Forex management slideshare

Slideshare uses cookies to improve functionality and performance, and to provide you with relevant advertising. If you continue browsing the site, you agree to the use of cookies on this website. See our User Forex and Privacy Policy. See our Privacy Policy and User Agreement for details. Published on Mar 16, The foreign exchange market, structure and organization- mechanics of management trading — types of transactions and settlement dates — exchange rate quotations and arbitrage — arbitrage with and without transaction costs — swaps and deposit markets — option forwards — forward swaps and swap positions — Interest rate parity theory.

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Forex Management Chapter - I. Options - Forex Management Chapter Show related SlideShares at end. Swaminath SamAssistant Professor at Bangalore University, Central College Follow.

Full Name Comment goes here. Are you sure you want to Yes No. Embeds 0 No embeds. No notes for slide. Forex Management Chapter - I 1. EVOLUTION OFAN OPEN FOREX MARKET 1. Introduced inearlier countries would commonly use gold and silver as method of international payment. Countries need to convert their local currency to gold and vice versa. In other words a currency was backed by gold. Governments needed a fairly substantial gold reserve in order to meet the demand for currency exchanges.

The gold standard eventually broke down during the beginning of World War I. Political tension in Germany and other European Countries on Military Equipment's. Scarcity of Gold Reserves created a to print extra currency. Before the end of World War II, the Allied nations felt the need to set up a monetary system in order to fill the void containing nothing that was left when the gold standard system was abandoned.

In Julymore than representatives from the Allies met in Bretton Woods, New Hampshire, to deliberate over what would be called the Bretton Woods system of international monetary management. To simplify, Bretton Woods led to the formation of the following: S government was obligated to maintain gold reserves equal to the amount of currency in circulation, making the United States a true gold standard economy. EVOLUTION OFAN OPEN FOREX MARKET 5.

Over the next 25 or so years, the system ran into a number of problems. By the early s, U. Treasury did not have enough gold to cover all the U. Finally, on August 15,U. President Richard Nixon closed the gold window, essentially refusing to exchange U. Forex event marked the end of Bretton Woods.

EVOLUTION OFAN OPEN FOREX MARKET The Chicago Mercantile Exchange CME became the first exchange to offer currency trading. Inthe CME launched the International Monetary Market IMM. BRETTON WOODS SYSTEM - TRAP 1. At the same time, an energy crisis was simultaneously pushing up the price of oil and other commodities. HISTORY OF FOREX MARKET IN INDIA 1. Reserve Bank of India RBI in the year allows banks to undertake intra-day trading in foreign currency exchange.

Appointment of an Expert Group committee on Forex currency in to study and develop forex mkt. Freedom was granted to banks in term of fixing their trading limits, allowed to borrow and invest funds in the overseas markets up to specified limits, accorded freedom to make use of derivative products for asset-liability management purposes. National Stock Exchange of India forex known as NSE was the first recognized exchange in Indian forex history to launch forex currency futures trading in India.

Forex transactions in India are managed by the government authorities. Rupee briefly pegged to the USD Rs 7. Rupee sterling parity revalued to Rs Sterling the intervention currency with a central bank rate of Rs Rupee dollar rate depreciated from It will not buy or sell forward Dollars though it will enter into Dollar swaps.

The Reserve Bank Provide Licenses to three categories of persons transact with public at different levels and they are as follows: The bulk of foreign exchange transactions undertaken in the country involve end-users and banks.

Banks — License by RBI. They are allowed to undertake banking operations only in designated foreign currencies essentially with non- residents.

These people are sub-classified as Full Fledged and Restricted Money Changes. Full fledged money changers are permitted to both buy as well as sell foreign exchange. Restricted money changers can purchased foreign exchange in the form of travellers cheques or currency notes, but they are not allowed to sell.

The end-users of foreign currencies are individuals, exporters, importers, travellers and tourist approach authorized dealers for their requirements. Total turnover and individual transaction size is very small in amount and time of maturity.

It is governed by rules and regulations of RBI. Wholesale Market Interbank Market: The market witness a bulk foreign exchange transactions. It is in between RBI and Authorized Delores of Foreign Exchange. The rates are determined by market and the volume of transactions as stated above is bulky and standard in lot size.

