The Foreign Exchange Market

The remote commute marketplaceThe irrelevant give-and-take trade is the market place where iodin money is traded for some some other. This market is somewhat similar to the over the counter market in securities. The trading in currencies is usually accomplished over the hollo or through the telex. With direct dialing telephone service anywhere in the word, unconnected transpose markets check become truly global in the sense that notes dealings now require only a single telephone call and take place twenty four hours per day. The different monetary centers atomic number 18 connected by a telephone network and video screens and ar in constant contact with one another, thus forming a single global exotic give-and-take market. However, the currencies and the extent of the wearicipation of indivi twofoldly currency in this market depend on local ordinances, which vary form country to country.Chapter 1 deals with the introduction and conceptual framework of inappr opriate substitution market in India. It withal deals with the structure of Indian Forex Market.Chapter 2 deals with the literature review of organization and regulation of forex market as sanitary as management of exchange risk, exchange gait mechanism.Chapter 3 deals with the methodology adopted in the research process push throughlining the objectives of the study, methods of info order of battle and limitations faced while conducting the study.Chapter 4 deals with the data analysis of the abroad exchange market in India. It savvys the long term and short term factors which narrative to the problems.Chapter 5 deals with the conclusion, recommendations and future prospects of forex market in India.Chapter1Conceptual Framework of forex MarketTheory of remote exchangeThe term distant exchange is normally employ to denote overseas currency surrendered or asked for in any of its current forms, i.e. a currency note or a negotiable instrument or transfer of funds through cable or mail transfer or a letter of credit transaction requiring sale and purchase of unknown exchange or transmutation of one currency into another, either at the local center or an overseas center. The banks, dealings in for exchange and providing facilities for conversion of one currency into another or vice versa are kn accept as Authorized Dealers or Dealers in Foreign Exchange. A bank is state to buy or sell foreign exchange when it handles the claims drawn in foreign currency or the actual legal tender money, i.e., foreign currency notes and coins of other countries.The theory of Foreign exchange covers different means and methods by which the claims expressed in terms of one currency are converted into another currency and specifically deal with the pass judgment at which more(prenominal) conversion takes place.With partial or complete exchange control, as exercised by countries since World warfare II exchange markets are no longer free. Exchange pass judgment toda y are not entirely determined by market forces provided are officially fixed and maintained by Central Monetary Authorities. Fluctuations in exchange rates are permitted by authorities only at bottom narrow limits,. And official rates often very different to what they would be if natural forces were allowed to operate.Forex MarketsThe foreign exchange market, like the market for any other commodity, comprises of buyers and sellers of foreign currencies. The surgical procedures in the foreign exchange market originate in the requirements of customers for making remittances to and receiving them from other countries. But the bulk of transactions take place among banks dealing in foreign exchange for their own requirements as they do cover operations. Banks undertake large and frequent deals with other banks through the agency of Exchange Brokers, and it is these deals which bind the market its signifi tushce. In addition, there are other transactions which take place in the foreig n exchange market. All transactions of the exchange market whitethorn be divided into five categories Transactions between banks and their customers.Transactions between different banks in the same centre.Dealings between banks in a country and their correspondents, and overseas branches.The purchase and sale of currencies between the central bank of a country and the commercial banks.The transactions of the central banks of one country, with central banks of other countries.There is not much difference between one market and another as far as the international transaction between markets at different centres is concerned. But local dealings, among members of the same market are organized in two different forms. One of them is the pattern adopted in immense Britain, U.S. A. and some other countries, where foreign exchange dealers never meet each other but transact business through a network of telephone lines linking the banks, with exchange brokers who act as intermediaries. In In dia withal the foreign exchange market is organized on these lines. The other type is the markets in countries of Western Europe, where the dealers in Foreign exchange meet on every working day at a meeting place for business proposals-They fix the exchange rates for certain kind of