PAN African e-Network Project

Diploma in Business Management

Managerial Economics & Analysis
Semester - I
Session - 10

Ms. Tavishi

Meaning of Foreign Exchange

The term Foreign exchange implies two things: a)foreign
currency and b) exchange rate
Foreign exchange generally refers to foreign currency, eg
for India it is dollar, euro, yen, etc &
the other part of foreign exchange is exchange rate which
is the price of one currency in terms of the other currency.
Forex is the international market for the free trade of
currencies. Traders place orders to buy one currency with
another currency.

 According to Hartly Withers, Foreign exchange is

the art and science of international monetary
exchange
The foreign exchange market is the worlds largest
financial market. Over $4 trillion dollars worth of
currency are traded each day. The amount of money
traded in a week is bigger than the entire annual GDP
of the United States.
The main currency used for foreign exchange trading
is the US dollar.
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Foreign exchange market

Foreign exchange market is that market in which
national currencies are traded for one another..
The major participants in this market are commercial
banks, foreign exchange brokers, and authorized
dealers and the monetary authorities.
Besides, transfer of funds form one country to another ,
speculation is an important dimension of foreign
exchange market.
Its where money in one currency is exchanged for
another

Advantages of Forex market

Its already the worlds largest market and its still
growing quickly
It makes extensive use of information technology
making it available to everyone
Traders can profit from both strong and weak
economies
Trader can place very short-term orders which are
prohibited in some other markets

 The market is not regulated

Brokerage commissions are very low or nonexistent
The market is open 24 hours a day during
weekdays

Terms related to Foreign Exchange

Foreign exchange reserves- holdings of other
countries' currencies
Foreign exchange controls- controls imposed by a
government on the purchase/sale of foreign currencies
Retail foreign exchange platform- speculative trading
of foreign exchange by individuals using electronic
trading platforms
Foreign exchange risk- arises from the change in price
of one currency against another

 International trade- the exchange of goods and

services across national boundaries
Foreign exchange company- a broker that
offers currency exchange and international
payments
Bureau de change- a business whose
customers exchange one currency for another

 Currency pair- the quotation of the relative

value of a currency unit against the unit of
another currency in the foreign exchange
market
Digital currency exchanger- market makers
which exchange fiat currency for electronic
money

Exchange rate
According to haines, Exchange rate is the price of
the currency of a country can be exchanged for the
number of units of currency of another country.
Exchange rate is that rate at which one unit of
currency of a country can be exchanged for the
number of units of currency of another country.
Its the the price for which one currency is exchanged
for another

Factors influencing Exchange Rates

As with any market, the forex market is driven by
supply and demand:
If buyers exceed sellers, prices go up
If sellers outnumber buyers, prices go down
The following factors can influence exchange rates:
National economic performance
Central bank policy
Interest rates
Trade balances imports and exports
Political factors such as elections and policy changes

 Market sentiment expectations and rumours

Unforeseen events terrorism and natural disasters
Despite all these factors, the global forex market is more
stable than stock markets; exchange rates change
slowly and by small amounts.

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Types of exchange rates

Fixed and Floating exchange rates

Fixed exchange rate is the official rate set by the
monetary authorities of the Governance for one or
more currencies.
Under floating exchange rate, the value of the
currency is decided by supply and demand factors

Direct and indirect exchange rates

Direct method - Under this, a given number of units
of local currency per unit of foreign currency is
quoted. They are designated as direct/certain rates
because the rupee cost of single foreign currency unit
can be obtained directly. Direct quotation is also
called home currency quotation.
Indirect method Under this, a given number of
units of foreign currency per unit of local currency is
quoted. Indirect quotation is also called foreign
currency quotation

Buying and selling

Exchange rates are quoted as two way quotes
for purchase
and for sale
transactions by the Bank

Spot and forward

The delivery under a foreign exchange transaction can
be settled in one of the following ways
Ready or cash To be settled on the same day
Tom To be settled on the day next to the date of
transaction
Spot To be settled on the second working day from
the date of contract
Forward To be settled at a date farther than the spot
date

Theories of exchange rate

determination
Meaning:
Theories which determine the prices of forex rate
considering inflation, interest rate, and elasticity of
price etc..
Methods:
a) Long run theory
b) Short run theory

Long Run Theory of Exchange rate

Determination:
This are the theories which predominately take into account the
fundamental changes of economy.
Here fundamental changes refers to the change which are going
to change the economic performance of the economy Purchasing
powfor all times to come.
Types of theory:
Purchasing power parity.
1) Absoulte purchasing power parity.
2) Relative purchasing power parity.
Interest Rate parity
1) Covered Interest Rate parity
2) UnCovered Interest Rate parity

Short Run theory of exchange rate

determination
This theories are based more on current information
or immediate performance of economic variables.
This theories try to take into account the short run
factor which may be eliminated in the long run.