It is also governed by the rules and regulations of RBI. The differences between the buying and selling prices is called as bid- offer spread. How BMW dealt with exchange rate risk The story. BMW Group, owner of the BMW, Mini and Rolls-Royce brands, has been based in Munich since its founding in But byonly 17 per cent of the cars it sold were bought in Germany.

India, Russia and eastern Europe have also become key markets. Despite rising sales revenues, BMW was conscious that its profits were often severely eroded by changes in exchange rates. BMW did not want to pass on its exchange rate costs to consumers through price increases. Its rival Porsche had done this at the end of the s in the US and sales had plunged.

BMW took a two-pronged approach to managing its foreign exchange exposure. However, not all exposure could be offset in this way, so BMW decided it would also use formal financial hedges.

To achieve this, BMW set up regional treasury centres in the US, the UK and Singapore. How the strategy was implemented. The natural hedge strategy was implemented in two ways. The first involved establishing factories in the markets where it sold its products; the second involved making more purchases denominated in the currencies of its main markets.

BMW now has production facilities for cars and components in 13 countries. Inits overseas production volume accounted for 20 per cent of the total. Byit had risen to 44 per cent. In the s, BMW had become one of the first premium carmakers from overseas to set up a plant in the US — in Spartanburg, South Carolina. This would create 5, jobs in the US while cutting 8, jobs in Germany.

This also had the effect of management the supply chain between Germany and the US market. The company boosted its purchasing in US dollars generally, especially in the North American Free Trade Agreement region. A joint venture with Brilliance China Automotive was set up in Management, China, where half the BMW cars for sale in the country are now manufactured.

The carmaker also set up a local office to help its group purchasing department to select competitive suppliers in China.

By the end ofRmb6bn worth of purchases were from local suppliers. Again, this had the effect of shortening supply chains and improving customer service. At the end ofBMW announced it would invest 1. It also announced plans to increase production in Kaliningrad, Russia. Meanwhile, the overseas regional treasury centers were instructed to review the exchange rate exposure in their regions on a weekly basis and report it to a group treasurer, part of the group finance operation, in Munich.

The group treasurer team then consolidates risk figures globally and recommends actions to mitigate foreign exchange risk. By moving production to foreign markets the company not only reduces its foreign exchange exposure but also benefits from being close to its customers. In addition, sourcing parts overseas, and therefore closer to its foreign markets, also helps to diversify supply chain risks. The writers are, respectively, professor of economics and finance and associate dean of research, and a research associate at CEIBS, reference: The Financial Times Limited POINTS TO KNOW 1.

Meaning of National and International Business. International Business can take three modes: Agreements Types — Unilateral, Bilateral, Multilateral 4. Licensing, Franchising, Management Control and Turn Key Projects, etc. Current Account and Capital Account in BOP and BOT. Current accounts involve transfer of real income. Capital account involves transfer of funds without affecting a shift in the real income. For example, Toyota assembles motor cars in Japan and the UK.

In case of forward vertical FDI, the FDI brings the company nearer to a market for example, Toyota buying a car distributorship in America. In case of backward Vertical FDI, the international integration goes back towards raw materials for example, Slideshare getting majority stake in a tyre manufacturer or a rubber plantation.

It is the most surprising form of FDI, as it requires overcoming two barriers simultaneously — one, entering a foreign country and two, working in a new industry.

The Greenfield project means that a work which is not following a prior work. In infrastructure the projects on the unused lands where there is no need to remodel or demolish an existing structure are called Green Field Projects. The projects which are modified or upgraded are called brownfield projects.

FDI Limits as of now in India — Please do refer sources MEANING OF FOREX MARKET: Foreign Exchange FOREX refers to the foreign exchange market. It is the over-the-counter market in which the foreign currencies of the world are traded. It is considered the largest and most liquid market in the world.

Foreign Exchange has no centralized market. Instead, a foreign exchange market exists wherever the trade of two foreign currencies are taking place. It is open 24 hours a day, five days a week. This foreign exchange market exists to ease investment and trade. The primary trading centers are London, Paris, New York, Tokyo, Zurich, Frankfurt, Sydney, and Singapore. All levels of traders, from central banks to speculators, trade currencies with one another.

