INTRODUCTION

What is Foreign Exchange?

Exchange of two different currency

As of August 30, 2024, India's forex reserves stood at $6,83,987

million, according to the Reserve Bank of India.
 The rate at which one currency is valued in terms of another
Currency is the rate of exchange between the currency concerned.
 ➢Purpose
Consolidating and amending the law relating
to Foreign Exchange with the objective of
facilitating external trade and payments and
Foreign for promoting the orderly development and
maintenance of foreign exchange market in
Exchange India.
Management ➢For the implementation of various provisions
Act, 1999 of FEMA the Central Government have issued
notifications notifying various rules formed
under the Act.
➢The Reserve Bank of India also issued several
regulations relating to FEMA.
Administrative
Set-up
 Central Government: Make rules to carry out the provisions of the
ACT.

Reserve Bank of India: Make regulations to carry out the

Administrative provisions of the Act and the rules made thereunder.
Set-up
Central Government empowers to give to RBI such directions as
it thinks fit. and RBI shall comply with such directions.

RBI has the powers as well as the responsibility to administer

foreign exchange in India.
 • RBI athorise any person to be known as authorised person to
Authorised deal in foreign exchange or in foreign securities as an
Persons authorised dealer, money changer or offshore banking unit in
any other manner as it deems fit.
• An authorised person should comply with the general or special
directions or orders of the Reserve Bank in all his foreign
exchange dealings.
• Before undertaking any transaction in foreign exchange he
should obtain from his customer such direction and information
as to ensure that the provision of the Act are not violated.
• In case of any discrepancies, he can deny to undertake the
transaction and in the matter of evasion or contravention of the
regulation he can report the matter to Reserve Bank of India.
Authorised Dealers
• Authorised dealers are the banks, financial institutions and other institutions authorised
by the RBI to deal in foreign exchange.
• They need to comply the instructions and directions of RBI in India.
• FEMA requires the resident in India who receives foreign exchange to surrender it to an
authorised dealer
i. Within 7 days of receipt in case of receipt by way of remuneration, settlement of
lawful obligation, income on asset held abroad, inheritance, settlement or gift.
ii. Within 90 days in all other cases.
• Any person hey who required foreign exchange
but could not use it for the purpose or for any
other permitted purpose is required to
surrender the unutilised foreign exchange to an
authorised dealer within 60 days from the date
of acquisition.
• In case of foreign exchange acquired for travel
abroad, the unspent foreign exchange should
be surrender within 90 days from the date of
return to India when the foreign exchange he is
in the form of foreign currency notes and coins
and within 180 days in case of travellers check
cheque.
• If a resident required for an exchange for an
approved purpose he should obtain from an
authorised dealer.
Authorised Money Changers
In order to provide facilities for encashment of foreign currency to visitors from abroad, especially foreign tourists,
Reserve Bank has granted licences to certain established firms, hotels and other organisations permitting them to
deal in foreign currency notes, coins and travellers cheques subject to directions issued to them from time to
time.

These firms and organisations who are generally known as “authorised money changers” fall into two categories,
viz. “Full-fledged money changers”.

“Restricted money changers” who are authorised only to purchase foreign currency notes, coins and travellers
cheques, subject to the condition that all such collections are surrendered by them in turn to an authorised dealer
in foreign exchange/full fledged money changer.
Foreign Exchange Dealers’ Association of India
FEDAI was established in 1985 as an association of all authorized dealers in India.

It has its headquarters at Mumbai and local offices at Bangalore, Calcutta, Chennai and New Delhi.

The affairs of FEDAI are managed by a Managing Committee at the Head Office and respective Local Committees at
local offices.

