribution. A higher standard deviation would signal a greater currency
risk. Economists have criticized the accuracy of standard deviation as a risk indicator for its
uniform treatment of deviations, be they positive or negative, and for automatically squaring
deviation values. Alternatives such as average absolute deviation and semi-variance have been
advanced for measuring financial risk.
VALUE AT RISK
Practitioners have advanced and regulators have accepted a financial risk management technique
called value at risk (VAR), which examines the tail end of a distribution of returns for changes in
exchange rates to highlight the outcomes with the worst returns. Banks in Europe have been
authorized by the Bank for International Settlements to employ VAR models of their own design
in establishing capital requirements for given levels of market risk. Using the VAR model helps

38

risk managers determine the amount that could be lost on an investment portfolio over a certain
period of time with a given probability of changes in exchange rates.

TYPES OF FOREIGN EXCHANGE RISK

Transaction Exposure
A firm has transaction exposure whenever it has contractual cash flows (receivables and
payables) whose values are subject to unanticipated changes in exchange rates due to a contract
being denominated in a foreign currency. To realize the domestic value of its foreigndenominated cash flows, the firm must exchange foreign currency for domestic currency. As
firms negotiate contracts with set prices and delivery dates in the face of a volatile foreign
exchange market with exchange rates constantly fluctuating, the firms face a risk of changes in
the exchange rate between the foreign and domestic currency. It refers to the risk associated with
the change in the exchange rate between the time an enterprise initiates a transaction and settles
it.
Economic Exposure
A firm has economic exposure (also known as operating exposure) to the degree that its market
value is influenced by unexpected exchange rate fluctuations. Such exchange rate adjustments
can severely affect the firm's market share position with regards to its competitors, the firm's
future cash flows, and ultimately the firm's value. Economic exposure can affect the present
value of future cash flows. Any transaction that exposes the firm to foreign exchange risk also
exposes the firm economically, but economic exposure can be caused by other business activities
Translation Exposure
A firm's translation exposure is the extent to which its financial reporting is affected by exchange
rate movements. As all firms generally must prepare consolidated financial statements for
reporting purposes, the consolidation process for multinationals entails translating foreign assets
and liabilities or the financial statements of foreign subsidiary subsidiaries from foreign to
domestic currency. While translation exposure may not affect a firm's cash flows, it could have a
significant impact on a firm's reported earnings and therefore its stock price. Translation

39

exposure is distinguished from transaction risk as a result of income and losses from various
types of risk having different accounting treatments.
Contingent exposure
A firm has contingent exposure when bidding for foreign projects or negotiating other contracts
or foreign direct investments. Such an exposure arises from the potential for a firm to suddenly
face a transactional or economic foreign exchange risk, contingent on the outcome of some
contract or negotiation. For example, a firm could be waiting for a project bid to be accepted by a
foreign business or government that if accepted would result in an immediate receivable. While
waiting, the firm faces a contingent exposure from the uncertainty as to whether or not that
receivable will happen. If the bid is accepted and a receivable is paid the firm then faces a
transaction exposure, so a firm may prefer to manage contingent exposures.

Foreign Exchange Market In India

Learning Objectives:
40

 Forex market in India

Forex market in India: A historical perspective
Forex Exchange Turnover
Pre-liberalization exchange rate regime in India and Hawala market
Brief introduction to currency convertibility in current & capital account.

Forex market in India

The foreign exchange market India is growing very rapidly. The annual turnover of the market is
more than $400 billion. This transaction does not include the inter-bank transactions. According
to the record of transactions released by RBI, the average monthly turnover in the merchant
segment was $40.5 billion in 2003-04 and the inter-bank transaction was $134.2 for the same
period.
The foreign exchange market India is growing very rapidly. The annual turnover of the market is
more than $400 billion. This transaction does not include the inter-bank transactions. According
to the record of transactions released by RBI, the average monthly turnover in the merchant
segment was $40.5 billion in 2003-04 and the inter-bank transaction was $134.2 for the same
period.
The average total monthly turnover was about $174.7 billion for the same period. The
transactions are made on spot and also on forward basis, which include currency swaps and
interest rate swaps.
The Indian foreign exchange market consists of the buyers, sellers ,market intermediaries and the
monetary authority of India. The main center of foreign exchange transactions in India is
Mumbai, the commercial capital of the country. There are several other centers for foreign
exchange transactions in the country including Kolkata, New Delhi, Chennai, Bangalore,
Pondicherry and Cochin.

