2. FOREIGN EXCHANGE INTENSIVE UNDERSTANDING OF THE CONCEPT AND FEW NUMERICALS BASED ON FOREX:
Direct quote is when a unit of foreign currency is expressed in terms of home currency E.g. SD/INR 45.00.
Indirect quotes is when a unit of home currency is expressed in terms of a foreign currency E.g. 1 unit of euro is equal to USD 1.40 – only a few currencieslike GBP/Euro, Euro/USD and AUD/USD are quoted in this manner.
In cross currency quotes where home currency (say, INR) is not involved, the currency to the right side of the quote is known as terms currency and the currency to the left side is base currency.
The usage applies to direct as well as indirect quotes.
TOD (or cash) is delivery on the same day (today) and TOM is delivery next day (tomorrow)
All the rates quoted by banks are interbank rates i.e. these rates are applicable between banks. For a customer margin is added or deducted When a customer wishes to buy currency .
Base currency is the currency which is being bought and sold and the other currency is incidental.
Forwards are quoted as follows • Spot/1 month 17/18 • Spot/ 2 months 35/37 • Spot/ 3 months 53/56 If forward differentials are in the ascending order (1st figure is lower than the 2nd) the base currency is at premium.
FEDAI prescribed types of rates of merchant transactions: • TT (buying)- clean inward remittances • Bill (buying)- purchase/discount of export bills • TT (selling) clean outward remittances • Bill (selling) remittance for import bills
1. Based on the data given below answer the questions from (i) to (iii) Following are Inter-bank quotes on certain date Spot USD/INR 45.70/75 1 month 5/7 2 month 8/10 3 month 12/15 Spot GBP/USD 1.8000/8010 1 month 30/25 2 month 50/45 3 month 60/65 Margin of the bank is 3 paise
(i) An exporter presents a sight bill. What rate will be quoted to the exporter. Ans. Spot USD/INR is 45.70/75. This means bank is willing to buy USD at 45.70 and sell at 45.75. When an export customer goes to bank he will be selling currency to bank thus bank will be buying currency from the customer.
The basic principle followed by bank is buy low sell high. Whenever bank buys currency it deducts margin from the spot so that it has to pay lower to the customer. In this case bank will buy at Spot – Margin ie. 45.70 -0.05 = 45.65. Thus rate quoted to the customer will be 45.65
(ii) Another exporter submitted 3 month usance bill. What rate will be quoted to the customer. Ans: Usance bills mean payment will be made after a specified period. 3 month export usance bill means foreign exchange will be received by the bank 3 months from now. To arrive at this forward rate add premium to the spot rate ie 45.70+0.12 = 45.82 from this deduct margin hence rate given to customer will be 45.79
(iii) Calculate GBP/INR rate Ans: This is the example of calculating cross rate. Here USD/INR is 45.70/75 & GBP/USD is 1.8000/8010. Now we need to calculate GBP/INR which means how many INRs will be equal to 1 GBP. Here 45.70 INR= 1 USD and 1.8000USD equals 1 GBP . It means 1.8000* 1 USD = 1 GBP . Thus 1.8000* 45.70 = 1 GBP thus GBP/INR is 82.26/40
Though bankers may find these questions tough they are not really so and just need basic understanding of the concepts. But First understand one basic concept that is exchange rates are determined. Various factors determine exchange rate most important being demand of currency. So a currency with higher demand will be a stronger currency. Dollar has very high demand and is thus a strong currency. Kuwaiti Dinar is the strongest currency the world 1 KWD = 3.42 USD 1 KWD = 2.80 Euro 1 KWD = 217.97 Indian Rupee –
Another factor which determines exchange rate between two countries is the interest rate between two countries. Remember one rule a country with high interest rates has weak currency and country with low interest rate has strong currency. A country like India which has interest rate of 8-9% has weak currency while a country like US has interest rate of around 0.25 % .
So suppose you want to buy one dollar now you can buy it a spot Rate lets say that rate is 1$= Rs 62. But what if you want to know what would be rate of this dollar 3 months from now? This will depend upon premium or discount. If a country has lower interest rate it will be at premium, if currency has higher rate of interest it will be at discount.
We add premium to the spot rate and deduct discount from spot rate to arrive at the future rate known as forward rate.
Calculation of Rates: Illustration 1: Spot USD is Rs 44.80/85. If forward premium is given as under 1M – 0234/0239 2M-0303/0307 3M – 0323/0327 What rate will be quoted to an export customer who books 1 month forward contract .
Ans 1: Spot rate is given as 44.80/85 here 44.80 is the bid rate and 44.85 is the ask rate. Now always remember that questions here are to be solved from the point of view of bank and not of customer. 44.80 which is bid rate means bank is willing to buy one dollar for Rs 44.80 from a customer but will sell one dollar for Rs 44.85 to a customer.
Now always remember export customer means a customer who has made exports and receives foreign exchange. He will go to bank to sell this foreign exchange to the bank which in other language means bank will buy foreign exchange from the exporter. So when quoting rates to an exporter buy rate of bank is to be considered which Rs 44.80 in this case. However forward contract for 1month to be booked which means bank will buy this exchange one month from now and hence one month rate is to be arrived.
The premium for one month is 0234.
We will add this premium to the spot rate to arrive at one month forward rate, Thus one month forward rate at which contract is to be booked is Spot rate --- ------------ 44.8000 Add- 1M Premium----- 0.0234 ------------- 44.8234