The principal functions of FEDAI are:

To frame rules for the conduct of foreign exchange business in India. These rules cover various aspects like hours of
business, charges for foreign exchange transactions, quotation of rates to customers, interbank dealings, etc
Foreign Exchange Dealers’
Association of India
• To coordinate with Reserve Bank of India in proper
administration of exchange control.
• To circulate information likely to be of interest to its
members.
Commercial Banks
• Banks are major players in market for buying and selling of currencies.
• Banks transactions for clients contributes only 5%. Rest of transaction which bank carry
on in FE market aims to earn profit.
• Exchange brokers facilitate deal between banks .Dealer connect all the bank inorder to
get the best quotes from all.
• The names of the counter parities are revealed to the banks only when the deal is
acceptable to them.
• In India, banks may deal directly or through recognized exchange brokers.
• 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.
Defining The Foreign Exchange Market
The Foreign Exchange Market can be defined in terms of specific functions, or the institutional structure that:

(1) Facilitates the conversion of one country’s • Through the buying and selling of currencies.
currency into another. • Allows global firms to move in and out of foreign
currency as needed.

• This is the ratio of one currency to another.

(2) Sets and quotes exchange rates. • These rates determine costs and returns to global
businesses.

• These hedging contracts allow global firms to offset their

(3) Offers contracts to manage foreign
foreign currency exposures and manage foreign exchange
exchange exposure.
risk.
• Thus, they can concentrate on their core business.
Quick Review of Market Characteristics
The total value of the Forex is the only financial
forex industry is $2.73 market in the world to
FM is World’s largest
quadrillion, increasing operate 24 hours a day
financial market.
from $1.93 quadrillion in and comprises over 170
2019. different currencies.

Trades take place through

a network of computer
There is no central
and telephone
trading location.
connections all over the
world.
Quick Review of Market Characteristics
London is the largest
forex trading center in USD is involved in 88%
the world, accounting of all forex trades.
for 43% of all trades.

Currencies are either

The most actively
traded for immediate
traded currency pairs
delivery (spot) or some
are EUR/USD, USD/JPY,
specified future delivery
and GBP/USD.
(forward).
 Two types of Market

Exchange Over the

Traded Counter

• FM Market is market where currencies are bought and sold against one another.
• Its an OTC market.
• RBI Regulates the market and has appointed authorised dealers for exchange rate
quotations.
Features of Foreign Exchange Market
1. Location
o OTC (Over the Counter)
o No Physical place
o Informal arrangement as connected through telecommunication.
o Wholesale segment – banks to banks
o Retail segment – banks to its customers
2. Size of the Market
o Largest Financial Market in the world.
o Average daily turnover in 2022 was USD 7.5 trillion.
o The largest foreign exchange market is in London followed by New York,
Tokyo, Zurich and Frankfurt.
3. 24 – Hours Market
o Situated throughout the different time zones of the globe.
o One market is closing the other is beginning its operations.
o So, Foreign exchange market is functioning throughout 24 hours of the day.
o However, a specific market will function only during the business hours.
o Retail segment – banks to its customers
4. Efficiency
o Continuous Development
o Development in one place, adopted globally in no time.
5. Currencies Traded
Settlement of Transaction: SWIFT
• Banks use the exclusive network SWIFT to communicate messages and
settle the transactions at electronic clearing houses such as CHIPS at
New York.
• 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.
• linking effectively more than 25,000 financial institutions throughout the
world who have been allotted bank identified codes.
Settlement of Transaction: SWIFT (Contd…)
• The messages are transmitted from country to country via central
interconnected operating centres located in Brussels, Amsterdam and
Culpeper.
• The SWIFT provides following advantages for the local banking community:
• Reliable (time tested) method of sending and receiving messages
• Reliability and accuracy
• Message relay is instantaneous .
• Access is available to a vast number of banks
• structure formats for various types of banking transactions .
• 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.
• 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.
• Bank of India, maintaining a dollar account with Amex Bank, New
York, sells USD 1 million to Canara Bank, maintaining dollar account
with Citibank:
CHIPS:
• Bank of India intimate Amex Bank debit 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.
• 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.
• 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.
• Citibank which receives the credit intimates Canara Bank through SWIFT.
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.
 1. Spot Transaction (T+2)

