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CAIIB-BFM-MOD-A-EXCHANGE RATES AND FOREX BUSINESS-Cont'd

EXCHANGE RATES AND FOREX BUSINESS

22. In a perfect market, with no restriction on finance and trade, the interest factor is the basic factor in arriving at the forward rate.

23. The Forward price of a currency against another can be worked out with the following factors:

# Spot price of the currencies involved
# The Interest rate differentials for the currencies.
# The term i.e. the future period for which the price is worked out.

24. The price of currency can be expressed in two ways i.e. Direct Quote, Indirect Quote.

25. Under Direct Quote, the local currency is variable E.g.: 1 USD = `48.10

26. Direct Quote rates are also called Home Currency or Price Quotations.

27. Under indirect Quote, the local currency remains fixed, while the number of units of foreign currency varies. E.g. `100 = 2.05 USD

28. Globally all currencies (Except a few) are quoted as Direct Quotes, in terms of USD = So many units of another currency)

29. Only in case of GBP (Great Britain Pound) £, €, AU$ and NZ$, the currencies are quoted as indirect rates.

30. Japanese Yen being quoted per 100 Units.

31. Cross Currency Rates: When dealing in a market where rates for a particular currency pair are not directly available, the price for the said currency pair is then obtained indirectly with the help of Cross rate mechanism.

32. How to calculate Cross Rate?:
The math is simple algebra: [a/b] x [b/c] = a/c
Substitute currency pairs for the fractions shown above, and you get, for instance,
GBP/AUD x AUD/JPY = GBP/JPY.
This is the implied (or theoretical) value of the GBP/JPY, based on the value of the other two pairs. The actual value of the GBP/JPY will vary around this implied value,as the following calculation shows.

Here are Friday's actual closing BID prices for the 3 currency pairs in this example (taken from FXCM's Trading Station platform): GBP/AUD = 1.73449, AUD/JPY = 0.85535 and GBP/JPY = 1.48417.
Now, let's do the math:
GBP/AUD x AUD/JPY = GBP/JPY
1.73449 x 0.85535 = 1.4836, which is not exactly the same as the actual market price
Here's why. During market hours (Sunday afternoon to Friday afternoon, EST), all prices are LIVE, and small departures from the mathematical relationships can exist momentarily.


33. Fixed Vs Floating Rates:
# The fixed exchange rate is the official rate set by the monetary authorities
for one or more currencies. It is usually pegged to one or more currencies.
# Under floating exchange rate, the value of the currency is decided by supply and demand factors for a particular currency.

34. Since 1973, the world economies have adopted floating exchange rate system.

35. India switched to a floating exchange rate regime in 1993.

36. Bid & Offered Rates: The buying rates and selling rates are referred to as Bid & Offered rate.
37. Exchange Arithmetic – Theoretical Overview:
# Chain Rule: It is used in attaining a comparison or ratio between two quantities linked together through another or other quantities and consists of a series of equations.
# Per Cent or Per mille: A percentage (%) is a proportion per hundred. Per Mille means per thousand.

38. Value Date: The date on which a payment of funds or an entry to an account becomes actually effective and/or subjected to interest, if any. In the case of TT, the value date is usually the same in both centers.

39. The payments made in same day, so that no gain or loss of interest accrues to either party is called as Valuer Compense, or simply here and there.

40. Arbitrage in Exchange: Arbitrage consist in the simultaneous buying and selling of a commodity in two or more markets to take advantage of temporary discrepancies in prices.

41. A transaction conducted between two centers only is known as simple or direct arbitrage.

42. Where additional centers are involved, the operation is known as compound or Three (or more) point arbitrage.

43. Forex Operations are divided into 3:
1) Forex Dealer
2) Back Office
3) Mid Office

44. The Forex dealing room operation functions:
# a service branch to meet the requirement of customers of other branches/divisions to buy or sell foreign currency,
# Manage foreign currency assets and liabilities,
# Fund and manger Nostro Accounts as also undertake proprietary trading in currencies.
# It is a separate profit center for the Bank/FI

45. A Forex Dealer has to maintain two positions – Funds position and Currency Position

46. Funds position reflects the inflow and out flow of funds.


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