business particularly with-customers. The foreign exchange markets in these countries are like commodity exchange or stock exchange. However, the global essential of these markets, is comparatively small.Indian Foreign Exchange MarketThe Indian foreign exchange market, broadly concentrated in big cities, is a three- course market. The first tier covers the transactions between the Reserve Bank and Authorized Dealers (Ads). As per the Foreign Regulation Act, the responsibility and authority of foreign exchange administration is vested with the RBI. It is the apex torso in this field of battle and for its own convenience, has delegated its responsibility of foreign exchange transaction functions to Ads , primarily the scheduled commercial banks. They have formed the Foreign Exchange Dealers necktie of India which framers rules regarding the conduct of business, coordinates with the RBI in the proper administration of foreign exchange control and acts as a clearing ho subprogram for information among Ads. likewise the commercial banks, there are money- changers operating on the periphery. They are well-established firms and hotels doing this business under license from the RBI. In the first tier of the market, the RBI buys and sells foreign currency from and to Ads agree to the exchange control regulations in force from clip to sequence. Prior to the introduction of the Liberalized Exchange trouble System, Ads had to sell foreign currency acquired by them from the primary quill market at rates administered by the RBI. The latter too sold overreachs greatest or US dollars, spot as well as forward, to Ads to cover the latters primary market requirements. But with the unified exchange rate system, the RBI now intervenes in the market to stabilize the value of the rupee.The second of the market is the inter-bank market where Ads transaction business among themselves. They normally do their business within the country, but they slew transact business overly with overseas bank in order to cover their own stead. Through they can do it independently, they do it normally through a recognized broker. The brokers are not allowed to execute any deals on their own account or for the draw a bead on of jobbing. Within the country, the inter-bank transactions can be some(prenominal) sport and forwards. These may be swap transactions. Any permitted currency can be sued. But while dealing with the overseas Ads, because the Indian market lacks depth in other currencies the Indian banks can deal mainly in two currencies, viz, the US branches must cover only genuine transactions relating to a customer in India or for the purpose of adjusting or squaring the banks own position. advancing trading with overseas banks is also allowed if it is done for the above two purpose, that is for covering genuine transactions or for squaring the currency position, and does not exceed a check of six months. In case the import is do on deferred defrayal terms and the period exceeds six months, permission has to be obtained from the RBI.Cancellation of forward contracts is allowed in India, although it has to be referred to the RBI. Previously, the banks used to get the forward transactions covered with the RBI, but since 1994-95 the RBI has stopped giving this cover and has permitted the banks to trade freely in the forward market. Cancellation of a forward contract involves entering into a reverse transaction at the going rate. Suppose US $1,000 was bough forward on 1 February for three months at Rs. 40/US $. On 1 March, it is cancelled involving selling the US dollar at the rate prevalent on this day. If the exchange rate on 1 March is Rs. 39.50/US $ ther e will be a departure of Rs. 500 (the dollar sold for Rs. 39.5 minus dollar bought at Rs. 40.00). The loss is borne by the customer. If the value of the US dollar is greater on the cancellation day, the customer shall reap the profit.The third tier of the foreign exchange market is represented by the primary market where Ads transact in foreign currency with the customers. The very existence of this tier is the bulge outcome of the legal provision that all foreign exchange transactions of the Indian residents must take place through Ads. The tourists exchange currency, exporters and importers exchange currency, and all these transactions come under the primary market Chapter 2LITERATURE REVIEW Organization And Regulation of Forex MarketThe Foreign Exchange plane surgical incision, which is also being called as the International Banking Division, is one of the important departments of the banks operating in international market. In India also all scheduled commercial banks, both i n the nationalized or non-nationalized sectors, do have Foreign Exchange departments, both at their principal bunks as well as offices, in metropolitan centers. This department functions independently under the overall change of some senior executive or a senior officer well-versed in foreign exchange operations as well as in the rules and regulations in force from time to time pertaining to foreign exchange transactions advised by various government agencies.The principal function of a Foreign exchange department is to handle foreign inward remittances as well as