Forex Market and Currency Risk

Forex market is a complex subject, here we will touch upon some of the important aspects of that effect the risk profile of an international transaction.

1.     Spot Rate : An arrangement to buy or sell currency at the current exchange rate is known as spot transaction. The exchange rate quoted for the transaction is called spot rate.

Generally, spot transactions are undertaken for an actual exchange of currencies two business days following the transaction date (T+2)

2.     Forward Rate : This is future rate, possibally as far as a year ahead. Traders agree to buy and sell currencies for settlement beyond two business days, at predetermined exchange rates. These type of transactions are often used by businesses to reduce their exchange rate risks.

Calculating the forward Rate : For an example, if when the client sells USD 100,000.00 transaction, the spot rate was 67 and the interest rate differential was 5%, the 30 day forward contact rate would be calculated as below :

 

USD 100,000 X 67 = INR 67,00,000

INR 67,00,000 X 5% divided by 12 months = INR 27,916.66

INR 67,00,000 + INR 27,916,.66 = INR 67,27,916.66

INR 67,27,916.66 /USD 100,000 = 67.28

 

In above example forward rate would be 28 paisa higher than the spot rate.

3.     RBI Reference Rate : This rate is given by RBI is based on the 12 noon rates of a few selected bank in Mumbai.

4.     Inter-Bank Rate : The rates quoted by the banks for buying and selling foreign currency in the inter-bank market, which works on wafer thing margins. For inter-bank transactions the quotation is up to four decimals with the last two digits being in multiples of 25.

5.     TT Rate: Stands for telegraphic transfer, it is the fastest means of transferring funds from one to another by wire. The main disadvantage with the cheques and the demand drafts is that these instruments have to be physically presented, often leading to delays in payment. To overcome delays, funds transfer through the medium of telex were introduced.

6.     TC Rate :  TC stands for travelers cheques, These are prepaid instruments available in fixed denominations, the holder of the TC is required to sign the instrument upon purchase and again in the presence of the merchant establishment, at the time of making payment or the realizing proceeds thereof.

The interbank rates are finer than TC rates and are based on the TT rates used for all inward and outward remittances.

Due to credit card and digital way of using money TC is used very rare in present scenario.

7.     Currency Rate: This is the rate at which the authorized dealer buys and sells the currency notes to its customers. It depends on the TC rate and is worse than the TC rate for the person who is buying them.

8.       Cross Rate : In Inter-Bank cases, mostly currencies are traded against USD which becomes the reference point, so if one is buying with INR a FCY X which is not normally traded, then he can arrive at a rupee-exchange rate but relating the Rupee-USD rate to the USD-X rate. This is known as a cross rate.

9.     Long and Short Rate : when we go long on a FCY, it means we are holding it in the expectation that it will increase in value. By contrast, going short means we are selling FCY in the expectation that what you are selling will b e decreasing in value further.

10. Bid and Ask Rate: Buying price for a FCY is called Bid rate and the selling price for a FCY is called its ask rate. Together the two prices constitute a quote, the difference between two rates is the sp5read, that is the difference between the price offered by a dealer willing to sell something and the price he is willing to give to buy.

 

Forward vs Spot rate :

It is possible for a forward rate of a currency to equal its spot rate. However, interest rates must be considered. The interest rate that can be earned by holding different currencies usually varies, thus forward rates can be higher or lower than the spot rates.

 

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Chandan Kumar Yadav
My name is Chandan Kumar Yadav CDCS, CSDG, CITF, PGDIBO,AML-KYC, CCFE, MLIBF, CSF, 6SIGMA a trade finance professional with an experience of 11 years whereas worked with several stages of letter of credit, bank guarantee and on other payments methods of trade transactions such as documentary collection, open accounts, SBLC etc., I have a fair understanding of Trade Based Money Laundering as well, Blogging related to Trade Finance is my passion and I want to share which I know and learn from others, I have worked with Wells Fargo, Yes Bank Limited and Bank of America, India which helped me to gain knowledge, view of Trade Finance and importance of International Trade in world's economy. Trade Finance is thumping product, everyday we are learning something new so in order to keep learning I started this as one of the platform. . Let's Learn Together

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