Finale Forex

8/2/2019 Finale Forex

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Indian Forex MarketTrend Analysis from 2001 to 2011

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Objectives

To study the functioning of Forex market and exchange rate system; To study the various currency derivatives exist in Forex market; To critically evaluate the performance of various major currencies in Foreign exchange market

in comparison with Indian rupee;

To analyze the trend of world and Indian Forex market through the performance of its variousderivatives in last 10 years.

Research Methodology

The research method adopted for this project is Secondary Research (also known as desk research)

which involves the summary, collation and synthesis of existing research rather than primary research.

The data is collected from the BIS Triennial Survey Report on Global Foreign Exchange Market

Activity in Dec2010, Forex Reports from RBIs website which external sources for this project. The

proliferation of web search engines has helped and increased opportunities to gather more such

secondary research work on Forex market.

Project had employed some of the most active and significant World traded currencies for its study.

The currencies chosen are US Dollars, Euro, Japanese Yen, Pound Sterling, Indian rupee (INR) and

others. The data used are daily average in month of April for spot, futures, forwards, options and

swaps exchange rates. The US dollar (USD) is used as the numeraire currency.

Data Collection and Limitations

The project is based on the data gathered through the reports which has been published by Bank of

International Settlements (BIS) in December 2010, 53 central banks and monetary authorities

participated in that survey, collecting information from 1,309 market participants .Datas are also

collection from the various other sources such as RBI foreign exchange reports from April 2000 till

March 2011 and uses of several Forex related websites.

As the entire data is based on these reliable secondary sources for making this project, thus the

project has to solely limit itself from any other channel or sources of information in accordance to be

the part of this entire project.


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Literature Reviews

1. Forex market deals in several currency derivatives, among them the most fundamentalfinancial derivatives instruments are Futures, Options and Swaps. Derivatives could be Over

the Counter (OTC), i.e. made to order or Exchange-Traded Facilities (EFTs), which are for fixlots, periods/tenors. Derivative markets provide three essential economic functions Risk

Management, Price Discovery, and Transactional Efficiency. Risk Management in it has 3

distinctive sequential steps i.e. Risk Identification, Risk Measurement and Risk

Mitigation.Foreign Trade and Exchange VI Edition 22.1Author O.P.Agrawal.

2. Every currency in the world has its own regulations and regulatory bodies to regulate,supervise and control the supply of their currency. In India we have the RBI the Central Bank

which regulates this system. RBI has given permission to Nationalized Banks and also to

several registered Authorized Dealers (ADs) to deal with the foreign exchange transaction as

per the guidelines issue by them.Currency Derivatives: A Beginners Module NSE 2009.

3. Forex market has grown tremendous growth in last one and the half decade and experts areoptimistic about the same pace of its growth for future. The following facts and figures relate

to the foreign exchange market. Much of the information is drawn from the 2010 Triennial

Central Bank Survey of Foreign Exchange and Derivatives Market Activity conducted by the

Bank for International Settlements (BIS) in April 2010. 53 central banks and monetary

authorities participated in the survey, collecting information from 1,309 market

participants.Starting with the 2010 survey.BIS Triennial Survey Report on Global Foreign Exchange

Market Activity in Dec 2010.

4. Trend analysis has been done on each currency derivative instruments individually along withthe turnovers achieved by various countries and by currencies. US Dollar still holds the

prominent position in the Forex market with 84.90% followed by Euro with 39.10% and

Japanese Yen with 19% of the total currency distribution of global foreign exchange market

turnover. Indian Rupee just account for 0.9% in this category. BIS Triennial Survey Report on

Global Foreign Exchange Market Activity in Dec 2010.


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Introduction

What is foreign exchange?

Foreign exchange is the exchange of one currency for another

or the conversion of one currency into another currency. Foreign

exchange also refers to the global market where currencies are

traded virtually around-the-clock. The term foreign exchange is

usually abbreviated as "Forex" and occasionally as "FX.

Foreign exchange transactions encompass everything from the

conversion of currencies by a traveler at an airport kiosk to

billion-dollar payments made by corporate giants and

governments for goods and services purchased overseas. Increasing globalization has led to a

massive increase in the number of foreign exchange transactions in recent decades .The primary

purpose of the foreign exchange is to assist international trade and investment, by allowing

businesses to convert one currency to another currency. For example, it permits a US business to

import British goods and pay Pound Sterling, even though the business's income is in US dollars.

Exchange rate is the price of one currency expressed in terms of another; it has been explained in

detailed later in this project. Exchange rate is the medium though which one currency is exchanged

for another. We have two options. One is to quote so many Rupees for each Dollar and the secondoption is to quote so many Dollars per rupee or per hundred rupees. The first is called the Direct

Method and the second is called the Indirect Method. The methods are further explained as under:

Direct Method (Home Currency Quotation): Indirect Method (Foreign Currency Quotation):

Under the above method, the unit of foreign

currency remains fixed and local currency varies.

Under this method, a given unit of local currency

remains fixed and foreign currency varies In India

the unit for quoting foreign currencies is always

taken as hundred rupees.

Example:

US$ = Rs.43.20 (Spot)

Pound = Rs.75.20 (Spot)

Example:

Rs.100 = US$ 2.35 (Spot)

Rs.100 = Pound 1.33 (Spot)
http://www.google.co.in/imgres?q=foreign+exchange+market&um=1&hl=en&rlz=1R2WZPC_enIN435&biw=1366&bih=461&tbm=isch&tbnid=Vih_K_KwQoSYNM:&imgrefurl=http://netnotebook2010.blogspot.com/2010/07/foreign-exchange-markets-information.html&docid=IKP0g0E8awr_FM&w=361&h=341&ei=J606TovCEpLqgQeFl4TOBg&zoom=1


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What is foreign exchange market?

The markets, in which participants are able to buy, sell, exchange, and speculate on various

currencies. Foreign exchange markets are made up of banks, commercial companies, central banks,

investment management firms, hedge funds, retail Forex brokers, investors and individuals. The Forex

market is considered to be the largest financial market in the world.

Because these currency markets are large and liquid, they are believed to be the most efficient

financial markets. It is important to realize that the foreign exchange market is not a single exchange,

but is constructed of a global network of computers that connects participants from all parts of the

world. The foreign exchange market determines the relative values of different currencies.

The foreign exchange market has three-tier dealings:

Dealing between banks and customers; Dealing between local banks including the Reserve Bank; Dealing between domestic banks and banks abroad.

The relative ranking of foreign exchange trading centers has changed slightly from the previous

survey of BIS in 2007. Banks located in the United Kingdom accounted for 37% of all foreignexchange market turnovers, against 35% in 2007, followed by the United States (18%), Japan (6%),

Singapore (5%), Switzerland (5%), Hong Kong SAR (5%) and Australia (4%).

UK

37%

USA

18%

Japan

6%

Singapore

5%

Switzerland

5%

Hong Kong

5%

Australia4%

Others

20%

Country wise bank accounted for foreign exchange market

turnover in April 2010

Sources: BIS report 2010


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The 2010 triennial survey shows another substantial increase in global foreign exchange market

activity (spot transactions, outright forwards, foreign exchange swaps, currency swaps, currency

options and other foreign exchange products1) since the last survey in 2007, following the

unprecedented 72% rise in activity between 2004 and 2007.2 In the wake of the financial crisis, global

foreign exchange market turnover was 20% higher in April 2010 than in April 2007.

This increase brought average daily turnover to $4.0 trillion (from $3.3 trillion) at current exchange

rates. Because euro/dollar exchange rates were almost unchanged in April 2007 and 2010, growth

calculated at constant exchange rates was similar at 18%.

Global foreign exchange market turnover was 20% higher in April 2010 than in April 2007, with

average daily turnover of $4.0 trillion compared with $3.3 trillion. The increase was driven by the 48%

growth in turnover of spottransactions, which represent 37% of foreign exchange market turnover.

Spot turnover rose to $1.5 trillion in April 2010 from $1.0 trillion in April 2007.