outward remittances buying and selling of foreign currencies, handling and forwarding of import and export documents and giving the consultancy services to the exporters and importers. Besides this, the department also gives the financial help in relation to the foreign trade, i.e., it gives assistance to the exporters by way of financing the exports and imports by giving them the financial assistance to clear the consig nments or open a letter of credit. The department issues letters of credit for their importer clients and handles letters of credit received from overseas correspondents in favour of exporters from India. yield of Performance and the Bid Bond guarantees and tender document is also one of the important functions of the banks that are dealing I foreign exchange.In India, the banks doing foreign exchange business are issued a license to this effect by the Reserve Bank of India under Foreign Exchange Regulation Act, 1973. No bank, not having such license to deal in foreign exchange, can handle foreign exchange operations. Besides Authorized Dealers, licenses are also issued to the Dealers with limited powers to change foreign currency notes, coins and travellers cheques. Such licensees are known as Authorized Money Changers.2.1 Organisation of A Foreign Exchange surgical incisionThe foreign exchange department of a medium or large sized-bank can be divided into various department and s ections such department are locked after by a senior person not lower than the category of a branch manager having both administrative and operational know-how as well as discretionary powers for advances required from time to time by the clients. The in charge of the department functions independently within the overall framework set(p) down by the Management of the bank. The in charge is assisted in hid day-to-day work by a team of officers, and workmen. One of the important functions of the Foreign exchange department, beside banking operations, is to maintain data link and correspondence relations with overseas banks who may be their correspondents.SECTION OF THE FOREIGN EXCHANGE DEPARTMENTThe Foreign exchange department is divided into number of sections, each one equally important and looked after by one officer or a department head. A particular section can be sub-divided into sub-section with specific duties allotted. The sections in Foreign exchange department can be broa dly stated as under1. Dealers SectionThis section is the nerve of the foreign exchange department as the exchange rates are computed and advised by this section. The exchange rates are the on a foreign exchange and so any incorrect fixation of rates (price) will turn the profits of the bank into losses and instead of earning from the foreign exchange transactions, the bank may keep on losing. This section is headed by an officer who is called a Dealer. In the morning, before the banking hours begin, the exchange rates of various currencies are computed. The rates are computed on the basis of certain fixed principles which may by either market quotations or any such approved channel. In India, the Dealer works out the exchange rates on cross rate method based on the sterling rate schedule fixed and advised by FEDAI vis--vis the front days closing rates in London market. This department calculates and advised both the ready rates as well as forward rates as and when requested. Beside s rate computation, it also looks after the foreign currency accounts of the bank and supervises the balancing position in foreign currency accounts maintained abroad. It also controls the exchange position of the department and reconciles the various entries put forth by other sections both for buying as well as selling of foreign exchange. In addition, the section also calculates and tabulates the statistical data required by the principal office of the bank concerned, as well as the Exchange support Department of the Reserve Bank of India. Such statistics prepared by the bank are to be reported to the authorities on the irrefutable forms at the prescribed intervals. This data is very essential and of prime important as the Balance of Trade and Balance of Payments position is arrived at only from the statistics provided by the banks. From the data procurable from the banks even the import policy is formed and other fiscal measure adopted by the monetary authorities from time to time depend.This section can be further sub-divided into following subsectionsRate calculation and advising earlier Exchange contractsForeign currency AccountsExchange position and control, andReconciliation of Foreign Currency Accounts.2. Foreign Remittances SectionThis section deals with the inward and outward remittances received in the country and sent outside, both on behalf of the transactions taken up by residents and non-residents. Foreign remittances are carried out in the form of cable transfers, mail transfers, demand drafts, travelers cheques and wages instructions by letters. All these forms are widely used both for inward remittances as well as outward remittances. The officer of this particular department has to be quite well-versed with various regulations in force from time to time and the amendments thereto