Purchasing power parity theory

Founder Swedish economist Gustav Cassel in 1918.
Meaning : According to this theory ,the price levels and
the changes in these price levels in different countries
determine the exchanges rates of these countries
currencies.
The basic principle of this theory is that the exchange
rates between various currencies reflect the purchasing
power of these currencies .This theory is based law of
one price.

Absolute form of PPP Theory

If the law of one price were to hold good for each and
every commodity then the theory is termed as Absolute
form of PPP Theory.
This theory describes the link between the spot
exchange rate and price levels at a particular point of
time

Relative form of PPP

This theory describes the link between the changes in
spot exchange rate and in the price levels over a
period of time.
According to this theory ,changes in spot rates over a
period of time reflect the changes in the price level
over the same period in the concerned economies.
This theory relaxes three assumptions of PPP ie
Absences of transportation cost ,transaction costs and
tarriffs.

Interest Rate Parity Theory

Definition :
The process that ensures that the annualized forward
premium or discount equals the interest rate
differential on equivalent securities in two currencies.
International Fisher effect:
Expected Rate of change = Interest rate of the
exchange rate differential
Interest Rate = Real Interest Expected Differential
Rate + inflation rate

Modern theory: demand & supply

theory
The most satisfactory explanation of the
determination of the rate of exchange is that a
free exchange rate tends to be such as to
equate the demand and supply of foreign
exchange..
The intersection of supply curve and demand
curve gives the equilibrium price
Modern theory also called balance of payments
theory of foreign exchange

Foreign Exchange Risk

Exposure to exchange rate movement.
Any sale or purchase of foreign currency entails
foreign exchange risk.
Foreign exchange transaction affects the net asset or
net liability position of the buyer/seller.
Carrying net assets or net liability position in any
currency gives rise to exchange risk.

Risk management
Controlling losses
You could control your losses, by mental stop or hard
stop. Mental stop means that you already set you limit
of your loss. A hard stop is your initiative to stop when
you think you must to stop it.
Using correct lot size
As a beginning just use smaller lots you could stay
flexible and logic than emotions while you trade.
Tracking overall exposure

 sample: you go to short on EUR/USD and long on

USD/CHF, you exposed two times for USD in the
same direction. If USD goes down , you have a
double dose of pain. So, keep your overall exposure
limited, it keeps you for the long haul for trading
The bottom line
Trading is about opportunities, you must take action
while the opportunities arise.

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MONEY MARKET

1) Meaning of Money Market:

Money market refers to the market where money and highly
liquid marketable securities are bought and sold having a maturity
period of one or less than one year. It is not a place like the stock
market but an activity conducted by telephone. The money market
constitutes a very important segment of the Indian financial
system.
The highly liquid marketable securities are also called as
money market instruments like treasury bills, government
securities, commercial paper, certificates of deposit, call money,
repurchase agreements etc.

According to the Geoffrey, money market is the

collective name given to the various firms and institutions
that deal in the various grades of the near money.

CONTENTS

What is Money Market?

Features of Money Market?
Objective of Money Market?
Importance of Money Market?
Composition of Money Market?
Instrument of Money Market?
Structure of Indian Money Market?
Disadvantage of Money Market?

Continued.
Characteristic features of a developed money Market?
Recent development in Money Market?
Summary

What is Money Market?

As per RBI definitions A market for short terms
financial assets that are close substitute for money,
facilitates the exchange of money in primary and
secondary market.
The money market is a mechanism that deals with the
lending and borrowing of short term funds (less than
one year).
A segment of the financial market in which financial
instruments with high liquidity and very short
maturities are traded.

Continued.
It doesnt actually deal in cash or money but deals with
substitute of cash like trade bills, promissory notes &
govt. papers which can converted into cash without any
loss at low transaction cost.
It includes all individual, institution and intermediaries.

Features of Money Market ?

It is a market purely for short-terms funds or financial
assets called near money.
It deals with financial assets having a maturity period
less than one year only.
In Money Market transaction can not take place
formal like stock exchange, only through oral
communication, relevant document and written
communication transaction can be done.

Continued..
Transaction have to be conducted without the help of
brokers.
It is not a single homogeneous market, it comprises of
several submarket like call money market, acceptance
& bill market.
The component of Money Market are the commercial
banks, acceptance houses & NBFC (Non-banking
financial companies).