The increase in turnover of other foreign exchange instrumentswas more modest at 7%, with average

daily turnover of $2.5 trillion in April 2010. Turnover in outright forwards and currency swaps grew

strongly (by 31% and 36%, respectively). Turnover in the large foreign exchange swaps segment was

flat relative to the previous survey, while trading in currency options fell.

0

1000

2000

3000

4000

1998 2001 2004 2007 2010

15281239

1934

3324

3981

Global foreign exchange turnover

Daily averages, in millions of US dollars


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What are the Importance & Uniqueness of foreign exchange market?

Today the daily volume of Forex trade exceeds 4 trillion US dollars, and this number is always

growing. Main currency for Forex operations is the United States dollar (USD).The foreign exchange

market is the most liquid financial market in the world.

Some of the advantages of Forex market over stock markets and/or other equities include:

Traders can make profits both on declining and developing economies; Virtually no minimum capital is required, quick registration process, etc.; Market is not regulated; Its geographical dispersion; There are no broker commissions or they are very low; Its huge trading volume representing the largest asset class in the world leading to

high liquidity;

Exchange rate are changing constantly, and fluctuations mayhappen many times per second;

The use of leverage to enhance profit and loss margins andwith respect to account size;

Unlike stock exchanges, Forex market doesn't have any fixedschedule or operating hours - it's open 24 hours per day, 5

days per week from Monday to Friday, since buy/sell orders

are performed by world banks any time during the day or

night (some banks even work on Saturdays and Sundays).

The main trading center is London, but New York, Tokyo, Hong Kong and Singapore are all important

centers as well. Banks throughout the world participate. Currency trading happens continuously

throughout the day; as the Asian trading session ends, the European session begins, followed by the

North American session and then back to the Asian session, excluding weekends.

Fluctuations in exchange rates are usually caused by actual monetary flows as well as by expectations

of changes in monetary flows caused by changes in gross domestic product (GDP) growth, inflation

(purchasing power parity theory), interest rates (interest rate parity, Domestic Fisher effect,

International Fisher effect), budget and trade deficits or surpluses, large cross-border M&A deals and

other macroeconomic conditions.


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Who are the market participants?

The market exchange rate between two currencies is determined by the interaction of the official and

private participants in the foreign exchange rate market. The official participants include the central

banks and other monetary agencies of the government. The private participants include banks, other

financial institutions, corporate and individuals.The major participants in Forex market are the buyers,

sellers, market mediators and the authorities. Besides the countrys commercial capital Mumbai,

centers for foreign exchange transactions in India include Kolkata, New Delhi, Chennai, Bangalore,

Pondicherry and Cochin.

The Authorized Dealers and the attributed brokers are qualified to participate in the foreign Exchange

markets of India. When the foreign exchange trade is going on between Authorized Dealers and RBI

or between the Authorized Dealers and the overseas banks, the brokers usually do not have any role

to play. Besides the Authorized Dealers and brokers, there are some others who are provided with

the limited rights to accept the

foreign currency or travelers`

cheque, they are the authorized

moneychangers, travel agents,

certain hotels and government

shops.Main Forex market

participants:

Central banks; Commercial banks; Investing banks; Brokers, dealers; Pension funds; Insurance companies; International corporations;

Individuals

Data for turnover by counterparty show that the increase in global foreign exchange market turnover

in 2010 is largely due to the enlarged trading activity of other financial institutions a category that

includes non-reporting banks, hedge funds, pension funds, mutual funds, insurance companies and

39%

48%

13%

Global foreign exchange market turnover by

participants percentage for April 2010

Authorized dealers Financial Institutes Individuals


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central banks. Turnover by this category grew by 42% to $1.9 trillion in April 2010 from $1.3 trillion in

April 2007.

Although a surge in activity with other financial institutions had already accounted for most of the

growth in total turnover in 2007, this categorys share (48%) surpassed transactions between

reporting dealers (39%) for the first time in 2010. Other financial institutions increased their activity

mainly in the spot market, with their share of turnover rising from 39% to 51%. In outright forwards,

their share rose from 44% to 54%.

Transactions between reporting dealers in the interbank market grew by 11% to $1.5 trillion in April

2010 from $1.4 trillion in April 2007. Some of the factors identified as drivers of the downward trend

in the share of the interbank market in analyses of previous triennial surveys, such as the increased

concentration of the banking sector and the spread of electronic broking platforms, may also have

had a dampening effect on interbank turnover.

The lower share of turnover between reporting dealers is consistent with ongoing concentration in

the FX industry. Among the top 13 global FX centers (covering 90% of global turnover), a decrease in

the number of banks accounting for 75% of the turnover was reported between 2007 and 2010 in

most centers. In contrast, in Denmark, Hong Kong SAR and Korea, an increase in competition is

evident.

Foreign exchange market transactions with non-financialcustomers have declined by 10%, falling to

$533 billion in April 2010 from $593 billion in April 2007. This category, which includes corporations

and governments, now represents around 13% of global foreign exchange market activity, its lowest

0

500

1000

1500

2000

2004 2007 2010

1018

13921548

634

1339

1900

276

593 533

Authorized dealers Financial Institutes Individuals


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share since 2001. An increase in spot transactions by these counterparties was offset by a decrease in

the use of foreign exchange swaps and currency options. The use of outright forwards and currency

swaps by non-financial customers was relatively unchanged

Exchange Rate Regimes

The term exchange rate regime refers to the mechanism, procedures and institutional framework for

determining exchange rates at a point of time and changes in them over time, including factors

which induced the changes.

Present System (under IMF Agreement) - Par Value of Exchange: Under IMF Agreement, acountry joining the Fund had to declare the value of its currency in terms of gold or of theUSD, of the weight and fineness in effect on July 1, 1944, established in the process a system

of fixed parities between the currencies of the member countries and later on April 1, 1978

the 2nd Agreement of the IMF stated, all the values established earlier for currencies have

ceased to exist, and the member countries are no longer bound to establish par values.

Under the Bretton Woods Agreement, the rates of exchange were permitted to fluctuate upto

1% on either side of the par values of the currencies of the member countries, the margin

was later widen to 2.25% from 1%.

In theory, there are a very large number of exchange rate regimes are possible. At two extremes, are

the perfectly rigid or fixed exchange rates, and the perfectly flexible or floating exchange rates?

Between them are hybrids with varying degrees of limited flexibility.

Fixed Exchange Rate: There are two ways the price of a currency can be determined againstanother. A fixed, or pegged, rate is a rate the government (central bank) sets and maintains

as the official exchange rate. A set price will be determined against a major world currency

(usually the U.S. dollar, but also other major currencies such as the euro, the yen or a basket

of currencies).

Floating Exchange Rates: Unlike the fixed rate, a floating exchange rate is determined by theprivate market through supply and demand. A floating rate is often termed "self-correcting",

as any differences in supply and demand will automatically be corrected in the market. Take a


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look at this simplified model: if demand for a currency is low, its value will decrease, thus

making imported goods more expensive and stimulating demand for local goods and

services. This in turn will generate more jobs, causing an auto-correction in the market.

What Does Purchasing Power Parity PPPMean?

PPP is an economic theory that estimates the amount of adjustment needed on the exchange rate

between countries in order for the exchange to be equivalent to each currency's purchasing power.

The relative version of PPP is calculated as:S=P1/P2

Where:

"S" represents exchange rate of currency 1 to currency 2

"P1" represents the cost of good "x" in currency 1

"P2" represents the cost of good "x" in currency 2

In other words, the exchange rate adjusts so that an identical good in two different countries has the

same price when expressed in the same currency. For example, a chocolate bar that sells

for C$1.50 in a Canadian city should cost US$1.00 in a U.S. city when the exchange rate between

Canada and the U.S. is 1.50 USD/CDN. (Both chocolate bars cost US$1.00.)


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How the currency exchange rate is calculated?

There are various factors that determine an exchange rate such as trade value, inflation, and interest

rates, to name a few. These are basic principles to help understand the concept.