as strict exchange control regulations are prevailing surplusly in case of outward remittances in developing and underdeveloped countries, callable to the a dverse balance of payments position, depleting foreign exchange reserves, and available resources required to meet with development programmes and national exigencies. This department also keeps Test Key arrangements used for transfer the instructions by cable, as in cable transfers no signature of the remitting bank is possible. So messages are computed with a particular number known as code or cipher. This code or cipher is recomputed at the other centre on the basis of the test arrangements exchanged between the two banks.In foreign exchange, whatever the reason may be irrespective of the amount, the entire gamut is focused close to the inward and outward remittances and so this section is of prime importance. The remittances are converted into local currency in case of inward remittances and in foreign currency in case of outward remittances at the prevailing rate of exchange on the date of each transaction or a forward exchange rate if exchange rate if exchange is already boo k earlier. So, the remittance department has to keep a close contact with Dealers section, both for get the rates and also advising them the funds position which changes from time to time due to the remittances flowing in either direction.3. Import Section Import section can be sub-divided into import letters of credit both opening and payment thereof, issue of Bid guarantees, performance guarantees and guarantees to judicature agencies for release of import consignment, import documents received on collection basis and imports on consignment basis. Import section has to keep in touch with latest developments in international markets as well as the rules and regulations in force in various centres to take up the import business at right earnest without violating the rules and regulations. Both in developing and developed countries, there are Import and Export Trade guard Regulations and such regulations are enforced through a licensing procedure. Hence the Import section has to take deal of the Import Trade Control Regulations as well as Exchange Control Regulations before allowing import transactions to be put through.4. Export Section The section deals with various exchange operations arising out of export trade. The principal functions of this sub-section areAdvising and confirming letters of credit received from abroadExtending financial assistance to exporters as and when required.Acting as an agent for collection on behalf of the clientsNegotiation of export bills drawn under letters of Credit whereby the dealer acts as an agent of overseas bank and facilitates smooth function/operation of international trade and Acting as an authorized channel appointed by Central Banking Authority to receive the export proceeds.5. Statistics SectionThis section collects the gross sales and purchase figures from various departments along with necessary exchange control forms, tabulates then and submits a periodical report by way of statements and returns to the Ex change Control Department of the Reserve Bank of India under whose authority it operates. This reports is also being submitted from time to time in one form or the other to the head office of the concerned bank to enable it to compile the overall position of the foreign exchange preferably of the bank as a whole.2.2 Exchange Regulation in India Exchange Control Regulations were first introduced in our country on 3rd September, 1939 at the outbreak of World War II. The control was introduced under the guidelines of Bank of England and also as a measure under the Defence of India rules to conserve and augment the foreign exchange resources of India to meet the defence requirements for Britishers. It primary objective was to conserve the foreign exchange resources, which needed to be diversified due to changed circumstances.It was initially introduced as a temporary device to meet the emergency situation arisen due to southward World War. In May, 1944 the Defence of India Rules were l ifted and all emergency sustenance promulgated during the Defence of India Rules were ineffective. But the Government of India was not in a position to lift the Exchange Control Regulations due to the strain on the sterling balances The Exchange Control Regulations were kept alive under a new legality named as Emergency Provisions Continuance Act of 1994. The Exchange Control was put on a permanent Statute and the First Foreign Exchange Regulations Act came into existence on 25th March, 1947 as a full fledged foreign Exchange Regulations Act.The system of control adopted in 1947 was structurally identical to provisions laid down in 1939 at the inception of the control, but important changes in detail were introduced in FERA 1947 to meet the specific requirements of the situation and to protect the interests of independent India.The Foreign Exchange Regulations Act (FERA) of 1947 has now been replaced by the FERA, 1973. Basic structure of the Exchange Control Regulations is till n ot very much divergent that the earlier ones, but keeping in view the economic conditions and balance of payments