EXCHANGE RATE & FINANCIAL DERIVATIVES
What do you mean by “bid and offered rate”? What do you mean by “Exchange profit”?
Ans. The buying and selling rates are also referred to as the bid and offered rates. The term “bid and offered rates” is prevalent in the money market. The bid rate is the rate the bank is willing to buy while offered rate is the rate the bank is prepared to sell. The difference between the buying and selling rates gives the dealers margin of profit in the exchange operation. It is called the “exchange profit”.
What do you mean by T. T. (Clean) & T.T. (Document)?
Ans. T. T. (Clean)- where the instruction by cable is simply to pay a certain some of money to a certain person without producing any documents, that is called T. T. (Clean).
T. (Document): Where the instruction by cable is to pay a certain some of money to a certain person on production of certain specified documents.
Discuss briefly different buying rates?
Ans. a). T. T. Buying Rate: This is the rate at which a banker buys a T.T. issued on him by an overseas branch or correspondent. It is the rate at which the foreign currency, in which the T.T. is drawn, is converted into the home currency before making payment thereof. Examples of transaction are: Payment of Drafts, M.T., T.T. , foreign bills collected.
b). T. T. Clean Rate: T.T. (Clean) rate is a rate in which the handling of documents is not involved. T. T. (Clean) rate is the basic rate from which all the other buying rates are worked out.
c). T. T. Documentary Rate: Application of T. T. (Document) rate in which the handling of documents is involved. Bank recovers handling charges on the transaction.
d). O D (on demand) Buying Rate: it is the T. T. (Clean) buying rate loaded with interest for the transit period. It is quoted by the Bank for foreign exchange transactions which arise out of purchase of ‘Demand” bills or clean instruments such as a personal cheque or draft in a foreign bank.
e). Long Buying Rate: This is the rate applicable to purchase and discount of usance or long bills. These are bills usually usance of 30, 60 or 90 days after sight or after date, or even of larger maturity but not exceeding 180 days.
f). Tel Quel Rates: The words Tel Quel mean such as it is. Tel Quel rates are rates for long bills which have already run a part of their usance. The long buying rate is calculated by loading the O.D. buying rate with interest for the full usance period, i.e. 60 days, 90 days etc.
Discuss briefly different selling rates?
Ans. a). B.C. (Bills for collection) sales: Sales arising out of import bills. It is to be used for transactions which involve handling of documents by the bank, viz., payment against import bills.
b). T. T. (Clean) Sales: T. T. selling rate is applicable to clean sales. It is to be used for all transactions which do not involve handling of documents by the bank and for which no special rate are prescribed. Examples of sales for which this rate can be quoted are issue of Drafts, mail transfers etc.
What do you mean by forward exchange?
Ans. A forward exchange is a transaction between bank and another party – customer of another bank involving delivery of foreign currency against local currency at an agreed exchange rate on a specified future date or within an agreed time frame.
What do you mean by foreign exchange market? What are the functions of foreign exchange market?
Ans. It is the organizational frame work within which individual firm & Banks buy & sell foreign currencies or exchange one currency for another. Functions of foreign exchange market:
- Transfer of funds or purchasing power from one nation and currency to another.
- Trade financing.
- Facilities for avoiding foreign exchange risks or hedging.
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What do you mean by exchange rate? What are the rate quotations?
Ans. Exchange rate is that rate at which two national currencies are exchanged. The rate quotations are as follows:
i). Direct exchange rate: If the exchange rate is expressed in variable units of domestic currency for a fixed unit(s) of foreign currency. It is also called ‘pence rate’. (Buy low sell high)
ii). Indirect exchange rate: If the exchange rate is expressed in variable units of foreign currency per fixed unit of the domestic currency. It is also called ‘currency rate’. (Buy high sell low) .
What do you mean by dealing spread/Margin or Bid – Ask spread?
Ans. Difference between buying (bid) and selling (ask) rates is known as dealing spread/Margin or Bid – Ask spread.
What do you mean by ‘spot rate’ , ‘cross rate’ & ‘forward rate’?
Ans. Spot Rate: It is an exchange rate for on the spot transaction. While quoting spot rate for customer, banks consider the exchange rate of the wholesale market and a margin. The underlying theory is that currency sold to (bought from) a customer is simultaneously bought (sold) in the wholesale market, the margin representing transaction costs (overheads, brokerage, etc.)and profit for the banks authorized dealers.
Cross Rate: It is a rate to be found out from two given exchange rates. The practice in the world foreign exchange market is that currencies are mainly dealt against the US Dollar.
Forward Rate: It is an exchange rate for transaction to be happened at some future date, but agreement for the transaction is to be done today. Forward rate is quoted either at premium or at discount rate over spot rate.
What is the distinguish between ‘Forward rate transaction’ & ‘spot rate transaction’?
Ans. The only distinguish between forward rate transaction & spot rate transaction is that spot transaction is that a spot deal is settled immediately while a forward deal is settled on a future date or within a definite time frame at an agreed rate.
What do you mean by ‘Fixed forward Contract’ & ‘Option forward Contract’?