2. Forward Transaction
Transactions in
Forex Market
3. Swap Transaction

4. Non-Deliverable Transaction
Forward Margin/Swap points :

• Forward rate may be the same as the spot rate for the currency. Then it is said to be at
par‘ with the spot rate. i.e. Forward Rate = Spot Rate
• The difference between the forward rate and the spot rate is known as the forward
margin‘ or swap points.
• If the forward margin is at premium, the foreign currency will be costlier under forward
rate than under the spot rate. i.e. Forward Rate > Spot Rate
• If the forward margin is at discount, the foreign currency will be cheaper for forward
delivery then for spot delivery. i.e. Forward Rate < Spot Rate
• Ready Transaction: Where the agreement to buy
and sell is agreed upon and executed on the
same date, the transaction is known as cash or
ready transaction. It is also known as value today.
• Spot Transaction: The transaction where the
exchange of currencies takes place two days
after the date of the contact is known as the spot
transaction.
• Forward Transaction: The transaction in which the
exchange of currencies takes places at a
specified future date, subsequent to the spot date,
is known as a forward transaction.
TRANSACTIONS IN INTERBANK MARKETS

The big banks in the market are

known as market makers, as they
are willing to buy or sell foreign Two Way Quotations :
currencies at the rates quoted by
them up to any extent.

Typically, the quotation in the

One at which it is willing to buy the
interbank market is a two – way
foreign currency, and the other at
quotation. It means the rate quoted
which it is willing to sell the foreign
by the market maker will indicate
currency.
two prices.
• A Mumbai bank may quote its rate for US dollar as under
• USD 1 = Rs 48.1525/1650
• Direct Quotation: The exchange quotation which gives the
price for the foreign currency in terms of the domestic
currency is known as direct quotation. In a direct quotation,
the quoting bank will apply the rule: ―Buy low; Sell high.
• Indirect Quotation : Rs. 100 = USD 2.0762/0767
• This type of quotation which gives the quantity of foreign
currency per unit of domestic currency is known as indirect
quotation.
• In this case, the quoting bank will receive USD 2.0767 per
Rs.100 while buying dollars and give away USD 2.0762
per Rs.100 while selling dollars.
Examples

Direct Quotes Indirect Quotes:

• 1$= Rs. 40 • Rs. 1= $0.0250
• 1£= Rs. 82 • Rs. 1= £0.0122
• 1 Euro = Rs. 54 • Rs. 1= Euro 0.0185
 Direct and Indirect quotes

Currency Rate Quote

Swiss Kroner 5.75 Rs. Per Kroner D

Euro 0.0101 euro per Re. ID

SGD 0.0388 SGD per Re. ID

UAE Dhm 12.15 Rs. Per Dhm D

Convert the following direct quotes into
indirect quotes”

1 $ = Rs. 72 Rs. 1 = $0.0139

1£= Rs. 108 Rs. 1 = £0.0093

Convert following currency in to direct or
indirect quotes

• 1 Re = 0.024 $
• 1 Re= 0.0125 Euro
• 1 $= 40 Re
Bid Rate: The buying rate of currency is known as
the bid rate.
Ask Rate: The selling rate of currency is known as
the offer‘ rate or Ask Rate.
Spread: The difference between these rates (Ask
rate – Bid Rate) is the gross profit for the bank and
is known as the Spread‘.
• Spot and Forward transactions :
The transactions in the interbank market may place
for settlement
• (a) on the same day; or
• (b) two days later; or
• (c) some day late; say after a month
American and European Quotation
• The quotation is in American quotation when the rate is expressed as
how much U.S. currency it takes to purchase one unit of foreign
currency. i.e. 1 Euro = ? Dollars
• It is in European terms when the quotation is the number of foreign
currency per unit of U.S. dollar. i.e. 1 Dollar = ? Euro
Base Base
Currency Currency