41

The foreign exchange market India is regulated by the reserve bank of India through the
Exchange Control Department. At the same time, Foreign Exchange Dealers
Association(voluntary association) also provides some help in regulating the market. The
Authorized Dealers (Authorized by the RBI) and the accredited brokers are eligible to participate
in the foreign Exchange market in India. When the foreign exchange trade is going on between
Authorized Dealers and RBI or between the Authorized Dealers and the Overseas banks, the
brokers have no role to play.
Apart from the Authorized Dealers and brokers, there are some others who are provided with
there stricted rights to accept the foreign currency or travelers cheque. Among these, there are the
authorized money changers, travel agents, certain hotels and government shops. The IDBI and
Exim bank are also permitted conditionally to hold foreign currency.
The whole foreign exchange market in India is regulated by the Foreign Exchange Management
Act, 1999 or FEMA. Before this act was introduced, the market was regulated by the FERA or
Foreign Exchange Regulation Act ,1947. After independence, FERA was introduced as a
temporary measure to regulate the inflow of the foreign capital. But with the economic and
industrial development, the need for conservation of foreign currency was felt and on there
commendation of the Public Accounts Committee, the Indian government passed the Foreign
Exchange Regulation Act,1973 and gradually, this act became famous as FEMA.

Forex market in India: A historical perspective

Indian forex market since independence can be grouped in three distinct phases.
1947 to1977: During 1947 to 1971, India exchange rate system followed the par value system.
RBI fixed rupees external par value at 4.15 grains of fine gold. 15.432grains of gold is
equivalent to 1 gram of gold. RBI allowed the par value to fluctuate within the permitted margin
of 1 percent. With the breakdown of the Bretton Woods System in 1971 and the floatation of
major currencies, the rupee was linked with Pound-Sterling. Since Pound-Sterling was fixed in
terms of US dollar under the Smithsonian Agreement of 1971, the rupee also remained stable
against dollar.
1978-1992: During this period, exchange rate of the rupee was officially determined in terms of
a weighted basket of currencies of Indias major trading partners. During this period, RBI set the
42

rate by daily announcing the buying and selling rates to authorized dealers. In other words, RBI
instructed authorized dealers to buy and sell foreign currency at the rate given by the RBI on
daily basis. Hence exchange rate fluctuated but within a certain range. RBI managed the
exchange rate in such a manner so that it primarily facilitates imports to India. As mentioned in
Section 5.1, the FERA Act was part of the exchange rate regulation practices followed by RBI.
Kharagpur Indias perennial trade deficit widened during this period. By the beginning of 1991,
Indian foreign exchange reserve had dwindled down to such a level that it could barely be
sufficient for three-weeks worth of imports. During June 1991, India airlifted 67 tonnes of gold,
pledged these with Union Bank of Switzerland and Bank of England, and raised US$ 605
millions to shore up its precarious forex reserve. At the height of the crisis, between 2nd and 4th
June 1991, rupee was officially devalued by 19.5% from 20.5 to 24.5 to 1 US$. This crisis paved
the path to the famed liberalization program of government of India to make rules and
regulations pertaining to foreign trade, investment, public finance and exchange rate
encompassing a broad gamut of economic activities more market oriented.
1992 onwards: 1992 marked a watershed in Indias economic condition. During this period, it
was felt that India needs to have an integrated policy combining various aspects of trade,
industry, foreign investment, exchange rate, public finance and the financial sector to create a
market-oriented environment. Many policy changes were brought in covering different aspects
of import-export, FDI, Foreign Portfolio Investment etc.
One important policy changes pertinent to Indias forex exchange system was brought in rupees
was made convertible in current account. This paved to the path of foreign exchange
payments/receipts to be converted at market-determined exchange rate. However, it is
worthwhile to mention here that changes brought in by government of India to make the
exchange rate market oriented have not happened in one big bang. This process has been gradual.