Let's work in a closed vacuum and assume there is no inflation between two countries or any other

factors and examine fluctuations based on wealth and trade. We begin with country A, which lets call

the USA and country B which we call Britain. Lets imagine that 1 UD Dollar = 1 British Pound.

Example of Trade Value: Now let's say that the Americans own $100 and the British own 100

Pounds. If America buys $5 worth of product from Britain, America would have $95 and Britain would

have 105 Pounds. Suddenly Britain becomes wealthier by approximately 10% now.

(100/95x105=10.52%), so suddenly $1 would be worth around 1 Pound and 10 Pence. This is the

principle of trade surpluses and trade deficits and wealth within a currency.


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Example of Interest rate: Now let's imagine that America and Britain each have $100 again. Let's say

that over 1 year, prices in America stayed the same but in Britain, prices went up 5%. We would now

have an effect where Britain is 5% poorer then America and $1 would be now worth 1 Pound and 5

Pence. This is where interest rates are determined. Britain could have helped keep $1 worth 1 Pound

by having an Interest rate of 5%.

Interest rates are determined normally by a Reserve Bank governor that determines economic policy

for a currency. Interest rates can also be manipulated to stimulate an economy by strengthening or

weakening a currency.

Example of Excess Money Printing: Now we can also consider what would happen if Britain deicide

to print money twice than what it had before. If America and Britain each has $100 and 100 Pounds

each respectively, and Britain decided to print 200 Pounds in an attempt to get wealthier, suddenly

$1 would equal 50 pence. However if Britain had found 100 Pounds of gold and was worth 200

Pounds, then $1 would still equal 1 Pound.

Very basically, this is how the system works, however is much more complex in reality.

Various Forex Terms

Convertibility: In a strict sense a currency can be considered convertible, only if both residents and

non-residents have full freedom to use and exchange it for any purpose whatsoever, at some definite

rate of exchange. However in practice large number of currencies is considered convertible with

various degrees of restrictions and controls.

Current Account & Capital Account: Current account includes all transactions, which give rise to or

use of our National income, while Capital Account consist of short term and long term capital

transactions.

As per FEMA "capital account transaction" means a transaction which alters the assets or liabilities,

including contingent liabilities, outside India of persons resident in India or assets or liabilities in India

of persons resident outside India. Those which are not Capital Account transactions are current

Account transactions.


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Current Account Transactions covers the following. All imports and exports of merchandise; Invisible Exports and Imports (sale/purchase of services);

Inward private remittances to & from; Pension payments (to & from); Government Grants (both ways).

Capital Account transactions consist of the following Direct Foreign Investments (both inward & outward); Investment in securities (both ways); Other Investments (both ways); Government Loans (both ways); Short-term investments on both directions.

The substance of convertibility is to dispense with the flexible management of foreign exchange and

exchange rates and to adopt a more liberal and market driven exchange allocation process. All

transactions are still conducted within the framework of exchange controls, as prescribed by the RBI.

Over-The-Counter (OTC): Within the derivatives markets, many of products are traded through

exchanges. An exchange has the benefit of facilitating liquidity and also mitigates all credit risk

concerns the default of a member of the exchange. Product traded on the exchange must be well

standardized to transparent trading.

Non-standard products are traded in the so-called over-the-counter (OTC) derivatives markets. OTC

derivatives have less standard structure and are traded bilaterally (between two parties). In such

bilateral contract, each party should have credit risk concerns with respect to the other party. OTC

derivatives are significant in the asset classes such as interest rate, foreign exchange, equities and

commodities.


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Growth in the positions of OTC foreign exchange instruments was moderate at 9%, compared with an

increase of 83% in notional amounts outstanding of currency instruments in the 2004 07 periods.

Notional amounts outstanding in all instruments peaked in June 2008, declined thereafter and

recovered somewhat by June 2010.

Notional amounts outstanding provide useful information on the structure of the OTC foreign

exchange market but should not be interpreted as a measure of the counterparty risk of these

positions. While no single comprehensive measure of risk exists, a useful concept is the cost of

replacing all open contracts at the prevailing market prices. This measure, called gross market value,increased at a considerably higher rate (96%) than notional amounts during the reporting period, to

$3.2 trillion at the end of June 2010.

0

500000

1000000

1500000

2000000

Spot Outright Forwards Forex Swaps

1187699

391501

1600101

691210

149687

609801

OTC foreign exchange turnover by instruments, counterparty and currency in April 2010.

Total reported transactions in all currenices by top four traded currencies.


USD

Euro

Yen

GBP

0

20000

40000

60000

80000

100000

120000

Currency Swaps Options Sold Options Bought

38313

105529 101003

17673

57445 54981


Total reported transactions in all currenices by top four traded currencies.


USDEuro

Yen

GBP


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Sharp asset price movements following the bankruptcy of Lehman Brothers in September 2008

resulted in a strong rise of gross market values in the second half of 2008. Gross market values

declined rapidly again in subsequent periods as prices moved closer to their pre-crisis values, but

increased again in the first half of 2010 as foreign exchange markets went through another bout ofturbulence.

The daily average OTC foreign exchange market for India during the month of April 2010 has shown

that the turnover in US Dollar holds the dominant position as compared with the other strong world

currencies such as, Euro, Yen, GBP and Swiss franc.

OTC market for US Dollar was almost 5 times more than taking all other currencies together. The

total OTC market for US Dollar has around 26474million dollars followed by Euro at only 3401million

dollars, GBP at 1987million dollars, Japanese Yen at 750 million dollars and CHF at 93 million dollars.

Arbitrageur: A type of investor who attempts to profit from price inefficiencies in the market by

making simultaneous trades that offset each other and capturing risk-free profits. Arbitrageurs are

typically very experienced investors since arbitrage opportunities are difficult to find and require

relatively fast trading.

An arbitrageur would, for example, seek out price discrepancies between stocks listed on more than

one exchange, and buy the undervalued shares on one exchange while short selling the samenumber of overvalued shares on another exchange, thus capturing risk-free profits as the prices on

the two exchanges converge.

Hedger: Hedgers are individuals and firms that make purchases and sales in the futures market solely

for the purpose of establishing a known price level weeks or months in advance, for something they

0

10000

20000

30000

USD Euro Yen GBP Swiss Franc

26474

3401 750 1987 93

OTC foreign exchange turnover of India in April 2010.



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later intend to buy or sell in the cash market. In this way they attempt to protect themselves against

the risk of an unfavourable price change in the interim.

Speculator: A person who trades derivatives, commodities, bonds, equities or currencies with a

higher-than-average risk in return for a higher-than-average profit potential. Speculators take largerisks, especially with respect to anticipating future price movements, in the hope of making quick,

large gains. Speculators are typically sophisticated; risk-taking investors with expertise in the market(s)

in which they are trading and will usually use highly leveraged investments such as futures and

options.

About 70% to 90%of the foreign exchange transactions are speculative. In other words, the person or

institution that bought or sold the currency has no plan to actually take delivery of the currency in

the end; rather, they were solely speculating on the movement of that particular currency. Hedge

funds have gained a reputation for aggressive currency speculation since 1996. They control billionsof dollars of equity and may borrow billions more, and thus may overwhelm intervention by central

banks to support almost any currency, if the economic fundamentals are in the hedge funds' favour.

Notional Amount: The notional amount (or notional principal amount or notional value) on a

financial instrument is the nominal or face amount that is used to calculate payments made on that

instrument. This amount generally does not

change hands and is thus referred to as

notional.

Appreciation: The rise in the value of one

currency relative to another is called

appreciation. When the currency of one country

appreciates relative to another country, ones

countrys goods prices raise abroad and foreign

goods prices decline in your country. This will

benefit domestic consumers who buy foreign

goods, but makes domestic businesses less

competitive.