Different countries have different currencies with different strengths. All the countries management the world are inter dependent. Forex is required to meet forex bills of a country.

Importers have to pay the bills in currencies at the choice of the exporters. NEED FOR FOREIGN EXCHANGE The foreign exchange market forex, FX, or currency market is a global decentralized market for the trading of currencies.

This includes all aspects of buying, selling and exchanging currencies at current or determined prices. Arbitrage is a risk free transaction. Transactions between RBI and Authorized Dealers B. A slideshare whose business was the exchanging of one currency for another. Firms and Individuals RBI buys and management forex from and to ADs according to exchange control regulations. RBI intervenes in the market to stabilize the value of rupee.

TIER - I TIER - II 1. Interbank market where ADs transact business among themselves. It is the wholesale market. Transactions are rooted through banks. Indian banks mainly deal in 2 currencies i. USD and pound sterling. Primary market where ADs transact with the customers. Over the counter transactions. Tourists, exporters, importers, NRIs, exchange currency through the commercial banks Forex and money changers TIER - III MECHANICS OF CURRENCY TRADING What is traded in the Forex market?

The instrument traded by Forex traders and investors are currency pairs. A currency pair is the exchange rate of one currency over another. The most traded currency pairs are: The first currency of each currency pair is referred as the base currency, while second currency is referred as the counter or quote currency. Each currency pair is expressed in units of the counter currency needed to get one unit of the base currency.

All currency pairs are commonly quoted with a bid and ask price. The bid always lower than the ask is the price your broker is willing to buy at, thus the trader should sell at this price.

The ask is the price your broker is willing to sell at, thus the trader should buy at this price. A pip is the minimum incremental move a currency pair can make. Pip stands for price interest point. In contrast with other financial markets where you require the full deposit of the amount traded, in the Forex market you require only a margin deposit. The rest will be granted by your broker.

The management provided by some brokers goes up to Most brokers offer Of course it is not recommended to open a position with such limited funds in our trading balance. If the trade goes against our trader, the position is to be closed by the broker.

This takes us to our next important term. Most of the time margin calls occur when money management is not properly applied. FOREX ORDER TYPES - Mechanics of Online Forex Slideshare A market order instructs the broker to buy or sell a currency at the current market price. As such, neither the trader, nor the broker has any control over where the trade is executed.

No action will be taken until the price quote is reached, regardless of the length of time. The disadvantage of the limit order is that the market may never move in the desired direction, and the trade may never be executed as a result.

The stop-loss order is a kind of safety mechanism that puts a ceiling over the losses that a misplaced trade can cause.

The trailing-stop order is a relatively uncommon order type. In this case, the stop-loss order is renewed automatically by the trading software at intervals specified by the trader.

When the price reaches 1. The take profit order specifies the price quote at which we would like our position to be closed, and profits to be realized. The Foreign Exchange Transactions refers to the sale and purchase of foreign currencies.

Simply, the foreign exchange transaction is an agreement of exchange of currencies of one country for another at an agreed exchange rate on a definite date.

The spot transaction is when the buyer and seller of different currencies settle their payments within the two days of the deal. It is the fastest way to exchange the currencies. Here, the currencies are exchanged over a two-day period, which means no contract is signed between the countries.

The exchange rate at which the currencies are exchanged is called the Spot Exchange Rate. This rate is often the prevailing exchange rate. The market in which the spot sale and purchase of currencies is facilitated is called as a Spot Market. A forward transaction is a future transaction where the buyer and seller enter into an agreement of sale and purchase of currency after 90 days of the deal at a fixed exchange rate on a definite date in the future.

The rate at which the currency is exchanged is called a Forward Exchange Rate. Future contract is same as forward except few points which are discussed. The Swap Transactions involve a simultaneous borrowing and lending of two different currencies between two investors. Here one investor borrows the currency and lends another currency to the second investor. The obligation to repay the currencies is used as collateral, and the amount is repaid at a forward rate.

The foreign slideshare option gives an investor the right, but not the obligation to exchange the currency in one denomination to another at an agreed exchange rate on a pre-defined date.

