When computing exchange rates for merchant transactions, the cover or the base rate at which the cover transaction can be undertaken in the Forex market is first computed, thereafter the profit margin as allowed by the Foreign Exchange Dealer's Association of India (FEDAI) is taken and the rate rounded off as per FEDAI Rule. In case of forward contracts, the procedure is similar except that while computing the base rate, the forward margin has to be appropriately taken. The forward margin is the extent to which the forward rate for a currency differs from its spot rate against a second currency. The forward margin when it tends to make a currency cheaper is called a 'Discount' while if it makes it costlier it is called a 'Premium.' Obviously if one currency is getting cheaper in the forward against another, the second should be getting costlier against the first. Thus while the first currency would be said to be at a discount against the second, the second would be at a premium against the first. Forward contracts for merchants generally provide for delivery within a specified period, with the merchant having the option of the date of delivery within the specified period. The ...

India is following the direct rate in Forex markets, i.e. foreign currency is fixed and home currency is varying. When we go to a shop and ask for the price of a product he tells us only one rate for the product, because the trader is only selling the product to consumers. He is not buying from consumers. Whatever rate the seller tells is implied as his selling price for the product. Even though the consumer is buying a product, what he pays to the trader is the selling price of the trader. Foreign Exchange market is different from this market in the sense that the authorized dealer buys as well as sells the foreign currency. Banks and financial institutes authorized by RBI to sell the foreign currency are called as Authorized Dealers. When you ask the rate of a foreign currency from an authorized dealer, he quotes two- way rates. It means that he quotes the rate for buying as well as selling the foreign currency. Example US$ 1=Rs.45.2200,45.2300 In this rate, the authorized dealer will buy US$ at the rate of US$ 1=45.2200 and he will sell the US$ at the rate of US$ 1=Rs.45.2300. The difference between the buying and selling price is his profit margin. Here, the dealer will ...

Transaction risk arises from executed contracts resulting in Forex payables or receivables in the future. The domestic currency value of these payables or receivables at current exchange rate and at future exchange rate is expected to be at variance, resulting in transaction risk. The forex transaction risk can be hedged using internal strategies. Internal strategies refer to strategies that are internal to the firm and its affiliates. These are “home’ arrangements. The counter party to the transactions may be involved. But third parties are never involved. The different internal strategies used for managing forex transaction risk are: Risk Netting: This strategy involves matching forex receivables in a currency with forex payables in that currency. Both currency and time matching are needed. Suppose an US firm has Yen 10 mn receivable from and Yen 7 mn payable to same counter party, both having 90 days to mature. These two transactions can be netted and the exposure reduces to Yen 3 mn. There are bilateral and multilateral netting. The above one is bilateral netting. Multilateral netting involves a firm having forex payables with a party netting the same against forex ...

Currency Call Options A currency call option is a contract that gives the buyer the right to buy a foreign currency at a specified price during the prescribed period. Firms buy call options because they anticipate that the spot rate of the underlying currency will appreciate. Currency option trading can take place for hedging or speculation. Hedging: Multinational companies with open positions in foreign currencies can utilize currency call options. For example, suppose that an American firm orders industrial equipment form a Indian company, and its payment is to be made in Indian Rupees upon delivery. An Indian rupee call option call option lacks in the rate at which the U.S company can purchase Rupees for Dollars. Such an exchange between the two currencies at the specified strike price can take place before the settlement date. Thus the call option specifies the maximum price which the U.S. company must pay to obtain Rupees. If the spot rate falls below the strike price by the delivery date, the importer can buy Rupees at the prevailing spot rate to pay for its imports and can simply let its call option expires. Speculation: Firms and individuals may speculate with ...

Future contracts allow the price risk to be separated from the reliability risk by removing the former from the set of factors giving rise to opportunism. The governance structure supplied by the exchange authority effectively eliminates reliability risk from future trading. The seller of futures contracts incurs a liability not to the buyer, but to the clearing house, and likewise the buyer acquires an asset from the clearing house. The clearing house in effect guarantees all transactions. In addition, the exchange rules, especially regarding its members’ contract, severely limit their ability to behave opportunistically. Organized exchanges greatly reduce default and reliability risk from future contracts. This is achieved by transferring transactions over price risks from a personal to an impersonal market through standard form futures contracts traded in self-regulated market price. Future contracts are standard form contracts with only one negotiable term: price. The standardization of future contracts has significant implications for transaction costs. This is so for several reasons. First, contracts standardization eliminates the costs of bargaining over non-price terms ...

There are two types of foreign exchange rates, namely the spot rate and forward rates ruling in the foreign exchange market. The spot rate of exchange refers to the rate or price in terms of home currency payable for spot delivery of a specified type of foreign exchange. The forward rate of exchange refers to the price at which a transaction will be consummated at some specified time in future. In modern times the system of forward rate of foreign exchange has assumed great importance in affecting the international capital movements and foreign exchange banks play an important role in this respect by matching the purchases and sales of forward exchange on the part of would be importers and would be exporters respectively. The system of forward foreign exchange rate has actually been developed to minimize risks resulting from the possibility of fluctuations over time in the spot exchange rate to the importers and exporters. An example would illustrate this point. Suppose that a tablet pc dealer in India wants to import tablet pc's and mobile tablet's from England. The foreign exchange rate at the moment is Rs.18 for a pound sterling and at this rate the Indian tablet pc ...