Depreciation: A decline in the value of one currency relative to another is called depreciation. When

the currency of one country depreciates relative to another country, ones countrys goods prices

0%

10%

20%

30%

40%

50%

60%

70%

80%

Speculative Hedge Arbitrage

75%

17%

8%

Foreign exchange transactions in percentage

by market participants


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decline abroad and foreign goods prices rise in your country. This will benefit domestic businesses,

but will affect domestic consumers who buy foreign goods.

Economic Indicator: A government issued statistic that indicates current economic growth and

stability. Common indicators include employment rates, Gross Domestic Product (GDP), Inflation,Retail sales, etc.

London Interbank Offered Rate LIBOR: An interest rate at which banks can borrow funds, in

marketable size, from other banks in the London interbank market. The LIBOR is fixed on a daily basis

by the British Bankers' Association. The LIBOR is the world's most widely used benchmark for short-

term interest rates. It's important because it is the rate at which the world's most preferred borrowers

are able to borrow money. It is also the rate upon which rates for less preferred borrowers are based.

For example, a multinational corporation with a very good credit rating may be able to borrow

money for one year at LIBOR plus four or five points. Countries that rely on the LIBOR for a reference

rate include the United States, Canada, Switzerland and the U.K.

Absolute Rate: The fixed portion of an interest-rate swap, expressed as a percentage rather than as a

premium or a discount to a reference rate. The absolute rate is a combination of the reference rate

and the premium or discounted fixed percentage. For example, if the LIBOR is 3% and the fixed

interest portion of the swap is at a 7% premium, the absolute rate is 10%.

Forward Discount: In a foreign exchange situation where the domestic current spot exchange rate is

trading at a higher level than the current domestic futures spot rate for a maturity period. A forward

discount is an indication by the market that the current domestic exchange rate is going to

depreciate in value against another currency.

Instruments

The Forex derivative products that are available in Indian financial markets can be sectored into three

broad segments viz. forwards, options, currency swaps. We take a look at all of these segments indetail. The major instruments used in the FX markets are spot, outright forwards, FX swaps, currency

options, currency swaps, currency futures and exchange traded options.

Spot exchange rate: Spot rates are the rates at which different currencies are traded forimmediate exchange. In a spot transaction the seller of exchange has to deliver the foreign


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exchange he has sold 'on the spot' (usually within 2 days). Similarly the buyer of exchange

will receive the foreign exchange he has bought immediately.

Spot Exchange of currency the second day after the date on which two foreign-exchange

traders agree to do the transaction Spot rate: Rate at which transaction is settled Value date/Settlement date: Day on which delivery of currency takes place i.e. on the second day of the

agreement.

Example: On Thursday, an Indian and an American agree to execute the deal in spot market. When

will the deal be affected? Now, the exchange of currencies will take place on Saturday. If the

particular market is closed on Saturday and Sunday, delivery of currency shall take place on Monday.

Foreign exchange spot turnover rose to $1.5 trillion in April 2010 from $1.0 trillion, an increase of48% at current exchange rates. The increase in spot market turnover to a share of 37% of the global

activity accounts for three quarters of the overall increase in global foreign exchange market activity

relative to the previous survey. The higher turnover in spot transactions is largely due to more active

trading by other financial institutions, followed by inter-dealer trading.Other financial institutions

increased their activity mainly in the spot market, with their share of turnover rising from 39% to

51%.

Forward exchange rate: This is the rate at which foreign currency dealers are willing topromise to buying or selling a currency in the future. This gives information about the view ofmarket participants on whether the currency appreciates or depreciates in future.

Inforward market foreign exchange instruments contracts are made to buy and sell currencies

for future delivery, say for duration of one month(30 days), three months(90 days), six

0

500

1000

1500

1998 2001 2004 2007 2010

568386

631

1005

1490

Global Spot transactions turnover

Daily averages in April, In Billions of US$


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months(180 days), nine months(270 days) and one year(360 days). Rate of exchange for the

transaction is agreed upon on the very day the deal is finalized.

Example: The one month forward contracts that were contracted respectively on the 28th & 29th

January 2011. What would be the settlement date? For both, it will be 28th February as 2011 as itwas not a leap year. So this is the value date in both the transactions.

Relation to Spot Rates: Forward exchange rate is generally expressed in relation to spot rate ruling

at the time when forward rate is quoted. Forward quotations can be made as: At a premium on the

spot rate or at a discount from it, referred to as forward differential or at par with the spot rate. The

linkage between the spot and forward exchange rates come from the actions of three groups of

economic agents who use the market, viz. Arbitrageurs, Hedgers, andSpeculators.

If forward rate > spot rate: forward premium, If forward rate < spot rate: forward

discount.

The global turnover in outright forwardstransactions was increased by 31% to $475 billion from $362

in 2007.Forward contracts among the banks and financial institutes around the globe have resulted in

this growing trend of this derivative instrument.

Forward Contracts: Forward contracts are offered by Banks. In forward contracts Banks quote an

exchange rated today for sale or purchase of foreign exchange at a future date.

0

100

200

300

400

500

1998 2001 2004 2007 2010

128 130

209

362

475

Global Forward transactions turnover



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Rupee Forwards Contracts: An important segment of the Forex derivatives market in India is the

Rupee forward contracts market. This has been growing rapidly with increasing participation from

corporates, exporters, importers, banks and FIIs.

Till February 1992, forward contracts were permitted only against trade related exposures and thesecontracts could not be cancelled except where the underlying transactions failed to materialize.In

March 1992, in order to provide operational freedom to corporate entities, unrestricted booking and

cancellation of forward contracts for all genuine exposures, whether trade related or not, were

permitted.

Cross Currency Forwards: Cross currency forwards are also used to hedge the foreign currency

exposures, especially by some of the big Indian corporates.

Example: A corporate having underlying exposure in Rupee, may book forward contract between

Dollar and Sterling. Here even though its exposure is in Rupee, it is also exposed to the movements

in Dollar visa-a-visa other currencies. The regulations for rebooking and cancellation of these

contracts are also relatively relaxed. The activity in this segment is likely to increase with increasing

convertibility of the capital account.

Futures Contract: Futures foreign exchange instruments is an agreement between two partiesto buy or sell a particular currency at a particular price on a particular date, as specified in the

0

5

10

15

20

25

30

35

40

45

2001 2004 2007 2010

3028 27 28

2017

13 14

1013 12

9

46 6 6

36 36

42 43

Global foreign exchange market turnover by Cross-currency

Daily averages in April, in percentages

USD/Euro

USD/Yen

USD/GBP

USD/AUD

USD/Others


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contract to all participants in that currency futures exchange. Its market is an organized

market like an exchange and not OTC.

Futuresdeal is not settled on maturity instead rates are matched daily with the movements in

spot market and gains and losses are credited and debited to the traders account everydayrespectively. This is known as marking to market.

Currency futures are exactly similar to forward contracts except that the deal is put through a futures

exchange, which functions on lines similar to a stock exchange. These contracts are available for fixed

amount and standard period, and thus do not command the same flexibility as forward contract.

Some of the advantages of future contract are:

Currency futures, since they are traded on organized exchanges, also confer benefits fromconcentrating order flow and providing a transparent venue for price discovery, while over-the-counter forward contracts rely on bilateral negotiations.

Two characteristics of futures contract- their minimal margin requirements and the lowtransactions costs relative to over-the-counter markets due to existence of a clearinghouse,

also strengthen the case of their introduction.

Credit risks are further mitigated by daily marking to market of all futures positions with gainsand losses paid by each participant to the clearinghouse by the end of trading session.

Contract standardization and clearing house facilities mean that price discovery can proceedrapidly and transaction costs for participants are relatively low.

Foreign Exchange Swaps:Exchanging a set of currencies in spot date and the reversal of theexchange of currencies at a predetermined time in the future.Swaps are long term hedging

instruments to manage exchange rate and interest rate risks. It is possible when there are two
http://en.wikipedia.org/wiki/Forex_swaphttp://en.wikipedia.org/wiki/Forex_swap


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parties interested in converting foreign currency in domestic currency and interested in

covering the transaction over a long span of time.

