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Forex Trading For Beginners

Foreign exchange market participation is one of the major tasks in international banking. And the treasury department of a bank deals with the foreign exchange risk in international banking with some different foreign exchange products. The greatest volume of currency is traded in the interbank market. By using effective strategies to manage foreign exchange, bank can help itself to mitigate risks and expand opportunities. The
most common cause of foreign exchange (FX) risk arises from making overseas payments for your imports that are priced in a foreign currency and Receiving foreign currency for your exports. Beside this banks can participate in the foreign exchange trade for speculative motive.

Functions of Foreign Exchange Market

# Adequate FX position
# Forward cover facility for Importer/ Exporters
# Market based pricing
# Spot sale for Import payments
# Spot purchase for export receipts
# Up to date Nostros reconciliation
# Prompt facilitation of transactions to & from foreign banks through Nostros/ Vostros Foreign exchange market is the organizational framework where the various national currencies are bought and sold. Practically it is a worldwide market, which is made up of individuals, commercial banks and other authorized agents. The foreign exchange market performs some important functions:
# Foreign exchange market transfers funds or purchasing power from one nation and currency to another.
# Foreign exchange market facilitates financing of International trade.
# Foreign exchange market facilitates avoiding foreign exchange. The exchange rate is the price of one country’s money in terms of another country’s money. This is the rate at which two national currencies are exchanged. The exchange rate is determined by the intersection of the market demand curve and supply curves of foreign currency. The demand for foreign exchange arises primarily in the course of importing goods and services from abroad and making foreign investments and loans. The supply of foreign exchange arises in the course of exporting goods and services and receiving foreign investments and loans. The “spot” exchange rate is the price for immediate exchange. (Immediate usually means within two working days. Banks normally quote a “two way price” in the currency i.e. both buying (bid) and selling (ask or offer)rates. The maxims for finding out buying and selling rates in two different quotation systems are different.

Structure of Foreign Exchange Market

In foreign exchange literature we come across a variety of terminology to indicate methods of expressing or quoting exchange rates. Sometimes exchange rate spot quotations are grouped as direct and indirect quotations. In case of direct quotation, domestic currency is expressed in variable units for a fixed unit of foreign currency; and in interest rates.

Foreign Currency Exchange´╗┐

Some operational exchange rates are in use in facilitation of trade services. For inward remittance, bank use TT clean buying rate. This rate is only used for the private remittance i.e. worker’s remittance. But for outward remittance TT and OD selling rate is used. For all import payment, banks use BC selling rate. In the case of export, for contract based receipts, like cash in advance, open account and documentary collection, TT DOC buying rate is applied for proceeds realization. For sight export LC, banks apply OD Sight buying rate. But in case of purchasing usance export LC, different bank group exercise different interest rates. In all export financing, lower interest rate should be applied. But there is a lack of uniformity in applying interest rate in purchasing usance export LC by different banks. The range of exchange rates of sample banks in different trade services are shown below:
Outward Remittance: TT & OD Selling
Cash in Advance Export: TT DOC Buying
Cash in Advance Import: BC Selling
Open account Export: TT DOC Buying
Open Account Import: BC Selling Documentary Collection Export: TT DOC Buying
Documentary Collection Import: BC Selling
Documentary Credit Export: OD Sight Buying
Documentary Credit Import: BC Selling

Currency Exchange Rates

A foreign exchange derivative is a financial derivative whose payoff depends on the foreign exchange rate(s) of two (or more) currencies. These instruments are commonly used for currency speculation and arbitrage or for foreign exchange risk. FX Derivatives can be used to mitigate the risk of economic loss arising from changes in the value of the underlying currency transaction. The basic derivative strategies are hedging, speculation
and arbitration. The main use of FX derivatives is to minimize risk for one party while offering the potential for a high return (at increased risk) to another. The foreign exchange via derivatives are traded (and privately negotiated) directly between two parties or specialized derivatives exchanges or other exchanges. In the foreign exchange market, beside spot contract other currency derivatives, forward, future, option and swap, are traded.

Spot Rate: A spot transaction is one in which the actual exchange of currencies takes place immediately. In a spot transaction, delivery of the currencies takes place on the second working day after the day of the contract-this is the international convention. Thus, for a spot transaction struck on Tuesday, delivery will take place on Thursday, provided both Wednesday and Thursday are working days. However, the exchange rate applicable is the rate prevailing at the time of striking the deal. In a spot transaction, the delivery date is referred to as the spot date.
Forward Rate: A forward exchange contract is one in which a party enters into a contract with a bank to buy or sell a fixed amount of foreign currency at a specified future date at a predetermined rate of exchange. Under this contract, a buyer and seller agree on an exchange rate for exchange of currencies on a future date. The actual delivery of currencies takes place only on such future date at the rate already agreed upon, regardless
of the market rates prevalent then. Thus, in a forward contract, currencies are bought and sold for delivery on a future date.
Future Rate: Futures are contracts of engaging currencies in the future at a predetermined exchange rate. In this respect they are similar to forward contracts. But futures are standardized contracts with standard contract sizes and maturity dates. Moreover, future are traded on an organized exchange created for this purpose. The settlement of the deal that is, the delivery of the currencies by the buyer and the seller is facilitated by the
clearing house of the exchange.
Options: A currency option contract is a derivative instrument. It is a contract that gives the buyer of the option the right, not the obligation, to buy or sell a particular currency at a pre-agreed exchange rate, known as the strike rate, within a specified period. The option that gives the right to buy a particular currency is referred to as call option, while the
option that gives the right to sell a particular currency is referred to as put option. Options is purchased by paying a price known as option premium.
Swaps: In a foreign currency swap transaction, two parties exchange a pair of currencies for a certain length of time and agree to reverse the transaction at a later date. It is the purchase of one currency against another currency for one value date (i.e., delivery date) and the simultaneous reversal of that exchange contract for a different value date.
Currency swaps may be affected for different time frames as spot against future basis, future against future basis or spot against spot basis.

Reasons for International Tarde

Commodity derivatives markets have been in existence for centuries, driven by the efforts of commodities producers, users and investors to manage their business and financial risks. Banks can hedge the price risk of commodities that are traded on exchanges or over-the-counter (OTC) of their customers through standard exchange traded futures/options and OTC derivatives on commodities subject to prior approval of respective authority. The use of commodity derivatives will only be permitted when customers have genuine underlying commodity price risk exposure(s). This can be monitored by the Banks through checking of the underlying risk exposure documents. Any kind of speculation through the use of commodity derivative instruments will not be permissible by domestic regulators. Banks must completely hedge the commodity price risk arising from the commodity hedge transactions by booking back to back transactions with banks having international standing or their branches operating in the country.



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