An option to buy the currency is called as a Call Option, while the option to sell the currency is called as a Put Option. Arbitrage is the simultaneous buying and selling of foreign currencies with intention of making profits from the difference between the exchange rate prevailing at the same time in different markets.

Hence, Nostro account points at - "Our account with you" Nostro accounts are generally slideshare in a foreign country with a foreign bankby a domestic bank from our perspective, our bank. It obviates that account is maintained in that foreign currency. For example, SBI account with HSBC in U. VOSTRO Account Italian word 'vostro' means 'yours'.

Hence, Vostro account points at - "Your account with us" Vostro accounts are generally held by a foreign bank in our country with a domestic bank. It generally maintained in Indian Rupee if we forex India For example, HSBC account is held with SBI in India.

Therefore, it points at - "Their account with them" Loro accounts are generally held by a 3rd party bank, other than the account maintaining bank or with whom account is maintained. For example, BOI wants to transact with HSBC, but doesn't have any account, while SBI maintains an account with HSBC in U. Then BOI could use SBI account. Number of domestic currencies per unit of foreign currency. Foreign currency is fixed and domestic currency varies.

Home currency is fixed and the foreign currency varies 2. Number of foreign currencies is expressed per unit of domestic currency. A cross rate is an exchange forex between two currencies, calculated from their common relationships with a third currency.

When cross rates differ from the direct rates between two currencies, inter-market arbitrage is slideshare. The foreign currency price of one dollar. The dollar price of a unit of foreign currency.

TYPES OF PEGGING SYSTEM — FOREX MARKET Dollarization and forex boards are among the examples of hard pegs, which severely limit the possibility of an autonomous independent monetary policy in a country.

Therefore, sometimes the exchange rate that stems from a management peg is referred to as a fixed exchange rate, as in the case of a metallic standard. Soft pegs are also called crawling pegs. The central bank guarantees convertibility of domestic currency into the foreign currency to which it is pegged. A floating exchange rate or fluctuating exchange or flexible exchange rate is a type of exchange-rate regime in which a currency's value is allowed to fluctuate in response to foreign-exchange market mechanisms.

A currency that uses a floating exchange rate is known as a floating currency. The rate is allowed to fluctuate in a band around a central value, which is adjusted periodically. This is done at an unannounced rate or in a controlled way following economic indicators.

Exchange Arrangements with No Separate Legal Tender: The currency of another country circulates as the sole legal tender formal dollarizationor the member belongs to a monetary or currency union in which the same legal tender is shared by the members of the union.

Adopting such regimes implies the complete surrender of the monetary authorities' independent control over domestic monetary policy. A monetary regime based on an explicit legislative commitment to exchange domestic currency for a specified foreign currency at a fixed exchange rate, combined with restrictions on the issuing authority to ensure the fulfillment of its legal obligation.

This implies that domestic currency will be issued only against foreign exchange and that it remains fully backed by foreign assets, eliminating traditional central bank functions, such as monetary control and lender-of-last-resort, and leaving little scope for discretionary monetary policy.

The slideshare rate is market-determined, with any official foreign exchange market intervention aimed at moderating the rate of change and preventing undue fluctuations in the exchange rate, rather than at establishing a level for it. Pegged Exchange Rates within Horizontal Bands: It also includes arrangements of countries in the exchange rate mechanism ERM of the European Monetary System EMS that was replaced with the ERM II on January 1, There is a limited degree of monetary policy discretion, depending on the band width.

Exchange Rates within Crawling Bands: Managed Floating with No Predetermined Path for the Exchange Rate: The monetary authority attempts to influence the exchange rate without having a specific exchange rate path or target.

Indicators for managing the rate are broadly judgmental e. Intervention may be direct or indirect. Foreign Exchange Derivative Instruments in India Foreign Exchange Forwards: Residents outside India enter into such contracts to hedge or transform permitted foreign currency exposure to the rupee, as permitted by the Reserve Bank.

Use of this product in a structured product not conforming to the specific purposes is not permitted. Foreign Currency Rupee Swap: Management Currency Rupee Options: ADs Category-I approved by the Reserve Bank and ADs Category-I who are not market makers are allowed to sell foreign currency rupee options to their customers on a back-to-back basis, provided they have a capital to risk-weighted assets ratio CRAR of 9 per cent or above.

