Tarheel Consultancy
Services
Bangalore, Karnataka
1
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Understanding Exchange Rates and Foreign Currency Transactions, Study notes of Finance
An introduction to exchange rates, the key players in the foreign exchange market, and the conventions and procedures involved in transnational deals. It covers the basics of exchange rates, their impact on international transactions, and the role of central banks and commercial banks in the market.
What you will learn
- Who are the key players in the foreign exchange market?
- How do commercial banks facilitate the flow of funds across borders?
- What are the different types of exchange rate quotes and how do they differ?
- What is an exchange rate and how does it impact international transactions?
- What is the role of central banks in the foreign exchange market?
Typology: Study notes
2019/2020
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Tarheel Consultancy
Services
Bangalore, Karnataka
Foreign Exchange Markets
When money flows across borders
payments have to be made/received in
foreign currency
◦ (^) This involves conversion from/to domestic currency ◦ (^) Thus there is exposure to exchange rate risk
Exchange – refers to the conversion of one
currency to another
◦ (^) The conversion rate is the exchange rate – the price of a currency in terms of another Introduction (Cont…)
Exchange rates are subject to random
fluctuations
So in addition to the various sources of
business risk there is an additional
dimension of risk in a cross-border
transaction
◦ EXCHANGE RATE RISK
Introduction (Cont…)
Firms operating in more than one country
are called Trans-National or Multi-National
Corporations (MNCs)
◦ (^) They face additional risks as compared to purely domestic businesses
MNC managers need a sound knowledge of
international financial markets
◦ (^) They need to be comfortable with sophisticated techniques for dealing with risk management – HEDGING Key Players (cont…)
The market for foreign exchange is
dominated by commercial banks
◦ (^) Most banks provide two-way quotes – they are ready to buy and sell a variety of currencies at all times
They also facilitate the flow of funds across
borders
Governments and Central Banks also play a
key role in FOREX markets
Key Players (Cont…)
An exchange rate is the price of one
currency in terms of another
◦ (^) The rate that is quoted for an immediate transaction is called the SPOT Rate
The terms of a spot contract are fixed
immediately
◦ (^) But the actual transaction will take place after two business days ◦ (^) The Maturity Date or Value Date or Delivery Date is 2 business days after the date of negotiations Foreign Exchange Rates
If the following day is a holiday then the
delivery date will be advanced to the next
working day
In addition to spot – there are what are
termed as short-dated transactions
◦ (^) A transaction where settlement takes place on the same day is referred to as TODAY or TOD ◦ (^) In some markets this is referred to as a CASH transaction FOREX Rates (Cont…)
Country Currency Symbol Country Currency Symbol Australia Dollar AUD Malaysia Ringgit MYR Brazil Real BRL Mexico Peso MXN Canada Dollar CAD New Zealand Dollar NZD China Renminbi Yuan CNY Russia Ruble RUB EMU Euro EUR Singapore Dollar SGD Hong Kong Dollar HKD South Africa Rand ZAR India Rupee INR Switzerla nd Franc CHF Israel Shekel ILS UK Pound Sterling GBP Japan Yen JPY USA Dollar USD Currency Symbols
Purchase & Sale
An exporter in Mumbai has shipped canned
food to Singapore and has received a draft
denominated in SGD
◦ (^) When he deposits it with his bank ◦ (^) The bank who is a dealer will pay out the equivalent in INR ◦ (^) This is a purchase transaction for the bank
A South African student receives a check in
ZAR and deposits it with his bank in Chennai
◦ (^) This too is a purchase transaction for the bank Illustration
A party in Sydney is importing machinery
from England
◦ (^) He approaches his bank for a draft in GBP for which he has to pay the equivalent amount in AUD ◦ (^) The bank is once again the dealer ◦ (^) This is a sale transaction for the dealer
An expatriate manager working in
Bangalore makes an outward remittance to
NYC in USD
◦ (^) This is also a sale transaction for the bank Illustration (Cont…)
We will use the following notation
◦ (^) The symbol for the variable currency will be on the Right Side of the quote ◦ (^) The symbol for the base currency will be on the Left Side of the quote ◦ (^) This is the Global Convention Conventions (Cont…)
Consider the following quote – 68.
USD/INR
◦ (^) The Indian Rupee is the Variable Currency ◦ (^) The US Dollar is the Base Currency
In a Direct Quote the rate is expressed as
the # of units of the domestic currency per
unit of the foreign currency
◦ (^) Thus the domestic currency is the variable currency ◦ (^) The foreign currency is the base currency Conventions (Cont…)