Forex Exchange Turnover

According to the RBI report (September 2009) by Goyal, Nair & Samataray titled Monetary
Policy, Forex Markets, and Feedback under Uncertainty in an Opening Economy,
The extract from the report highlights the foreign exchange turnover in India
Indian FX market has grown many times over the last several years. The average daily
turnover, which was in the vicinity of US $ 3.0 billion in 1998-99 grew to US $ 18 billion during
43

2005-06. The turnover rose considerably to US $ 48 billion during 2007-08 with the monthly
turnover crossing US $ 65 billion in February 2007.
The inter-bank to merchant turnover ratio halved from 5.2 during 1997-98 to 2.3 during 2007-08
reflecting the growing participation in the merchant segment of the foreign exchange market.
The spot market remains the most important FX market segment accounting for 51 per cent of
the total turnover. Its share has declined marginally in recent years due to a pick up in the
turnover in derivative segment. Even so, Indian derivative trading remains a small fraction of
that in other developing countries such as Mexico or South Korea. Short-term instruments with
maturities of less than one year dominate, and activity is concentrated among a few banks (IMF
2008).

Pre-Liberalization exchange rate regime in India and

Hawala Market:
At this juncture, it is pertinent to discuss Hawala market operating in India before
liberalization. Before 1992, RBI was strictly controlling the exchange rate. This created a
parallel foreign exchange market a black market in foreign exchange popularly known as
Hawala Market. At this juncture, it is pertinent to discuss Hawala market operating in India
before liberalization. Before 1992, RBI was strictly controlling the exchange rate. This created a
parallel foreign exchange market a black market in foreign exchange popularly known as
Hawala Market. Hawala market is nothing but illegal foreign exchange market where forex
trading happen at rates different than the rate mandated by the RBI. When the official rate
overvalues the home currency, Hawala market starts operating. Hawala market is nothing but
illegal foreign exchange market where forex trading happen at rates different than the rate
mandated by the RBI. When the official rate overvalues the home currency, Hawala market
starts operating.

Example of a Hawala Transaction: a NRI working in USA wants to send

20,000 US$ to his family member. If he send this money through bank, he receives rupees at
prevailing exchange rate of INR 35/US$. But in the black market, the exchange rate is INR
40/US$. Example of a Hawala Transaction: a NRI working in USA wants to send 20,000 US$ to
his family member. If he send this money through bank, he receives rupees at prevailing
exchange rate of INR 35/US$. But in the black market, the exchange rate is INR 40/US$. In
other words, RBI puts a value of INR.35 per US$ , when it should have been Rs.40/US$. Hence
44

INR is overvalued at the official rate. The NRI contacts a hawala operator in USA and gives
$20,000 to him. The USA hawala operators counterparty in India, pays Rs. 40/US$ to the family
members of NRI here in India. The transaction between hawala dealer in USA and his
counterparty India are done through smugglers.
During the heyday of hawala transactions in 1990s, it was a common knowledge that exporters
under invoice their export earnings and importers over invoice their imports goods ( so as to
increase the cost of import denominated in foreign currency) and the differences are kept abroad
and later repatriated back through Hawala route.
Even after 17 years of liberalization and even though exchange rate is market determined by
supply & demand forces, Hawala market still operates, though at a smaller scale. According to a
news report in Hindu ( March 2005), many people working in the Gulf countries opt for the
`pipe' or Hawala transactions for obvious reasons of convenience and speedy transactions. No
bank can beat these operators in delivering the money so fast, and that too at the receiver's
doorstep!