A major advantage of swap is that it allows both the parties to hedge exchange rate

fluctuations over a long period of time. FX Swap is a simultaneous spot and forwardtransaction a simultaneous sale and purchase of a certain amount of foreign currency for two

different dates it is accounted as a single transaction.

First Leg: Spot transaction (Trader buys or sells on the spot market).

Second Leg: Forward transaction - reverse (Trader buys or sells on the forward market) Also known

as spot-forward swap.

Example: A borrower wishes to obtain Swiss francs (CHF) to finance business expansion in

Switzerland but may not be able to do so. At the same time, this borrower has access to dollar

capital market and may be able to borrow it on relatively attractive terms. If counterparty exists who

has, a net asset position in CHF and a desire for low-cost dollar funds, the opportunity for currency

swap exists.

Foreign exchange swaps, the most actively traded foreign exchange instrument by far, are widely

used by banks to raise liquidity across money markets for different currencies.The dominance of

reporting banks in this market has declined markedly over time, falling from 70% of total turnover in

1998, and around 60% in 2001 and 2004, to just 47% in 2010. At $1.8 trillion (+3%), the level of

turnover is largely unchanged from the prior survey. The distribution of trading across other

counterparties and maturities was also largely unchanged from 2007.

Swap as a Financial Market Product: Swap literally implies exchange in Forex market the term

Swap implies simultaneous spot purchase and forward sale of a foreign currency against another

0

500

1000

1500

2000

1998 2001 2004 2007 2010

734 656954

1714 1765

Global Forex Swaps transactions turnover



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and vice versa. The Bank for International Settlements defines the term a swap is in financial

transaction in which two counterparties agree to exchange streams of payments over time.

Swap, as mechanism for widespread use is a development of recent origin during the last two

decades. This is due to the progressive elimination of exchange and capital controls and therevolutionary developments in telecommunication and computer technology, active 24-hour trading

in foreign exchange has emerged.

As a result of these innovations the process of liberalization and consequent integration of markets is

underway. The high volatility of exchange rates and interest rates have opened up opportunities for

large profit to market participants in the spot as well as in the forward markets, provided they are on

the right side of the market. Trading is now increasingly guided by new decision techniques,

particularly chart-based by sell recommendations, rather than considerations of the underlying

economic factors as previously done.

Such a move towards sophistication and globalization of markets in turned opened up arbitrage

opportunities, which are increasingly availed through swaps and options (which will be explained in

detailed later) in an effective manner.

The most commonly used types of Swaps are Currency and Interest Rate Swaps. The currency swap

began in 1981, while interest rate swap started in 1982.


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A Currency swap enables contracting parties to exchange predetermined streams of payments

denominated in another currency during an agreed period of time. Two types of Currency Swaps are

commonly transacted:

1.

Fixed/Fixed Currency Swap (Both terms fixed refer to interest rates)2. Cross Currency Interest Rate Swaps. Fixed/Fixed Currency Swap: In this type of swap contracts, fixed interest payments on a

specified principal amount of one currency is swapped for fixed interest payment on an

agreed equivalent principal amount of another currency.

Unlike in the case of interest rate swap, where principal currency amount being in the same

currency and therefore not exchanged on the final maturity exchanged, in a currency swap

the principal amount may be exchanged on the final maturity date of the swap contract at

pre-determined exchange rate. Sometimes the principal amount in the respective currency

may be exchanged initially and then re-exchanged at the maturity of the contract.

Example: An American firm can take out a loan in the U.S. at a 7% interest rate, but requires a loan

in yen to finance an expansion project in Japan, where the interest rate is 10%. At the same time, a

Japanese firm wishes to finance an expansion project in the U.S., but the interest rate is 12%,

compared to the 9% interest rate in Japan. Each party can benefit from the other's interest rate

through a fixed-for-fixed currency swap. In this case, the U.S. firm can borrow USD for 7%, and then

lend the funds to the Japanese firm at 7%. The Japanese firm can borrow Japanese yen at 9%, andthen lend the funds to the U.S. firm for the same amount.

0

10

20

30

40

50

1998 2001 2004 2007 2010

107

21

31

43

Global Currency Swaps transactions turnover



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Trading in currency swaps also grew strongly, by 39%, although from a much lower level, to $43

billion. The use of outright forwards and currency swaps by non-financial customers was relatively

unchanged. Not all foreign exchange OTC instruments showed limited growth in amounts

outstanding. Currency swaps increased to almost $19 trillion outstanding in June 2010, growing by a

third relative to 2007, increasing their share of outstanding instruments to 30%.

There are four main elements in a fixed/fixed currency swap.

1. There are fixed interest payments on due dates in the respective currencies.2. There are specified principal amounts in two currencies on which interest payments at the

specified interest rates are calculated.

3. There is an exchange rate involved. In this case it is the spot rate on contract date. It caneven be a mutually agreed forward rate. The same exchange rate is used for computing the

principal amount for calculating the interest payments and also for the exchange of principal

on the initial date and re-exchange on the maturity date of the swap contract.

4. There is a specified maturity period.There are three types of interest rate swaps:

a. Coupon Swaps: A coupon swap is a fixed or floating rate interest swap in which two partiesexchange fixed interest payments with floating interest payments on an underlying principal

amount denominated in the same currency.

Example: Party A agrees to exchange fixed Interest rate at 10% on $10 million for floating

interest rate based on 6 months LIBOR for $10 million with a swap Bank for a period of 3 years.

b. Basic Swaps: A basic swap involves exchange of interest payments calculated on differentterms, such as 6 month LIBOR and prime rate (or triple a commercial paper rate).

c. Cross Currency Interest Swaps: In this type of swaps exchange of payment on differentcurrencies is involved.

Example: Exchange dollar 6 months floating rate with fixed rupee interest rates for a specifiedperiod on equivalent not notional principal amounts, or fixed rate dollar with fixed rate rupee.


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Options Market: Options is a right but not the obligation to buy or sell a foreign currencywithin a certain time period or on a specific date at a specific exchange rate. The rate at

which one currency can be purchased or sold is known as exercise/strike price. The fee or

cost of the option is called premium. Options are purchased OTC from a commercial or

investment bank or it can be purchased on a stock exchange where options are traded.

Options, as an instrument is an improvement over forward and futures contracts. In a forward

contract the Bank as well as the customers are under obligation to complete the transaction

art the specified date irrespective of the exchange rate movement. In an option the bank has

an obligation but the customer has a right and no obligation.

Types of Options:

Call Option: An option to purchase the underlying currency, it gives the right but not the obligation

to purchase an option.

Put Option: An option to sell the underlying currency, it gives the right but not the obligation to sell

an option.

Example: A person decides to acquire options to buy CHF at a price of US $ 0.70 along with a

premium for US $ 0.02. On the maturity date, if:

Spot rate of CHF (0.65) < Agreed rate (0.70) the buyer will let the option expire as he canpurchase it in the spot market at a cheaper rate.

Spot rate of CHF (0.75) > Agreed rate (0.70) the buyer will exercise the option as his cost ofbuying the Swiss francs under the options contract will be 0.72 (0.70+0.02), whereas, he can

sell this currency in spot market at a higher rate (0.75).

0

50

100

150

200

250

1998 2001 2004 2007 2010

8760

119

212 207

Global Options & other transactions turnover



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Cross Currency Options: The Reserve Bank of India has permitted authorized dealers to offercross currency options to the corporate clients and other interbank-counterparties to hedge

their foreign currency exposures.

Before the introduction of these options the corporates were permitted to hedge their foreigncurrency exposures only through forwards and swaps route. Forwards and swaps do remove

the uncertainty by hedging the exposure but they also result in the elimination of potential

extraordinary gains from the currency position. Currency options provide a way of availing of

the upside from any currency exposure while being protected from the downside for the

payment of an upfront premium.

Currency options market declined by 2% between surveys, with average daily turnover of $207 billion

in April 2010. However, turnover in currency options with other financial institutions increased, their

share in this sector rising from 43% to 55%.