Ans. Fixed forward contract: The forward contract under which the delivery of foreign exchange should take place on a specified future date is known as ‘fixed forward contract’. For instance, if on 5th March’2009 a customer renters into a three months forward contract with his bank to sell GBP 10,000.00, it means the customer would be presenting a bill or any other instrument on 7th June 2009 to the bank for GBP 10,000.00.
He cannot deliver foreign exchange prior to or later than the determined date.
Option forward contract: This is an arrangement whereby the customer can sell or buy from the bank foreign exchange on any day during a given period of time at a predetermined rate of exchange is known as option forward contract. It helps the customer eliminating the difficulty in fixing the exact date for delivery of foreign exchange.
Write down different foreign exchange market operations method?
Ans. a). Arbitrage: It refers to the purchasing of foreign currency where it’s price is low & selling the foreign currency where it’s price is high. This is called currency arbitrage. Arbitrage may be due to interest rate differences in two financial centers., which is known as interest arbitrage.
b). Swap: Purchasing of foreign currency on the spot for selling forward or selling a foreign currency on the spot for purchasing forward.
c). Hedging: This usually refers an agreement today to buy or sale a certain amount of foreign currency on a future date at a rate agreed upon today. Foreign exchange risk can be avoided or covered by hedging.
d). Speculation: It is opposite of hedging, where a hedger seeks to avoid or cover a foreign exchange risk for fear or loss, the speculator accepts or even seeks a foreign exchange risk in the hope of making a profit. Speculation usually occurs in the forward exchange market.
e). Covered interest arbitrage: It refers to the transfer of one monetary center and currency to another to take advantage of higher rates of return (or interest) an at the same time the resulting foreign exchange risk is covered or hedged by a forward sale of the foreign currency to coincide with the maturity of the foreign investment.
What are the different types of foreign exchange markets?
Ans. a). Spot market: for spot transaction.
b). Forward market: For forward transaction.
c). Future market: Future market is a contract traded on an organized market of a standard size and settlement date, which is resoluble at the market price up to the close of trading in the contract.
d). Option market: An option is a contract specifying the right to buy or sell (By the buyer of the contract) a standard amount of foreign exchange within a specified period (American option) or at specific date (European option) at a certain price (strike price).
What is the distinguish between ‘Forward’ transaction & ‘Future’ contracts?
Ans. There is an important distinguish between “Forward” transaction & “Future” contracts. The former are individual agreements between two parties, say a bank & customer. The latter is a contract traded on an organized market of a standard size and settlement date, which is resoluble at the market price up to the close of trading in the contract.
What is the distinguish between “Call option” & “Put option” ?
Ans. A call option confers/give the right to buy and a put option confers the right to sell.
What is the distinguish between “American Option” & “European option” ?
Ans. Under “American option” contract specifying the right to buy or sell (by the buyer of the contract) standard amount of foreign exchange within a specific period on the other hand under “European option” contract specifying the right to buy or sell (by the buyer of the contract) standard amount of foreign exchange within a specific date.
What do you mean by ‘long position/ overbought’ & ‘short position/oversold’?
Ans. If the total of purchase side of the exchange position is more than the total of the sales, the result is called ‘long position’ or ‘overbought’. On the other hand if total of sales side is more than the totals purchase side the result is called ‘oversold’ or ‘short position’
What do you mean by ‘outright’ & ‘SWAP’?
Ans. Outright: It involves forward purchase or sale of a currency at a forward exchange rate which express the actual price of one currency against another for delivery on a specified value date.
SWAP: It is common in developed markets, involves purchase of or sale of a currency spot with a reserve deal in the forward market. The difference between the two is called SWAP margin or SWAP rate.
What do you mean by “At par” At premium” & “At discount”?
Ans. At par: The forward rate is at par with the corresponding spot rate if the forward exchange is worth as much as the spot exchange. This means that the relevant foreign currency can be purchased or sold at the same rate as the spot exchange.
At premium: When forward exchange are worth more than the spot exchanges, they are said to be at a premium.
At Discount: If forward exchanges are worth less than the corresponding spot exchanges, they are said to be a discount.
What do you mean by financial derivatives? What are the different types of derivative instruments?
Ans. In order to afford protection from exchange risk, new instruments like ‘Future’ & ‘Option’ are designed. These instruments are called financial derivatives as their value is derived from the value of some other financial contract or assets. These underlying assets may be foreign currency, bonds, equities or commodities.
Derivative instruments are two types:
a). Traded on the floor of an organized exchanges.
b). Over the counter market.
What are the difference between ‘Forward contract’ & ‘Option contract’?
Ans. Under the ‘forward contract’ the customer is expected to deliver/receive the asset on the due date at the forward rate irrespective of the sport rate prevailing. On the other hand under an ‘Option contract’ on the due date, the customer can make a reassessment of the situation and seek either execution of the contract or its non existent as may be advantageous to him.
Write short notes on the following:
Ans. i). Strike price: The exchange rate at which the currencies are agreed to be exchanged under the contract is the Strike Price.
ii). In the money option: An option is in the money when it would be advantageous for the holder of the option to exercise his right.
iii). Out of the money: An option is out od the money, if it is not advantageous for the buyer to exercise his right.
iv). At the money: An option contract is at the money when the strike price is equal to the spot rate for the currency concerned on the due date of the contract.