Convertibility in current account

Convertibility in current account means that individuals and companies have the freedom to buy
or sell foreign currency on specific activities like foreign travel, medical expenses, college fees,
as well as for payment/receipt related to export-import, interest payment/receipt, investment in
foreign securities, business expenses etc. An related concept to this is the convertibility in
capital account. Convertibility in capital account indicates that Indian people and business
houses can freely convert rupee to any other currency to any extent and can invest in foreign
assets like shares, real estate in foreign countries. Most importantly Indian banks can accept
deposit in any currency.
Even though the exchange rate has been market determined, from time to time RBI intervenes in
spot and forward market, if it feels exchange rate has deviated too much.

ANALYSIS OF THE DATA & INTERPRETATION

1. The following table shows the frequency of customers visiting
45

Thomas cook gender-wise.

Table 1
Gender

Frequency

Male

72

Female

28

Total

100
GENDER

28%
Male

Female

72%

INFERENCE:
72% are the male respondents using the Thomas cook forex service 28% are the female
respondents using the Thomas cook forex service.
2. The following table shows the foreign exchange transactions.
46

Transaction

Frequency

Buying
Selling
Total

69
31
100

INFERENCE:
69% of the respondents visits the Thomas cook to buy the foreign exchange and 31% of the
respondents visits the Thomas cook to sell the foreign exchange.

3. The following table shows the foreign exchange service customer wants.

Foreign exchange service

Frequency

Foreign currency
Wire transfer
Foreign currency demand draft
Travellers cheque
Total

70
5
11
14
100

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Foreign exchange service customer want

14%
11%
foreign currency 5%
w ire transfer of money

foreign currencydemand draft

traveller's cheque

70%

INFERENCE:
70% of the respondents visits the Thomas cook for the foreign currency, 5% of the respondents
visits the Thomas cook to use wire transfer service, 11% of the respondents visits the Thomas
cook for making foreign currency demand draft and 14% of the respondents visits Thomas cook
for travellers cheque.

4. The following table shows the customers satisfaction level with the foreign exchange rates.

Foreign exchange rates

Frequency

Highly satisfied
Satisfied
Moderately satisfied
Dissatisfied
Highly dissatisfied
Total

12
38
29
13
8
100
48

Foreign exchange rates

8%

13%
highly satisfied

satisfied

12%

moderately satisfied

29%

dissatisfied

38%

highly dissatisfied

INFERENCE:
12% of the respondents are highly satisfied with the foreign exchange rates provided by the
Thomas cook, 38% of the respondents are satisfied, 29% of the respondents are moderately
satisfied, 13% of the respondents are dissatisfied and only 8% of the respondents are highly
disatisfied with the foreign exchange rates provided by Thomas cook.

5. The following table shows the customers satisfaction level with the accessibility of the branch
visited.
Accessibility of the branch visited
Highly satisfied
Satisfied
Moderately satisfied
Dissatisfied

Frequency
19
28
41
3
49

Highly dissatisfied
Total

9
100

Accessibility of the branch visited

3%
highly satisfied

satisfied

9%

moderately satisfied

41%

19%
dissatisfied

higly dissatisfied

28%

INFERENCE:
19% of the respondents are highly satisfied with the accessibility of the branch visited,28% of
the respondents are satisfied, 41% of the respondents are moderately satisfied, 3% of the
respondents are dissatisfied and 9% of the respondents are highly dissatisfied with the
accessibility of the branch visited.

6. The following table shows the customers satisfaction level with the signages to identify the
branch.

Signages

Frequency

Highly satisfied
Satisfied
Moderately satisfied

16
22
51
50

Dissatisfied
Highly dissatisfied
Total

5
6
100

INFERENCE:
16% of the respondents are highly satisfied with the signages to identify the branch, 22% of the
respondents are satisfied, 51% of the respondents are moderately satisfied, 5% of the respondents
are dissatisfied and 6% of the respondents are highly dissatisfied with the signages to identify
the branch.
7. The following table shows the customers satisfaction level with the staff greeting and friendly
welcome.