Turnover of outright forwards, foreign exchange swaps, currency swaps, currency options and other

OTC foreign exchange products continues to be many times larger than the volumes traded on

organized exchanges. Daily turnover for currency instruments on organized exchanges was $168billion, less than 7% of the $2.5 trillion average daily turnover in those instruments.

0

50

100

150

200

250

1998 2001 2004 2007 2010

87

60

119

212 207

Global Currency options and other products turnover

Daily averages in April, in billions of US dollars


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30

Other Exotic Options: Options being over the counter products can be personalized to therequirements of the clients. More sophisticated hedging strategies call for the use of complex

derivative products, which go beyond plain vanilla options.

These products could be introduced at the inception of the Rupee vanilla options or inphases, depending on the speed of development of the market as well as comfort with

competencies and Risk Management Systems of market participants. Some of these products

are mentioned below:

Simple structures involving vanilla European calls and puts such as range-forwards,bull and bear spreads, strips, straps, straddles, strangles, butterflies, risk reversals,etc.

Simple exotic options such as barrier options, Asian options, Look-back options andalso American options.

More complex range of exotics including binary options, barrier and range digitaloptions, forward-start options, etc.

Some of the above-mentioned products especially the structure involving simple European calls and

puts may even be introduced along with the options itself, But in India such kind of options are still

not in operation.According to the BIS 2010 survey the trading activity in other related foreign

exchange instruments continued to expand, but at a much more moderate pace than in the three

years to April 2007. Average daily turnover in these instruments grew by 7% to $2.5 trillion in April

2010, compared with an increase of 78% in the previous three-year period.


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Indian Forex Market

Indian Forex market is small when compared with other developed countries but with the

multinationals coming up and new government policies the path of expansion is on its new heights.The Indian government has now open up new ways to trade and regulated this market as well. India

has shown great rise in its Forex turnover in last three years. People now feel comfortable to trade in

and exit from the market.

In India people are now more aware of the kinds of trading like derivative markets, options,

swapping, hedging etc. The most important characteristic of Forex is the impact on various currencies

by the change in one currency rates. Any economic activity in world affects the Forex market

immediately.In India, the economic liberalization in the early nineties provided the economic rationale

for the introduction of FX derivatives. Business houses started actively approaching foreign markets

not only with their products but also as a source of capital and direct investment opportunities.

The liberalization process has significantly boosted the foreign exchange market in the country by

allowing both banks and corporations greater flexibility in holding and trading foreign currencies. The

Sodhani Committee set up in 1994 recommended greater freedom to participating banks, allowing

them to fix their own trading limits, interest rates on FCNR deposits and the use of derivative

products.

Indian foreign exchange market have shown one of the most significant increases in emerging market

currencies along with for the Turkish lira, Chinese renminbi and Korean won, followed by the Brazilian

0

5000

10000

15000

Spot Outright

Forwards

Forex Swaps Currency

Swaps

Options

13527 13620

6789

50

4623


Total reported transactions in all currenices by India.



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real and Singapore dollar. The renminbi now accounts for almost 1% of global turnover, on a par

with the Indian rupee and the Russian ruble.

India's share in world Forex market has shown growth of 0.9% last year and will grow further. It is the

fastest growth of any country. The growth rates of developed countries are much lower compared

with developing countries. UK and USA have shown the lowest change in contribution of foreign

exchange.

The foreign exchange market in India started in earnest less than three decades ago when in 1978

the government allowed banks to trade foreign exchange with one another. Today over 70% of the

trading in foreign exchange continues to take place in the inter-bank market. The market consists of

over 90 Authorized Dealers (mostly banks) who transact currency among themselves and come out

square or without exposure at the end of the trading day.

Trading is regulated by the Foreign Exchange Dealers Association of India (FEDAI), a self regulatory

association of dealers. Since 2001, clearing and settlement functions in the foreign exchange market

are largely carried out by the Clearing Corporation of India Limited (CCIL) that handles transactions of

approximately 3.5 billion US dollars a day, about 80% of the total transactions.

0

0.2

0.4

0.6

0.8

1

1998 2001 2004 2007 2010

0.10.2

0.3

0.7

0.9

INR distribution of global foreign exchange market turnover

percentage shares of averages daily turnover in April


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India today operates around 27 billion dollars foreign exchange market as compared with 2 billion

dollars in 1998, tough in the 2010 the foreign exchange transaction in India went down from 38

billion dollars in 2007 to the current position of 27 billion dollars in 2010, the expert of the Forex

market still are very bullish as they see this down fall as an impact of global crisis on Indian market.

In March 2006, about half (48%) of the transactions were spot trades, while swap transactions

(essentially repurchase agreements with a one-way transaction spot or forward combined with a

longer- horizon forward transaction in the reverse direction) accounted for 34% and forwards and

forward cancellations made up 11% and 7% respectively. About two-thirds of all transactions had the

rupee on one side.

In 2004, according to the triennial central bank survey of foreign exchange and derivative markets

conducted by the Bank for International Settlements (BIS (2005a)) the Indian Rupee featured in the

20th position among all currencies in terms of being on one side of all foreign transactions around

the globe and its share had tripled since 1998. As a host of foreign exchange trading activity, India

Spot

36%

Forwards

36%

Forex Swaps

18%

Currency Swaps

0%

Options & other

instruments

10%Currency and instrument

distribution of

INR market turnover

Percentage shares of

average dailyturnover in April 2010

0

10

20

30

40

1998 2001 2004 2007 2010

2 37

38

27

Geographical distribution of global foreign exchange market turnover

Daily averages in April, in billions of USD and percentage


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ranked 23rd among all countries covered by the BIS survey in 2004 accounting for 0.3% of the world

turnover. Trading is relatively moderately concentrated in India with 11 banks accounting for over

75% of the trades covered by the BIS 2004 survey.

The foreign exchange market can be classified into two segments.

The merchant segment consists of the transactions put through by customers to meet their

transaction needs of acquiring/offloading foreign exchange, and inter-bank segment encompassing

transactions between banks. At present, there are over 100 Authorized Dealers (Ads) operating in the

foreign exchange market.

The banks deal among themselves directly or through foreign exchange brokers. The inter-bank

segment of the Forex market is dominated by few large Indian banks with State Bank of India (SBI)

accounting for a large portion of turnover, and a few foreign banks with benefit of significant

international experience.

The customer segment is dominated by Indian Oil Corporation and certain other large public sector

units like Oil and Natural Gas Commission, Bharat Heavy Electricals Limited, Steel Authority of India

Limited, Maruti Udyog and also Government of India (for defense and civil debt service) on the one

hand and large private sector corporates like Reliance Group, Tata Group, Larsen and Tubro, etc., on

the other. Of late, the Foreign Institutional Investors (FIIs) have emerged as a major component in the

foreign exchange market and they do account for noticeable activity in the market.

The Indian foreign exchange market is a huge financial market exceeding an annual turnover of 400

billion valued in US$ in terms only by public dealings (i.e. excluding inter-bank transactions). It is the

third wing of the financial markets in India, the others being the money market and the capital

market.One of big advantages of the market is its' close relation with latest information technologies.

Clients from different parts of the planet may connect to Internet and start trading. Even big banks

tend to use electronic trading - it's the most common way of trading now. At this moment, Forex is

at the rapid developing phase, and it's expected to grow more and more in the future.


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Liberalization has transformed Indias external sector and a direct beneficiary of this has been the

foreign exchange market in India. From a foreign exchange-starved, control-ridden economy, India

has moved on to a position of $319 billion plus in international reserves in Jul 2011, with a confident

rupee and drastically reduced foreign exchange control. As foreign trade and cross-border capital

flows continue to grow, and the countrymoves towards capital account convertibility, the foreignexchange market is poised toplay an even greater role in the economy, but is unlikely to be

completely free of RBIinterventions any time soon.

Who is the authorized Forex Dealer?