Objective of Money Market?

To provide a parking place to employ short term
surplus funds.
To provide room for overcoming short term deficits.
To enable the central bank to influence and regulate
liquidity in the economy through its intervention in
this market.
To provide a reasonable access to users of short-term
funds to meet their requirement quickly, adequately at
reasonable cost.

Importance of Money Market?

Development of trade & industry.

Development of capital market.
Smooth functioning of commercial banks.
Effective central bank control.
Formulation of suitable monetary policy.
Source of finance to government.

Composition of Money Market?

Money Market consists of a number of sub-markets
which collectively constitute the money market. They
are,
Call Money Market
Commercial bills market or discount market
Acceptance market
Treasury bill market

Instrument of Money Market?

A variety of instrument are available in a developed
money market. In India till 1986, only a few instrument
were available.
They were : Treasury bills
Money at call and short notice in the call loan market.
Commercial bills, promissory notes in the bill market.

New instrument
Now, in addition to the above the following new
instrument are available:
Commercial papers.
Certificate of deposit.
Inter-bank participation certificates.
Repo instrument
Banker's Acceptance
Repurchase agreement
Money Market mutual fund

Treasury Bills (T-Bills)

(T-bills) are the most marketable money market
security.
They are issued with three-month, six-month
and one-year maturities.
T-bills are purchased for a price that is less than their
par (face) value; when they mature, the government
pays the holder the full par value.
T-Bills are so popular among money market
instruments because of affordability to the individual
investors.

Certificate of deposit (CD)

A CD is a time deposit with a bank.
Like most time deposit, funds can not withdrawn
before maturity without paying a penalty.
CDs have specific maturity date, interest rate and it
can be issued in any denomination.
The main advantage of CD is their safety.
Anyone can earn more than a saving account interest.

Commercial paper (CP)

CP is a short term unsecured loan issued by a
corporation typically financing day to day operation.
CP is very safe investment because the financial
situation of a company can easily be predicted over a
few months.
Only company with high credit rating issues CPs.

Repurchase agreement (Repos)

Repo is a form of overnight borrowing and is used by
those who deal in government securities.
They are usually very short term repurchases
agreement, from overnight to 30 days of more.
The short term maturity and government backing
usually mean that Repos provide lenders with
extreamly low risk.
Repos are safe collateral for loans.

Banker's Acceptance
A bankers acceptance (BA) is a short-term credit
investment created by a non-financial firm.
BAs are guaranteed by a bank to make payment.
Acceptances are traded at discounts from face value
in the secondary market.
BA acts as a negotiable time draft for financing
imports, exports or other transactions in goods.
This is especially useful when the credit worthiness
of a foreign trade partner is unknown.

Structure of Indian Money Market?

I . ORGANISED STRUCTURE
1. Reserve bank of India.
2. DFHI (discount and finance house of India).
3. Commercial banks
i. Public sector banks
SBI with 7 subsidiaries
Cooperative banks
20 nationalised banks
ii. Private banks
Indian Banks, Foreign banks
4. Development bank
IDBI, IFCI, ICICI, NABARD, LIC, GIC, UTI etc.

Continued..
II. UNORGANISED SECTOR
1. Indigenous banks
2. Money lenders
3. Chits
4. Nidhis
III. CO-OPERATIVE SECTOR
1. State cooperative
i. Central cooperative banks
Primary Agri credit societies
Primary urban banks
2. State Land development banks
Central land development banks
Primary land development banks

Disadvantage of Money Market

Purchasing power of your money goes down, in case
of up in inflation.
Absence of integration.
Absence of Bill market.
No contact with foreign Money markets.
Limited instruments.
Limited secondary market.
Limited participants.

Characteristic features of a developed

money Market?

Highly organized banking system

Presence of central bank
Availability of proper credit instrument
Existence of sub-market
Ample resources
Existence of secondary market
Demand and supply of fund

Recent development in Money Market

Integration of unorganized sector with the organized
sector
Widening of call Money market
Introduction of innovative instrument
Offering of Market rates of interest
Promotion of bill culture
Entry of Money market mutual funds
Setting up of credit rating agencies
Adoption of suitable monetary policy
Establishment of DFHI
Setting up of security trading corporation of India ltd.
(STCI)

Summary
The money market specializes in debt securities that
mature in less than one year.
Money market securities are very liquid, and are
considered very safe. As a result, they offer a lower
return than other securities.
The easiest way for individuals to gain access to the
money market is through a money market mutual fund.
T-bills are short-term government securities that
mature in one year or less from their issue date.
T-bills are considered to be one of the safest
investments.