These options are used by customers who have genuine foreign currency exposures, as permitted by the Reserve Bank and by ADs Category-I for the purpose of hedging trading books and balance sheet exposures.

ADs Category-I are permitted to issue cross- currency options to a person resident in India with crystallized slideshare currency exposure, as permitted by the Reserve Bank. The clients use this instrument to hedge or transform foreign currency exposure arising out of current account transactions. ADs use this instrument to cover the risks arising out of market- making in foreign currency rupee options as well as cross currency options, as permitted by the Reserve Bank.

FOREIGN EXCHANGE RESERVES Foreign Currency Management refers to systematic process of maintaining adequate foreign exchange reserves which are readily available with central bank to meet the liabilities and unexpected payments which may arise in future.

The Reserve Bank of India publishes half-yearly reports on management of foreign exchange reserves for bringing about more transparency and enhancing the level of disclosure. These reports are prepared half yearly with reference to the position as at end-March and end-September each year. Reserve management should seek to ensure that: Foreign Exchange Reserves in India averaged ROLE OF FEDAI — FOREX MARKET IN INDIA Authorized Dealers in Foreign Exchange Ads have formed an association called Foreign Exchange Dealers Association of India FEDAI in order to lay down certain terms and conditions for transactions in Foreign Exchange Business.

Ad has to given an undertaking to Reserve Bank of India to abide by the exchange control and other terms and conditions introduced by the association for transactions in foreign exchange business. Accordingly FEDAI has evolved various rules for various transactions in order to protect the interest of the exporters, importers general public and also the authorized in dealers.

FEDAI which is a company registered under Slideshare 25 of the companies Act, has subscribed to the 1. Uniform customs and practice for documentary credits UCPDC 2. Uniform rules for collections URC 3.

Uniform rules for bank to bank reimbursement. Guidelines and Rules for Forex Business. Training of Bank Personnel in the areas of Foreign Exchange Business. Accreditation of Forex Brokers. Announcement of daily and periodical rates to member banks. Due to continuing integration of the global financial markets and increased pace of de-regulation, the role of self-regulatory organizations like FEDAI has also transformed. In such an environment, FEDAI plays a catalytic role for smooth functioning of the markets through closer co-ordination with the RBI, other organizations like FIMMDA, the Forex Association of India and various market participants.

FEDAI also maximizes the benefits derived from synergies of member banks through innovation in areas like new customized products, bench marking against international standards on accounting, market practices, risk management systems, etc. Arbitrage is the simultaneous purchase and sale of an asset to profit from a difference in the price.

It is a trade that profits by exploiting the price differences of identical or similar financial instruments on different markets or in different forms. Arbitrage exists as a result of market inefficiencies. Though this forex not the most complicated arbitrage strategy in use, this example of triangular arbitrage is more difficult than the above example.

In triangular arbitrage, a trader converts one currency to another at one bank, converts that second currency to another at a second bank, and finally converts the third currency back to the original at a third bank.

The same bank would have the information efficiency to ensure all of its currency rates were aligned, requiring the use of different financial institutions for this strategy. ARBITRAGE - MEANING You see that at three different institutions the following currency exchange rates are immediately available: Cross-Rates and Three-Point Arbitrage For example: Infosys is quoting at Rs on the BSE and Rs on the NSE.

Hence one can sell the stock on the NSE and buy from the BSE at the same time. This trade will lead to a profit without any risk. This process is arbitrage. Simple Arbitrage Institution 1: Next, you would take the 1, euros and convert them to pounds at the 1. Next, you would take the pounds and convert them back to U.

A currency pair is denoted by the 3-letter SWIFT codes for the two currencies separated by an oblique or a hyphen. The exchange rate quotation is given as the amount of the quoted currency per unit of the base currency. The last two digits are called slideshare points or pips. The quotations are usually shortened as follows: Types of Arbitrage Transactions A. COVERED INTEREST ARBITRAGE CIA — CIA is one of the segments of interest parity theory.

COVERED INTEREST ARBITRAGE CIA — Steps to be followed UNCOVERED INTEREST ARBITRAGE — Does not involve forward market transaction as interest rate differential leads to changes in future spot rate. Types of Arbitrage Transactions To begin with, we will assume away all transactions costs. This means that in the foreign exchange market there are no bid-ask spreads and in the money market, there is no difference between borrowing and lending rates.