Any type of financial institution that has received authorization from a relevant regulatory body to act

as a dealer involved with the trading of foreign currencies. Dealing with authorized Forex dealers

ensure that your transactions are being executed in a legal and just way.

Which are the Forex Regulatory & Supervisory Bodies?

In the current system, the Reserve Bank of India and its affiliates intervene in the market whenever

they decide it is necessary.The FX market in India is regulated by The Foreign Exchange Management

Act, 1999 or FEMA, before this act was introduced; the foreign exchange market in India was

regulated by the reserve bank of India through the Exchange Control by Foreign Exchange Regulation

Act, 1947.

Foreign exchange market in India is totally structured, well regulated both of RBI and also by a

voluntary association (Foreign Exchange Dealers Association). Only Dealers authorized by RBI can

undertake such transactions.All inter-bank dealings in the same center must be affected through

accredited brokers, who are the second arm in the market-structure. However, dealings between the


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authorized dealers and the RBI and also between the AD (Authorized Dealers) and overseas Banks are

affected directly without the intervention of the brokers.

In addition to the authorized dealers covering commercial banks, who undertake comprehensive

transactions covering all spheres of foreign exchange, there are also a peripheral market consisting oflicensed money changers and travel agents, who enjoy limited authorization especially for

encashment of travelers cheques, notes.

Specified hotels and Government owned Shops are also given restricted licenses to accept payment

from non-residents in foreign currencies. IDBI and Exim Bank are permitted to handle and hold

foreign currencies in a restricted way.Now, the regulators have introduced several innovations to

promote the growth of FX market in India.

Factors that affects IndFX market

The factors affecting the exchange rates in the long run include relative price levels in each country,

preferences for domestic vs. foreign goods, productivity and government controls. The buying and

selling of currency by the policy makers to control the supply and demand in the FX market influence

exchange rates in countries like India.

Exchange rates are highly influenced by:

Economic factors (economic indicators of countries at the moment, politics of Central banks,changing interest rates, behaviour of importers and exporters, etc.);

Political factors (speeches of political leaders, president elections, etc.); Market participants' mood and feelings, their expectations, rumours, etc.; Force-major events (terroristic acts, accidents, catastrophes, etc.).


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Size of World Forex Market

The foreign exchange market is the most liquid financial market in the world. Traders include large

banks, central banks, institutional investors, currency speculators, corporations, governments, other

financial institutions, and retail investors. The average daily turnover in the global foreign exchange

and related markets is continuously growing. According to the 2010 Triennial Central Bank Survey,

coordinated by the Bank for International Settlements, average daily turnover was US$3.98 trillion in

April 2010 (vs. $1.7 trillion in 1998).Of this $3.98 trillion, $1.5 trillion was spot foreign exchange

transactions and $2.5 trillion was traded in outright forwards, FX swaps and other currency

derivatives.


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Data for turnover by counterparty show that the increase in global foreign exchange market turnover

in 2010 is largely due to the enlarged trading activity of other financial institutions a category that

includes non-reporting banks, hedge funds, pension funds, mutual funds, insurance companies and

central banks. Turnover by this category grew by 42% to $1.9 trillion in April 2010 from $1.3 trillion in

April 2007.

Although a surge in activity with other financial institutions had already accounted for most of the

growth in total turnover in 2007, this categorys share (48%) surpassed transactions between

reporting dealers (39%) for the first time in 2010. Other financial institutions increased their activity

mainly in the spot market, with their share of turnover rising from 39% to 51%. In outright forwards,

their share rose from 44% to 54%.

Transactions between reporting dealers in the interbank market grew by 11% to $1.5 trillion in April

2010 from $1.4 trillion in April 2007 (Table B.2). Some of the factors identified as drivers of the

downward trend in the share of the interbank market in analyses of previous triennial surveys, such as

the increased concentration of the banking sector and the spread of electronic broking platforms,

may also have had a dampening effect on interbank turnover

Trading in the UK accounted for 36.7% of the total, making UK by far the most important globalcenter for foreign exchange trading. In second and third places, respectively, trading in the USA

accounted for 17.9%, and Japan accounted for 6.2%.

Turnover of exchange-traded foreign exchange futures and options have grown rapidly in recent

years, reaching $166 billion in April 2010 (double the turnover recorded in April 2007). Exchange-


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traded currency derivatives represent 4% of OTC foreign exchange turnover. FX futures contracts were

introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other

futures contracts.

Most developed countries permit the trading of FX derivative products (like currency futures and

options on currency futures) on their exchanges. All these developed countries already have fully

convertible capital accounts. A number of emerging countries do not permit FX derivative products

on their exchanges in view of controls on the capital accounts. The use of foreign exchange

derivatives is growing in many emerging economies.Countries such as Korea, South Africa, and India

have established currency futures exchanges, despite having some controls on the capital account.

Turnover by currency

0

20

40

60

80

100

2001 2004 2007 2010

89.9 88 85.6 84.9

37.9 37.4 37 39.1

23.5 20.8 17.2 1913 16.5 14.9 12.9

Currency distribution of global foreign exchange market turnoverPercentage shares of average daily turnover in April

USD

Euro

Yen

GBP


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The currency compositionof turnover has

changed only slightly over the past three

years, with the relative share of the maincurrencies diverging somewhat. The market

share of the top three currencies (the US

dollar, euro and Japanese yen) increased by

3% points, with the market share of the top 10

increasing by only 1.4 percentage points. The

biggest increases were seen for the euro and

yen, and the biggest decline for sterling. The most significant increases in emerging market currencies

were seen for the Turkish lira, Chinese renminbi and Korean won, followed by the Brazilian real and

Singapore dollar.The renminbi now accounts for almost 1% of global turnover, on a par with the

Indian rupee and the Russian ruble.

The US dollar continued the slow retreat from its 90% peak share of all transactions, reached in the

2001 survey just after the introduction of the euro. The share of foreign exchange transactions

involving the US dollar has fallen over time, to 85% in April 2010. This decline benefited the euro,

which gained 2 percentage points in market share since the last survey and accounted for 39% of all

transactions. The Japanese yen also increased its market share by 2 percentage points, to 19%, a

recovery relative to the 2007 survey but still below its 2001 peak of 24%.

Geographical distribution of turnover

US Dollar43%

Euro

18%

GBP

7%

Yen

9%

Others

23%

Foreign exchange market turnover by currency

Daily averages in April 2007

US Dollar42%

Euro

20%

GBP

6%

Yen

10%

Others

22%

Foreign exchange market turnover by

currency Daily averages in April 2010


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The geographical distribution of foreign exchange trading typically changes slowly over time, and the

2010 results are no exception (Table B.8). Banks located in the United Kingdom accounted for 37% of

global foreign exchange market turnover, followed by those in the United States (18%), Japan (6%),

Singapore (5%), Switzerland (5%), Hong Kong SAR (5%) and Australia (4%). Japan has recovered its

third-place ranking, which it lost in the 2007 survey. Singapore has moved ahead of Switzerland in

2010.

In dollar terms, the greatest increases in trading activity were in the United Kingdom ($370 billion),

the United States ($159 billion), Japan ($62 billion) and Hong Kong SAR ($57 billion). Other countries

that saw significant growth relative to the 2007 survey include Denmark, France, Singapore, Finland,

Turkey, Australia and Spain.

Regional turnover by instrument is fairly evenly divided between spot transactions, which account for

about 50% of turnover in North and Latin America and for about a third of turnover in other regions,

and outright forwards and FX swaps, which account for almost two thirds of turnover in most regions

but around 45% in the Americas. The remainder comprises options, which account for around 5% ofturnover.

