Foreign Exchange Market

1. Foreign Exchange Market

2. Foreign Exchange Markets • The market where the commodity traded is Currencies. • Price of each currency is determined in term of other currencies.

3. Deals are done over Telephone, REUTERS dealing system etc R E U T E R S Dealing Terminal • Industry Standard for FX trading. • Security guaranteed by Reuters Int. • Password Protected. • Maintains record of all transactions. • SBPK (SBP’s REUTERS address) News Terminal • Domestic Market Data/ news available on line. • Real Time Exchange Rate quotes of all major Currencies. • Data about Interest Rates (e.g. LIBOR) • Various SBP pages on REUTERS.

4. SBP’s Role in the Forex Market • To manage the exchange rate mechanism. • Regulate inter-bank forex transactions and monitor the foreign exchange risk of the banks. • Keep the exchange rate stable. • Manage and maintain country's foreign exchange reserves.

5. SBP’s Role in the Forex Market • SBP has imposed foreign exchange exposure limits on banks (FE 12 of 1999). • The limits are tied with the Paid up capital of the bank. • Previously banks had NOP limit, which was based on foreign exchange volume handled by the bank.

6. INTERVENTION • To keep exchange rate in line with macro objectives SBP has to intervene from time to time • Intervention is a process where FX is sold or purchased to keep the right amount of liquidity available in the FX market so that demand / supply equilibrium is maintained

7. What is an Exchange Rate ? Exchange Rate is the price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another. e.g. Rs. 63.50 per USD Major currencies of the World • USD • EURO • YEN • POUND STERLING

8. What is a Foreign Exchange Transaction ? • Any financial transaction that involves more than one currency is a foreign exchange transaction. • Most important characteristic of a foreign exchange transaction is that it involves Foreign Exchange Risk.

9. PARTICIPANTS IN THE FOREIGN EXCHANGE MARKET • All Commercial Banks (Authorized Dealers only). • State Bank of Pakistan. • Corporate Treasuries. • Public Sector/Government. • Inter Bank Brokerage Houses. • Resident Pakistanis • Non Residents • Exchange Companies • Money Changers

10. Components of a Standard FX Transaction • Base Currency (USD/PKR) • ‘Dealt’ or ‘Variable’ Currency • Exchange Rate • Amount • Deal Date • Value Date • Settlement Instructions

11. ValueDate Conventions Currencies are traded both inReadyandforward value dates. 1) Ready: Settlement on the deal date. e.g. Pakistan 2) Value Tom : Settlement on next day. e.g. Canada 3) Spot Transaction : settlement usually in two working days. In international FX transactions, Spot is the Standard value date.

12. FX Rate Quotation: In the forex market rates are always quoted ‘two way’. Two way quote gives both ‘Bid’ and ‘Offer’. e.g. USD/PKR= 63.40 / 50 Bid / Offer ‘Big Figure’: Term referring to the first digits of an exchange rate. These figures are rarely change in normal market fluctuations and are usually omitted in dealer quotes. ‘Pips (or Point): The smallest incremental move an exchange rate can make. ‘Base Currency’ Vs. ‘Dealt Currency’ Number of variable or dealt currency unit in one unit of base currency. In international quotes base currency comes first. e.g. BC/VC USD/PKR= 63.55/60

13. Price maker Vs. Price Taker The bank quoting the price is ‘price maker’ or ‘market maker’. The bank asking for the price or ‘quote’ is the ‘price taker’ or ‘user’.

14. RATEQUOTATION CONVENTIONS IN-DIRECT QUOTATION: “Price of one Unit of Foreign Currency in terms of Domestic Currency” e.g. USD/PKR = 63.45/50 Buy One USD at 63.45 Sell One USD at 63.50 Spread 00.05 In the international market, almost all currencies are quoted indirectly.

15. RATE QUOTATION CONVENTIONS DIRECT QUOTATION: “Price of one Unit of Domestic Currency in terms of Foreign Currency” e.g. EURO= 1.5805/12 Buy One Euro at 1.5805 Sell One Euro at 1.5812 Spread 0.0007 Five Currencies are quoted in Direct Terms 1) Pound Sterling 2) Euro 3) Australian Dollar 4) New Zealand Dollar 5) Irish Punt

16. In the international market, almost all the currencies are quoted in terms of USD. e.g. JPY= 117.54/60 A visit to REUTERS ‘EFX=’ Page.

17. Foreign exchange transactions are settled through Nostro and Vostro accounts. • Nostro: our account with banks abroad. SBP maintains various Nostro accounts in a number of countries. • Vostro: their account with us. Many multilateral agencies (e.g. IMF, World Bank) maintain their Nostro accounts at SBP. • SWIFT (Society for Worldwide Interbank Financial Telecommunications)

18. Bid - Ask Spread • Consider the quote of GBP 1.9975 – 1.9985 for a U.S. investor • What is the quote for a British investor? • The direct quote is always DC / FC • The Quote will become 1/1.9985 – 1/1.9975 • Percentage spread

19. Cross Rates • 120 Yen is equivalent to 1 USD • 140 Yen is equivalent to 1 EUR • What is the cross rate of EUR/USD?

20. Bid Ask – Cross Rates • A British dealer quotes 0.583 bid / 0.588 ask for the U.S. dollar. • An Australian dealer quotes pound 1.90 / 1.91 • What is the AUD/$ bid and ask for the Australian dealer