Staff greeting

Frequency

Highly satisfied
Satisfied
Moderately satisfied
Dissatisfied
Highly dissatisfied
Total

48
32
12
8
0
100

51

INFERENCE:
48% of the respondents are highly satisfied with the staff greeting and welcome,32% of the
respondents are satisfied, 12% of the respondents are moderately satisfied, 8% of the respondents
are dissatisfied, and not even the single respondent is highly dissatisfied with the staff greeting
and welcome.
8. The following table shows the customers satisfaction with the staffs ability of understanding
their requirement.
Staffs understanding of customer

Frequency

requirement
Highly satisfied
Satisfied
Moderately satisfied
Dissatisfied
Highly dissatisfied
Total

13
25
47
8
7
100

INFERENCE:
13% of the respondents are highly satisfied with the staffs ability to understanding their
requirement,25% of the respondents are satisfied, 47% of the respondents are moderately
satisfied, 8% of the respondents are dissatisfied and 7% of the respondents are highly dissatisfied
with the staffs ability to understanding their requirement.
9. The following table shows the customers satisfaction with the staff grooming.
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Staff grooming

Frequency

Highly satisfied
Satisfied
Moderately satisfied
Dissatisfied
Highly dissatisfied
Total

41
28
11
20
0
100

INFERENCE:
41% of the respondents are highly satisfied with the staffs grooming ,28% of the respondents
are satisfied, 11% of the respondents are moderately satisfied, 20% of the respondents are
dissatisfied and not even the single respondents is highly dissatisfied with the staffs grooming.

10. The following table shows the customers satisfaction with the accuracy in documentation.

Accuracy in documentation

Frequency

Highly satisfied
Satisfied
Moderately satisfied
Dissatisfied
Highly dissatisfied
Total

24
32
23
21
0
100

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INFERENCE:
24% of the respondents are highly satisfied with the accuracy in documentation,32% of the
respondents are satisfied, 23% of the respondents are moderately satisfied, 21% of the
respondents are dissatisfied and not even the single respondents is highly dissatisfied with the
accuracy in documentation.
11. The following table shows the customers satisfaction with the clarification given to their
queries.

Clarification for the queries

Frequency

Highly satisfied
Satisfied
Moderately satisfied
Dissatisfied
Highly dissatisfied
Total

21
33
35
10
1
100

INFERENCE:
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21% of the respondents are highly satisfied with the clarifications given to their queries,33% of
the respondents are satisfied,35% of the respondents are moderately satisfied, 10% of the
respondents are dissatisfied, and only 1% of the respondents is highly dissatisfied with the
clarification given to their queries.
12. The following table shows the customers satisfaction with the time taken by the staff to
complete their requirement.
Time taken to complete the requirement
Highly satisfied
Satisfied
Moderately satisfied
Dissatisfied
Highly dissatisfied
Total

Frequency
27
37
23
13
0
100

INFERENCE:
27% of the respondents are highly satisfied with the time taken by the staff to complete their
requirement, 37% of the respondents are satisfied, 23% of the respondents are moderately
satisfied, 13% of the respondents are dissatisfied and not even the single respondent is highly
dissatisfied with the time ta ken by the staff to complete their requirement.

13. The following table shows the customers satisfaction with the operating hours of Thomas
cook.
55

Operating hours

Frequency

Highly satisfied
Satisfied
Moderately satisfied
Dissatisfied
Highly dissatisfied
Total

32
20
22
18
8
100

INFERENCE:
32% of the respondents are highly satisfied with the operating hours of Thomas cook, 20% of the
respondents are satisfied, 22% of the respondents are moderately satisfied, 18% of the
respondents are dissatisfied, and 8% of the respondents are highly dissatisfied with the operating
hours of Thomas cook.

14. The following table shows the customers satisfaction with the updates given to them
regarding various new service.

56

Updates regarding new services

Frequency

Highly satisfied
Satisfied
Moderately satisfied
Dissatisfied
Highly dissatisfied
Total

10
18
36
33
3
100

INFERENCE:
10% of the respondents are highly satisfied with the updates given to them regarding various
new services, 18% of the respondents are satisfied, 36% of the respondents are moderately
satisfied, 33% of the respondents are dissatisfied and 3% of the respondents are highly
dissatisfied with the updates given to them regarding various new services.