positions, certain new provisions have been included and the control has been bewilder more comprehensive. Under the Act of 1973, the Authorized Dealers have been given wider powers for releasing foreign exchange to the residents in India and a strict view has been taken of the non-resident interests.I) all-embracing FEATURES OF EXCHANGE CONTROL There is an elaborate machinery to enforce Exchange Control Regulations in our country. The machinery comprises of the controller of the Exchange Control department of the Reserve Bank of India at the helm of affairs, which in turn has empowered the Banks dealing in foreign exchange to deal with frequent public for their foreign exchange requirements. This authority enforces the provisions of the Foreign Exchange Regulations Act and has the powers to deal with any infringement or violation of the provisions of the Act.II) THE FERA AND THE EXCHANGE CONTROL MANUAL All the provisions of the FERA have been transcribed in the banking terminology by the Reserve Bank of India to facilitate the day to day transactions between Reserve Bank, between the various dealers and the general public.Exchange control in India is administered by the Reserve Bank of India in accordance with the general policy laid down by the Union Government in consultation with the Reserve Bank. The Bank has an Exchange Control Department which is entrusted with this functions. Under the system, the Reserve Bank is authorized to license export of sumptuous, silver, currency notes, securities, and a variety of other transactions involving the sue of foreign exchange.For foreign exchange transactions, which the general public conducts with the authorized dealers in foreign exchange, the Reserve Bank of India has laid down general instructions for the guidance of the latter. The directions cover all transactions relating to imports and expor ts, foreign travel payments, family maintenance remittances by foreign nationals, transfers of investment income, capital transfers by foreign and Indian Nationals and other invisible items. Some of these transactions particularly those pertaining to capital transfers, have to be referred by the authorized dealers to the Reserve Bank for its front approval. Some remittances may, however, be made by the authorized dealers without prior approval of the Reserve Bank, such as those for foreign Nationals seeking to remit a part of their, earnings for the maintenance of their families abroad, provided the amounts are within limits specified by the Reserve Bank.The institutional framework of the exchange control system also compromised of a special machinery for enforcement and for dealing with any infringements of the provisions of the Act. The function is entrusted to the Directorate of Enforcement attached to the Union Ministry of Finance. The directorate deals with offenders who viola te the control provisions and is authorized to take punitive action. It is also empowered to adjudicate in certain cases of infringement.III) Purchases and Sales by Authorized Dealers Authorized dealers purchase and sell foreign currencies in accordance with the regulations.Purchase They purchase T.Ts., M.Ts., drafts, bill etc., freely from banks and the general public. The receipt of remittances from any country is free and banks are, therefore allowed to purchase freely.Purchase of foreign currencies is also done from their overseas branches and correspondents for the purpose of making rupee payments into non-resident accounts in India and also for making payments to residents.The authorized dealers and authorized moneychangers purchase foreign currency notes, coins, and travellers, cheques from travellers coming from abroad. The amounts purchased are endorsed on the reverse of the custom stamped currency declaration forms of the travellers. Foreign currency notes and coins are al so purchased from other authorized dealers and money changers.Sales Sales of foreign currency are made by authorized dealers subject to control regulations. No remittances may be made to countries advised from time to time and no transactions may be carried out with persons, firms or banks residents in those countries.For the purpose of sales persons, firms, and banks residents in Nepal are treated as non- residents. 2.3 Exchange Rate Mechanism in India India is a founding father member of the IMF. It followed the fixed mirror symmetry system till the early 1970s as a result which the value of the rupee in terms of gold was originally fixed as the equivalent of 0.268601 gram of fine gold. In view of Indias long economic and political relations with England and membership of the sterling area from September 1939 to June 1972, the rupee was pegged to the pound sterling. The exchange rate was thus remained unchanged but the gold content of the rupee fell to 0.186621 gram. Again, with the devaluation of the Indian rupee in June 1996 the gold content fell further to 0.118489 gram. The following year, the pound was also devalued. This devaluation did have an impact on the rupee pound link, but the rupee was kept stable in terms of the pound. The latter continued as an intervention currency.In August 1971 when the system of fixed parity was under a cloud, the rupee