GBP/USD 1.4326/4330 USD/CHF 0.9425/9440

Quoted Quoted
Currency Currency
Direct and Indirect two-way quotes
• 1 $= Rs. 40.10/Rs. 40.15
• 1 £ = Rs. 79.95/Rs. 80.05
• Rs. 1 = $ 0.0250/0.0251
• Suppose you have Rs. 100000/ You go to bank to convert them into $. You
will be selling rupees to the bank. Bank will be buying Rupees. So the
applicable rate is $0.025. For Rs. 100000, You will get how much?
Ans.
1 Rs. = $0.0250
Rs. 1,00,000 = ? = 1,00,000 X 0.0250 = $2,500
Solution
i) The firm needs to sale the Euro to buy rupees. So Bank’s buying
Rate would be 1 Euro = Rs. 56 So, 1,12,000 Euro X Rs.56 = Rs.
62,72,000/-.
ii) The firm needs to buy yen by paying Rs. So Bank’s selling rate
would be 100 Yen = Rs. 44.10.
So, 2,00,000 X 44.10 / 100 = Rs. 88,200/-.
iii) The firm need to sale the US $ and to buy the Rs. So bank’s buying
Rate would be 1$ = Rs. 40.00 So, 3,00,000 X 40 = Rs. 1,20,00,000.
iv) The firm needs to buy the Singapore Dollars by paying Rs. So, Bank’s
Selling Rate would be 1 SGD = Rs. 25.00 So, 4,00,000 X 25 =
Rs. 1,00,00,000.
Solution
i) The firm needs to sale the Euro to buy British Pound. So Bank’s buying
Rate would be 1 Euro = £ 0.60 So, 1,20,000 Euro X £ 0.60 = £
72,000/-.
ii) The firm needs to buy yen by paying British Pound. So Bank’s selling rate
would be 1 Yen = £ 0.0050
So, 2,00,000 X 0.0050 = £ 1,000/-.
iii) The firm need to sale the US $ and to buy the British Pound. So bank’s
buying Rate would be 1$ = £ 0.50 So, 3,00,000 X 0.50 = £ 1,50,000.
iv) The firm needs to buy the Singapore Dollars by paying the British Pound.
So, Bank’s Selling Rate would be 1 SGD = £ 0.40 So, 4,00,000 X 0.40 =
£ 1,60,000.
Interpretation of Interbank quotations
• The market quotation for a currency consists of the spot rate and the
forward margin. The outright forward rate has to be calculated by
loading the forward margin into the spot rate.
• For instance, US dollar is quoted as under in the interbank market on
25th January as under:
• Spot USD 1 = Rs.48.4000/4200
• Spot/February 2000/2100
• Spot/March 3500/3600
• Spot April 4100/3900
• If the forward currency is at discount, it would be indicated by quoting
the forward margin in the descending order. Suppose that on 20th
April, the quotation for pound sterling in the interbank market is as
follows:
• Spot GBR 1 = Rs. 73.4000/4300
• Spot/May 3800/3600
• Spot/June 5700/5400
• Since the forward margin is in descending order (3800/3600), forward
sterling is at discount. The outright forward rates are calculated by
deducting the related discount from the spot rate. Thus is shown below:
Factors Determining Spot Exchange Rate
• Balance of Payment: Export from the country creates demand for the
currency of the country in the foreign exchange market. The exporters
would offer to the market the foreign currencies they have acquired
and demand in exchange the local currency. Conversely, imports into
the country will increase the supply of the currency of the country in
the foreign exchange market.
• Inflation: Inflation in the country would increase the domestic prices
of the commodities. With increase in prices exports may dwindle
because the price may not be competitive. With the decrease in
exports the demand for the currency would also decline; this in turn
would result in the decline of external value of the currency.
Continue…
• Interest rate: The interest rate has a great influence on the short – term
movement of capital. When the interest rate at a centre rises, it
attracts short term funds from other centers. This would increase the
demand for the currency at the centre and hence its value. Rising of
interest rate may be adopted by a country due to tight money
conditions or as a deliberate attempt to attract foreign investment.
• Money Supply :An increase in money supply in the country relative to
its demand will lead to large scale spending on foreign goods and
purchase of foreign investments. Thus the supply of the currency in the
foreign exchange markets is increased and its value declines. The
downward pressure on the external value of the currency then
increases the cost of imports and so adds to inflation.
Continue…
• Political factors Political stability induced confidence in the investors
and encourages capital inflow into the country. This has the effect of
strengthening the currency of the country. On the other hand, where the
political situation in the country is unstable, it makes the investors
withdraw their investments. The outflow of capital from the country
would weaken the currency.
End of Module – 1
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