Foreign exchange rates concepts

Foreign exchange rates concepts

• 1.
  Dr. Mohamed KuttyKakkakunnan Associate Professor P.G. Dept. of Commerce N A M College Kallikkandy Kannur – Kerala – India
• 2.
  FOREIGN EXCHANGE RATES– DIFFERENT CONCEPTS The rate at which one currency is converted into another currency The price of one currency expressed in terms of another currency Two markets – exchange traded markets and over the counter market (OTC market) Exchange traded market, information related with the transaction (rate, quantity) etc are available to the public. Based on the rate, the broker receives commission
• 3.
   In anOTC, rates are generally displayed, but may not be actual or real, it is only indicative  In such situation banker is the price maker and quotes two rates one for purchases and the other for sale - known as two-way quote 1. Bid rate: rate at which currencies are bought 2. Ask rate: rate at which currencies are sold  Profit : difference between bid and ask rates  Generally quoted up to four decimals – but for currencies whose base rate is 100 – quoted up to two decimals  RBI publishes reference rates – indicative only
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  Merchant and bankrate Two-tiers in foreign exchange market First-tier – banker and ultimate customer – applicable rate merchant rates Second tier – inter-bank transactions – inter-bank rate The market is known as inter-bank market Inter-bank rates are generally quoted at four decimals Merchant rates are derived from interbank rates
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  Cross and VehicleCurrency In the case of two countries, when direct exchange of currencies is not possible, exchange rate of these two countries is determined on the basis of a third country, which is popular in these two countries. This third currency, which is used to determine the exchange rate is called the vehicle currency The rate determined with reference to the third currency is called the synthetic rate or cross rate
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  Effective exchange rate Deprecationand appreciation in the values of currencies A particular currency may depreciate in terms of one currency and the same currency at the same time may appreciate in terms of other currencies. To understand how particular currency perform an index will be calculate known as effective exchange rate Effective exchange rate is the measure of the average value of a currency relative to two or more other currencies
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  Steps involved inthe calculation of effective exchange rates 1. Identify / select currencies of countries to be included in the calculation. All currencies may be considered or few selected currencies 2. Assign weights to these currencies on the basis of their significance in foreign trade  For assigning weights the following procedure is followed • Suppose India has trade relation only with two countries- Japan and US Export to Japan - 4000, to US 6000 Import from Japan 3000, from US 7000 Weight to Japan (4000+3000) / (4000+30000)+ (6000+7000) = 0.35 Weight to US (6000+7000) / (6000 + 7000) + (4000+3000) = 0.65
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  3. Find outthe simple index number of the currencies of these currencies P1/P0*100 4. Determine effective exchange rate (index of country 1 x weight of the country) + (index of country 2 x weight of the country) By comparing the indices, it is possible to determine real value changes in the home currency Index base year 100 current year 113, then home currency is depreciated by 13 points
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  CURRENCY ARBITRAGE Arbitrage meansbuying and selling the same security in different market to make profit by taking advantage of the price differentials Buying from the markets at lower prices And selling the same in another market at higher prices Simultaneous sale or purchase of currency in different markets to take advantage of exchange rate differences