was briefly pegged to the US dollar at Rs. 7.50/US $ and this continued till December 1971. The peg to the dollar was not very effective as the pound sterling remained to continue as the intervention currency. In December 1971, the rupee returned to the sterling peg at a parity of Rs. 18.9677/ with of course , a adjustment of 2.2 S percent.After the Smithsonian arrangement had failed and the pound had began to float, the rupee tended to depreciate. The reserve Bank then had to delink it from the pound sterling in September 1975 and link it with a handbasket of five currencies but the pound sterling was r etained as the intervention currency for fixing the external value of the rupee. The weight of different currencies forming the basket remained orphic and the exchange rate continued to be administered. The administered rate did not keep pace with the growing rate of inflation and this resulted in a widening counterpane between the real and the nominal exchange rates that was more evident during the late 1980s and early 1990s. Thus, when economic reforms were initiated in the country, the rupee was depreciated by around 20 percent in two successive instalments in the first weeks of July 1991. In absolute terms, depreciation occurred from Rs. 21.201/US $ to Rs. 25.80 /US $From March 1992 a dual exchange rate system was introduced, in terms of which 40 percent of export earnings were to be converted at the official exchange rate prescribed by the Reserve Bank and the remaining 60 percent were to be converted at market determined rates. The US dollar was he intervention currency. Fro m March 1993 the receipts on merchandise trade account and some of the items of invisible trade account came to be convertible entirely at the market determined rates on all items of current account.The acceptance of the unified exchange rate system form March 1993 means adoption of a floating-rate regime, but it is a managed floating and the reserve Bank of India intervenes in the foreign exchange market in order to influence the value of the rupee. In the first two years, the value of the rupee remained stable but the onward, it has been depreciating despite RBIs intervention.2.4 Management of Exchange Risk Risk Hedging tools in Forex MarketIn recent years financial markets have developed many new products whose popularity has become phenomenal. Measured in terms of trading volume, the growth of these products in the first place futures and options has confused traditional investors. Although active markets in futures and options contracts for physicals commodities have only rec ently attracted Internet.Multinational Companies normally use the spot and forward markets for international transactions. They also use currency futures, currency options, and currency futures options for various corporate functions. While speculators trade currencies in these three markets for profit, multilingual companies use them to cover open positions in foreign currencies.2.4 (a) Forward contract Forward Exchange Forward exchange is a device to protect traders against risk arising out of fluctuations in exchange rates. A trader, who has to make or receive payment in foreign currency at the end of a given period, may find at the time of payment or receipt that the foreign currency has appreciated or depreciated. Ifthe currency moves down or gets depreciated the trader will be att a loss as he will get lesser units of home currency for a given amount of foreign currency, which he was holding.Similarly, an importer, who was contracted to make payment of a given amount in pound sterling at the end of a given period, may find that at the time of payment, the rupee sterling rate is higher. He would then have to pay more in rupees than what it would have been at the time when the contract was made.To protect traders against such risks of appreciation and getting lesser amount of home currency, there is a device in exchange market of booking forward exchange contracts. The emergence of forward exchange contracts has been due to the rate fluctuations and possible losses that the traders might have to suffer in their foreign exchange business. The forward exchange transaction is an umbrella which gives security to the dealers against the adverse movement of exchange rates. The forward exchange market in fact came into existence when the exchange rates were highly unstable following the renunciation of the gold standard by most of the countries at the end of first and Second World Wars. There are other means of taking care of the risks of the adverse effects of the exchange rate fluctuations such as including the Escalation Clause in the sale and purchase contracts entered between the buyers and sellers or fixing a parity rate between the home currency and foreign currency and any variation in the fixed parity entered into between the importers and exporters, the exchange risks will be passed on as per the terms of the contract. Escalation clause is more adaptable in contracts amounting to a very large volume,. especially in contracts entered into on deferred payment terms.Forward Exchange Contracts Under option forward exchange contracts, the customers has an option to receive or deliver the contract