TREND, ANALYSIS AND TIMING

57

Markets don't move straight up and down. The direction of any market at any time is either
Bullish (Up), Bearish (Down), or Neutral (Sideways). Within those trends, markets have
countertrend (backing & filling) movements. In a general sense "Markets move in waves", and
in order to make money a trader must catch the wave at the right time.

58

59

FINDINGS
It was found that most of the customers of thomas cook are male as they

constitute

72% of the respondents.

It was found that out of 100 samples taken for the study 69% of the customers come
to Thomas cook for buying the foreign exchange , and only 31% of the customers
come for selling of foreign exchange.
It was found that majority of the customers comes to thomas cook for purchasing or
selling of foreign currency, which comprises of 70% of the customers of Thomas
cook.
It was found out that most of the customers are satisfied with the foreign exchange
rates, and 8% of the customers are highly dissatisfied with the foreign exchange rates.
It was found out that most of the customers are moderately satisfied with the
accessibility of the branch visited.
It was found that most of the customers are moderately satisfied with the signages to
identify the branch which comprises of 51% and 16% of the customers are highly
satisfied with signages to identify the branch.
It was found that most of the customers are highly satisfied with the thomas cooks
staff greeting and friendly welcome.
It was found that most of the customer are only moderately satisfied (47%)with the
staffs ability of understanding their requirement.
It was found out that most of the customers are highly satisfied with the staff
grooming(41%) and no customer is highly dissatisfied with the staff grooming.
It was found out that most of the customers are satisfied(32%) with the accuracy in
documentation and no customer is highly dissatisfied with the documentation.
It was found out that most of the customers are moderately satisfied(35%) with the
clarifications given to their queries. and only 1% of the customers highly dissatisfied.

It was found out that most of the customers are satisfied (37%)with the time by the
staff to complete their requirement.
60

 It was found out that most of the customers are highly satisfied(32%) with the
operating hours of thomas cook.
It was found out that most of the customers are moderately satisfied(36%) with the
updates given to them regarding various new services.

CONCLUSION
61

The foreign monetary exchange market is the biggest financial market in the world. Bigger than
the New York Stock Exchange and Futures Market combined. And with reduced "buy-in" limits
now, even small-time players can join the Forex trading marketplace. That doesn't mean
everyone should join, however. Buying an auto-trading program sold to you with the promise of
making you millions probably won't. In fact, it may cost you everything you own. The only way
to win in Forex trading is the good, old-fashioned way - hard work and a solid understanding of
the market.
One has to be clued in to global developments, trends in world trade as well as
economic indicators of different countries. These include GDP growth, fiscal and monetary
policies, inflows and outflows of the currency, local stock market performance and interest rates.
The currency derivatives market is highly leveraged. In the stock futures market, a 20% margin
gains a five-fold leverage. In forex futures, the margin payable is just 3%, so the leverage is 33
times. This means that even a 1% change can wipe out a third of the investment. However, the
Indian currency markets are well-regulated and there is almost no counter-party risk. Investors
should start small and gradually invest more.
Liberalization has transformed Indias external sector and a direct beneficiary of this has been the
foreign exchange market in India. From a foreign exchange-starved, control-ridden economy,
India has moved on to a position of $150 billion plus in international reserves with a confident
rupee and drastically reduced foreign exchange control. As foreign trade and cross-border capital
flows continue to grow, and the country moves towards capital account convertibility, the foreign
exchange market is poised to play an even greater role in the economy, but is unlikely to be
completely free of RBI interventions any time soon.

WEBLIOGRAPHY
http://www.slashdocs.com/kvuttx/fem.html
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http://www.travelspk.com/forex/Forex-Development-History.htm
http://www.global-view.com/forex-education/forexlearning/gftfxhist.html
http://en.wikipedia.org/wiki/Foreign_exchange_risk

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