Notice that covered arbitrage involves activities in four markets, viz. In case of one way arbitrage the arbitrage transaction that avoids the use of one of the markets. In the foreign markets, these are in the form of bid-ask spreads in addition, there are costs such as telephone calls, telexes, etc.

The relative magnitudes of these spreads vary between markets depending primarily upon the volume of business. Also as mentioned above, the interest rates faced by a particular firm may be different from the eurodollar market rates. The net result of all this is that different ways of achieving the same end result can sometimes have different costs or returns.

COVERED INTEREST ARBITRAGE IN PRACTICE We have already examined how transaction costs can create a range slideshare forward rates which are all consistent with the no riskless profits condition. The one way arbitrage imposes tighter limits on forward quotes than two way arbitrage. The departures from interest parity attributable to transaction costs are, therefore, likely to be quite small since bid-ask spreads in foreign exchange markets as well as deposit markets are quite small.

Another factor which is said to cause departures from interest parity is political risk. For an investor resident in country A, home investments are free from political risks such as confiscation, temporary freezing of foreign deposits, etc.

Another example may be of tax rates which differ from country to country may cause interest rate differences for arbitrage. Also referred to as a "forward start swap," "delayed start swap," and a "deferred start swap.

Sometimes swaps don't perfectly match the needs of investors wishing to hedge certain risks. A financial institution that acts as an intermediary for interest and currency swaps. The function of these intermediaries is to find counterparties for those who want to participate in swap agreements. The swap bank typically earns a slight premium for facilitating the swap. A Currency Swap is an agreement between two parties to exchange principal and fixed rate interest payments on a loan in one currency for principal and fixed rate interest management on an equal loan in another currency.

The parties to the contract exchange the principal of two different currencies immediately, so that each party has the use of the different currency. They also make interest payments to each other on the principal during the contract term. In many cases, one of the parties pays a fixed interest rate and the other pays a floating interest rate, but both could pay fixed or floating rates.

When the contract ends, the parties re-exchange the principal amount of the swap. For example, two companies in different countries may need to acquire currency in the opposite denomination. The two companies could arrange to swap currencies by establishing an interest rate, an agreed-upon amount, and a common maturity date for the exchange.

Currency swap maturities are negotiable for at least 10 years, making them a very flexible method of foreign exchange. Currency swaps originally were used to get around exchange controls and forex give each party access to enough foreign currency to make purchases in foreign markets.

Increasingly, parties arrange currency swaps as a way to enter new capital markets or to provide predictable revenue streams in another currency, typically as a hedge against currency risk slideshare. How a Forex Swap Transaction Works In the first leg of a forex swap transaction, a particular quantity of a currency is bought or sold versus another currency at an agreed upon rate on an initial date.

This is often called the near date since it is usually the first date to arrive relative to the current date. In the second leg, the same quantity of currency is then simultaneously sold management bought versus the other currency at a second agreed upon rate on another value date, often called the far date. This forex swap deal effectively results in no or forex little net exposure to the prevailing spot rate, since although the first leg opens up spot market risk, the second leg of the swap immediately closes it down.

Forex Swap Points and the Cost of Carry The forex swap points to a particular value date will be determined mathematically from the overall cost involved when you lend one currency and borrow another during the time period stretching from the spot date until the value date.

This is sometimes called the "cost of carry" or simply the "carry" and will be converted into currency pips in order to be added or subtracted from the spot rate. The carry can be computed from the number of days from spot until the forward date, plus the prevailing interbank deposit rates for the two currencies to the forward value date. Generally, the carry will be positive for the party who sells the higher interest rate currency forward and negative for the party who buys the higher interest rate currency forward.

Why Forex Swaps are Used A foreign exchange swap will often be used when a trader or hedger needs to roll an existing open forex position forward to a future date to avoid or delay the delivery required on the contract. Nevertheless, a forex swap can also be employed to bring the delivery date closer.

Some retail forex brokers top list of trusted brokers will even perform these rollovers automatically for their clients on positions open after 5pm EST.