Continued.
A certificate of deposit (CD) is a time deposit with a
bank.
Annual percentage yield (APY) takes into account
compound interest, annual percentage rate (APR) does
not.
CDs are safe, but the returns aren't great, and your
money is tied up for the length of the CD.
Commercial paper is an unsecured, short-term loan
issued by a corporation. Returns are higher than T-bills
because of the higher default risk.
Bankers acceptance (BA) are negotiable time draft for
financing transactions in goods.
Repurchase agreement (repos) are a form of overnight
borrowing backed by government securities.

CAPITAL MARKET

The market where investment instruments like bonds,

equities and Securities are traded is known as the
capital market.
The primary role of this market is to make investment
from investors who have surplus funds to the ones
who are running a deficit.
The capital market offers both long term and short
term.

Types of financial Instruments

Equity instrument
Credit market instruments
Foreign exchange instruments
Derivative instruments.

Equity instrument
An equity instrument refers to a document which
serves as a legally applicable evidence of the ownership
right in a firm, like a share certificate. Equity
instruments are, generally, issued to company
shareholders and are used to fund the business. It is,
however, not necessary that the issued equity must
return a dividend for it is based on profits and the terms
of business.

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Credit market instruments

A marketplace for the exchange of debt securities
and short-term commercial
paper. Companies and
the government are able to raise funds by allowing
investors to purchase these debt securities. Activity in
credit markets is often used to gauge investor sentiment.
If more bonds from the government are being
purchased, this is typically a good indicator that
investors are worried about the stock market.

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FOREIGN CURRENCY
CONVERTIBLE BONDS(FCCBs)
A convertible bond is a mix between a debt and equity
instrument. It is a bond having regular coupon and
principal payments, but these bonds also give the
bondholder the option to convert the bond into stock.
FCCB is issued in a currency different than the issuer's
domestic currency. The investors receive the safety of
guaranteed payments on the bond and are also able to
take advantage of any large price appreciation in the
company's stock.
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Continued..
Due to the equity side of the bond, which adds value,
the coupon payments on the bond are lower for the
company, thereby reducing its debt-financing costs.

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Derivative instruments.
A derivative is a financial instrument whose
characteristics and value depend upon the
characteristics and value of some underlying asset
typically commodity, bond, equity, currency, index,
event etc. Advanced investors sometimes purchase or
sell derivatives to manage the risk associated with the
underlying security, to protect against fluctuations in
value, or to profit from periods of inactivity or decline.

59

Continued..
Derivatives are often leveraged, such that a small
movement in the underlying value can cause a large
difference in the value of the derivative.

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Nature of Capital Market

It has two segments

It deals in long-term securities
It helps in capital formation
It helps in creating liquidity

Types of Capital Market

Primary Market
The primary market is that part of the Capital Markets
that deals with the new securities.
It is that market in which Shares, Debentures and other
securities are sold for the first time for collecting longterm capital.
This market is concerned with new issues. Therefore,
the primary market is also called New Issue Market.

Features of Primary Market

It is related with new issues

It has no particular place
In a primary issue, the securities are issued by the
company directly to investors.
Companies, governments or public sector institutions
can obtain funding through the sale of a new stock or
bond issue.

Methods of Issuing Securities

Initial Public Offer

Offer For Sale
Private Placement
Right Issue
Book building

Secondary Market

The secondary market is that market in which the

buying and selling of the previously issued securities
is done.
The transactions of the secondary market are
generally done through the medium of stock
exchange.
The chief purpose of the secondary market is to create
liquidity in securities.

Features of Secondary Market

Creates liquidity
Comes after primary market
Has a particular place
Encourage new investments

INDIAN CAPITAL MARKET

The Indian Capital Market is one of the oldest capital
markets in Asia which evolved around 200 years ago

Chronology Of Indian Capital Market

1994-Equity Trading commences on NSE
1995-All Trading goes Electronic
1996- Depository comes in to existence
1999- FIIs Participation- Globalization
2000- over 80% trades in Demat form

ROLE OF CAPITAL MARKET IN

INDIAS INDUSTRIAL GROWTH

Promotion of industrial growth

Raising long-term capital.
Ready and continuous market
Proper channelization of funds
Provision of a variety of services

Broad Constituents in the Indian

Capital Markets

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Thank you
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Thank You
Please forward your query
To: tavishie@amity.edu