Financial Markets

    • There are a number of intricacies involved in the operations of the foreign exchange market. In every forex market around the world, there is a regulatory authority which ensures the smooth functioning of the these markets, regulating their operations to varying extent.
    • The understanding of the operations of these markets and the regulatory framework is essential for a finance manager trying to manage foreign currency risk for his firm.
    • Another important aspect is the interlinkages between the various financial markets, i.e., the money markets, the real markets and the forex markets.
    • The main players in the foreign exchange market are large commercial banks, forex brokers, large corporations and the central banks.
    • The market in which the commercial banks deal with their customers (both individuals and corporates) is called the retail market, while that in which the banks deal with each other is called the wholesale or the inter bank market.
    • In the foreign exchange markets, it is a practice to quote most of the currencies against the dollar, and to calculate the exchange rates between other currencies with the dollar as the intermediate currency. The rate thus calculated is called cross rate or synthetic cross rate.
    • A currency is said to be in premium against other currency if it is more expensive in the forward market than in the spot market. A currency is said to be discount if it is cheaper in  the forward market than in the spot market.
    • A broken-date contract is a forward contract for maturity, which is not a whole month. The rate for a broken date contract is calculated by interpolating between the available quotes for the preceding and succeeding maturities.
    • Option forward contracts can be used when the customer knows the estimated time when the need to deal in a foreign currency may arise, but may not be sure about the exact timing.
    • When the bank is buying a currency, it will add on the minimum premium possible and deduct the maximum discount possible from the spot rate, resulting in the bank quoting the rate applicable to the beginning of the option period when the currency is at premium, and the rate applicable to the end of the option period when the currency is at a discount.
    • When the bank is selling a currency, it will add on the maximum premium possible and deduct the minimum discount possible from the spot rate, resulting in the bank quoting the rate applicable to the end of the option period when the currency is at premium, and the rate applicable to the beginning of the option period when the currency is at a discount.
    • In India, the foreign exchange markets are regulated by the Foreign Exchange Management Act. The FEDAI provides for the early delivery/extension/ cancellation of forward exchange contracts.
    • Convertibility of currency means that a foreign currency can be converted into domestic currency without any restrictions and vice-versa.
    • The convertibility on Current Account means that there are no restrictions on transacting foreign currency on current account. All the foreign currency transactions except those for creating or liquidating foreign assets/liabilities are free from any type of transactions.
    • Convertibility on Capital Account (CAC) is to convert Indian currency into foreign currencies, the currency could be banked or used to acquire any assets, financial instruments and foreign nationals will be free for transformations of domestic currency to a foreign currency and vice-versa.
    • Capital Flow is movement of capital in international flows of country either in the form of loans or in the form of investments. The capital movement can be inflow or an outflow depending upon the indebtness of a country with respect to other countries. It is a classic example of Balance of Payments (BOP) when a country's capital inflow is equated to the capital outflows.
    • The market operates through foreign exchange brokers who are accredited by the Federation of Exchange Dealers Association of India. The brokers are not allowed to hold positions and are only expected to obtain and communicate prices to enable contracts between banks.