On the other hand, a corporation might wish to use a forex swap for hedging purposes if they found that an anticipated currency cash flow, which had already been protected with a forward outright contract, was actually going to be delayed for one additional month.

In this case, they could simply roll their existing forward outright contract hedge out one month. They would do this by agreeing to a forex swap in which they closed out the existing near date contract and then opened a new one for the desired date one month further out. Pricing of Swaps The relationship between spot and forward is known as the interest rate parity, which states that OPTION FORWARDS A Standard forward contract calls for delivery on a specific day, the settlement date for the contract.

In most of the currency markets, banks offer what are known as Slideshare Forward Contracts or Option Forwards. Here the contract is entered into at some time t0with the rate and quantities being fixed at this time, but the buyer has the option to take or make delivery on any day between two specified future dates t1 and t2. In this case the pre-agreed exchange rate, or strike price, is 2. This type of contract is both a call on dollars and a put on sterling, and is typically called a GBPUSD put, as it is a put on the exchange rate; although it could equally be called a USDGBP call.

If the rate is lower than 2. SWAP POSITIONS The banks are always arbitrage between foreign exchange swap markets and management euro deposit markets. What does this mean? It means that banks will constantly monitor its swap rates so that they are not out of management with the forwards implied by euro deposit markets. It is quite similar to a combination of lending a currency and borrowing another.

Swap transactions need not be restricted to swaps between spot and a forward rate. They can be between two forward dates. For example, a one-month forward sale can be combined with a three month forward purchase. Such transactions are called forward- forward swaps. It can be used to take a view on interest rate differentials with a minimum of exchange rate risk. INTEREST RATE PARITY THEORY Interest Rate Parity IPR theory is used to analyze the relationship between at the spot rate and a corresponding forward future rate of currencies.

The Interest Rate Parity states that the interest rate difference between two countries is equal to the percentage difference between the forward exchange rate and the spot exchange rate.

The IPR theory states interest rate differentials between two different currencies will be reflected in the premium or discount for the forward exchange rate on the foreign currency if there is no arbitrage - the activity of buying shares or currency in one financial market and selling it at a profit in another.

The theory further states size of the forward premium or discount on a foreign currency should be equal to the interest rate differentials between the countries in comparison.

The relationship can be seen when you follow the two methods an investor may take to convert foreign currency into U. Then convert the proceeds from the investment into U. Option B would be to invest the same dollars in the U. When no arbitrage opportunities exist, the cash flows from both options are equal. In equilibrium, returns on currencies will be the same i. No profit will be realized and interest rate parity exits which can be written as: Domestic Investment In the U. Types of IPP are: Covered Interest Rate Parity CIRP Covered Interest Rate theory states that exchange rate forward premiums discounts offset interest rate forex between two sovereigns.

Uncovered Interest Rate Parity UIP Uncovered Interest Rate theory states that expected appreciation depreciation of a currency is offset by lower higher interest. In the above example of covered interest rate, the other method that Google Inc. This method is uncovered because the exchange rate risks persist in this transaction. Buy Euro forward 30 days to lock in the exchange rate.

Then Google can invest in dollars for 30 days until it must convert dollars to Euro in a month. This is called covering because now Google Inc.

Convert dollars to Euro today at spot exchange rate. Invest Euro in a European bond in Euro for 30 days equivalently loan out Euro for 30 days then pay it's obligation in Euro at the end of the month. Under this model Google Inc. This is also called covering because by converting dollars to Euro at the spot, the risk of exchange rate fluctuation is eliminated.

VIOLATION OF IRP If interest rate parity is violated, then an arbitrage opportunity exists. The simplest example of this is what would happen if the forward rate was the same as the spot rate but the interest rates were different, then investors would: If domestic interest rates are less than foreign interest rates, you will invest in foreign country at higher forex rates. Domestic investors can benefit by investing in the foreign market.

If domestic interest rates are more than foreign interest rates, you will invest in domestic market at higher interest rates 4. Foreign investors can benefit by investing in the domestic market. Options - Forex Management Chapter II - Part I.

Foreign exchange market-final ppt my. Chapter 2 - Risk Management - 2nd Semester - M. Com - Bangalore University. Start clipping No thanks. You just clipped your first slide!

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