0

200

400

600

800

1000

1200

1400

1600

1800

2000

2001 2004 2007 2010

542

835

1483

1854

273

499

745

904

104 134242 266

153207 250

312

91 120 101 109

Geographical distribution of global foreign exchange market turnover

Daily averages in April, in billions of US Dollar

UK

USA

Singapore

Japan

Germany


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The US dollar continued the slow retreat from its 90% peak share of all transactions, reached in the

2001 survey just after the introduction of the euro. The share of foreign exchange transactions

involving the US dollar has fallen over time, to 85% in April 2010. This decline benefited the euro,

which gained 2 percentage points in market share since the last survey and accounted for 39% of all

transactions. The Japanese yen also increased its market share by 2 percentage points, to 19%, a

recovery relative to the 2007 survey but still below its 2001 peak of 24%.


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Turnover by currency pair

Turnover by currency pair in April 2010 showed no major changes in ranking from three years earlier,

although absolute turnover in the major currency pairs tended to increase, with the exception of

dollar/sterling transactions. USD/EUR remained by far the dominant pair (with a 28% share), followed

at some distance by USD/JPY with a slight increase to 14% of turnover. The USD/GBP pair continued

to retreat from its 2004 peak to a 9% share or about the level reached in pre-euro 1998, but the

EUR/GBP pair gained almost 60% in absolute terms.

0

200

400

600

800

1000

1200

2004 2007 2010

541

892

1101

328438

568

259

384 360

107185

249

Global foreign exchange market turnover by currency pair

Daily averages in April, in Billions of USD and percentages

USD/Euro

USD/Yen

USD/GBP

USD/AUD

Sources: BIS 2010


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Growth & opportunities in Indian Forex market

The Indian foreign exchange market has grown significantly in the last several years. The daily

average turnover has gone up from about USD 5 billion per day in 1998 to more than USD 50 billion

per day in 2008. There is also evidence of growing merchant turnover reflecting the huge increase in

external transactions. The bid offer spreads are also narrow.

The Foreign Exchange Market in India is a flourishing ground of profit and higher initiatives are taken

by the central government in order to strengthen the foundation.Until 1992 all foreign investments in

India and the repatriation of foreign capital required previous approval of the government. The

Foreign-Exchange Regulation Act rarely allowed foreign majority holdings for foreign exchange in

India. However, a new foreign investment policy announced in July 1991, declared automatic approval

for foreign exchange in India for thirty-four industries. These industries were designated with highpriority, up to an equivalent limit of 51 percent.

Indian authorities are able to manage the exchange rate easily, only because foreign exchange

transactions in India are so securely controlled. From 1975 to 1992 the rupee was coupled to a trade-

weighted basket of currencies. In February 1992, the Indian government started to make the rupee

convertible, and in March 1993 a single floating exchange rate in the market of foreign exchange in

India was implemented. In July 1995, `31.81 were worth US$1, as compared to`7.86 in 1980, `12.37 in

1985, and `17.50 in 1990.

0

0.2

0.4

0.6

0.8

1

2001 2004 2007 2010

0.2

0.3

0.7

0.9

INR distribution of global foreign exchange market turnover

Percentage shares of average daily turnover in April


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The foreign exchange market India is growing very rapidly, since the annual turnover of the market is

more than $400 billion. This foreign exchange transaction in India does not include the inter-bank

transactions. According to the record of foreign exchange in India, RBI released these transactions.

The average monthly turnover in the merchant segment was $40.5 billion in 2003-04 and the inter-

bank transaction was $134.2 for the same period. The average total monthly turnover in the sector of

foreign exchange in India was about $174.7 billion for the same period. The transactions are made on

spot and also on forward basis, which include currency swaps and interest rate swaps.

Since the onset of liberalization, foreign exchange markets in India have witnessed explosive growth

in trading capacity. The importance of the exchange rate of foreign exchange in India for the Indian

economy has also been far greater than ever before. While the Indian government has clearly

adopted a flexible exchange rate regime, in practice the rupee is one of most resourceful trackers of

the US dollar.

The foreign exchange market in India is actively influenced by macro level changes in the

international foreign exchange market. Hence to understand the present scenario of Indian Foreign

Exchange Market, it is necessary to focus on the major developments in the international FX. Markets

that have taken place in the recent past that hasan impact in Indian environment such as:

Liberalization of trade and economic activities creating global pattern of trade and commerce Globalization process has taken deep roots in the world and every country now looks to the

world as the market for its product;

Trade barriers are being dismantled world over and a closer integration of the worldeconomy is taking shape;

Revolutionary change in the structure of FX business today financial transactions and intra-day trading constitute more than 90-95% of daily turnover in the market;

With revolutionary developments in telecommunication and computer technology, an active24-hour trading in foreign exchange has emerged;

Due to instantaneous dissemination of information simultaneously to all centers around theworld, exchange rates in all centers are today closely aligned.


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Forex derivative instruments status as on 31st March 2011.

The Bank uses the following types of derivative instruments for hedging and trading purposes.

Interest rate and bond futures are contractual agreements to receive or pay a net amountbased on changes in interest rates or bond prices on a future date. Futures contracts are

settled daily with the exchange. Associated margin payments are settled by cash or

marketable securities.

Currency and gold options are contractual agreements under which the seller grants thepurchaser the right, but not the obligation, to either buy (call option) or sell (put option), by

or on a set date, a specific amount of a currency or gold at a predetermined price. In

consideration, the seller receives a premium from the purchaser.

Currency and gold swaps, cross-currency interest rate swaps and interest rate swaps arebilateral contractual agreements to exchange cash flows related to currencies, gold or interest

rates (for example, fixed rate for floating rate). Cross-currency interest rate swaps involve the

exchange of cash flows related to a combination of interest rates and foreign exchange rates.

Except for certain currency and gold swaps and cross-currency interest rate swaps, no

exchange of principal takes place.

Currency and gold forwards are bilateral contractual agreements involving the exchange offoreign currencies or gold at a future date. This includes undelivered spot transactions.

Forward rate agreements are bilateral interest rate forward contracts that result in cashsettlement at a future date for the difference between a contracted rate of interest and the

prevailing market rate.

Swaptions are bilateral options under which the seller grants the purchaser the right, but notthe obligation, to enter into a currency or interest rate swap at a predetermined price by or

on a set date. In consideration, the seller receives a premium from the purchaser.


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In addition, the Bank sells products to its customers who contain embedded derivatives. Where the

host contract is not accounted for as held at fair value, embedded derivatives are separated from the

host contract for accounting purposes and treated as though they are regular derivatives. As such,

the gold currency options embedded in gold dual currency deposits are included within derivatives as

currency and gold options.

The table below analyses the fair value of derivative financial instruments:


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Suggestions for improvement

The Indian foreign exchange market hasundergone transformation from a closed and

heavilycontrolled setting of the 1970s and the 1980s to amore open and market oriented regime

since the mid-1990s. The foreign exchange market, which witnessedderegulation in conjunction with

current accountconvertibility and liberalization of capital controls inmany areas, lent considerable

support to the externalsector reform process. The criticality of a well-functioningmarket with its ability

to trade and settletransactions in new products and adapt itself quicklyto the changing regulatory

and competitiveenvironment has been demonstrated well in the Indiancontext.

The bid-ask spread of rupee/US dollar ratehas almost converged with that of other majorcurrencies in

the international market. On someoccasions, in fact, the bid-ask spread of rupee/USdollar rate was

lower than that of some major currencies. The Reserve Bankintervenes in the foreign exchange

market primarilyto prevent excessive volatility and disorderlyconditions. Such intervention is notmotivated by anypre-determined target or band around the exchangerate. The objective is to keep

market movementsorderly and ensure that there is no liquidity problem or rumour/panic-induced

volatility. Indias approach ofmarket determination of the exchange rate, flexibility,combined with

intervention, as felt necessary, hasserved it well so far. Moving forward, further initiatives

fordeveloping the Indian foreign exchange market needto be aligned with the external sector

reforms,particularly the move towards:

Improvement in Market Infrastructure: Against the backdrop of corporates in Indiagoing global, it

is essential that the Indian foreignexchange market is able to provide them with thesame types ofproducts and services as are availablein the major markets overseas. The agenda for thefuture should,

therefore, include introduction of moreinstruments, more participants and improved

marketinfrastructu

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