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International Financial Management

Notes persuaded to move to a single-dealer channel from the multi-dealer channel, which would
not be very difficult once the initial step is taken.
When the traditional and clerical jobs are automated by these electronic exchanges, sales
desk officers/client relationship managers would be left with more time to spend on
value added activities – delivering advice and information. Hence, these platforms could
go a long way in lowering cost and improving service quality.
Question
Do you think that a web-enabled Foreign Exchange Market would revolutionise the forex
trading practices in the future? Elucidate with examples.
Source: International Financial Management, Madhu Vij, Excel Books.

3.4 Summary

Foreign exchange is essentially about exchanging one Currency for another. The complexity
arises from three factors. Firstly, what is the foreign exchange exposure, secondly, what
will be the rate of exchange, and thirdly, when does the actual exchange occur.

Foreign exchange exposures arise from many different activities. A traveler going to visit
another country has the risk that if that country’s Currency appreciates against their own,
their trip will be more expensive.

An exporter who sells his product in foreign Currency has the risk that if the value of that
foreign Currency falls then the revenues in the exporter’s home Currency will be lower.
An importer who buys goods priced in foreign Currency has the risk that the foreign
Currency will appreciate thereby making the local Currency cost greater than expected.
The most, basic tools in the FX market are Spot rates and forward rates. In any FX contract
there are a number of variable that need to be agreed upon.
A deal can be performed with a maturity of two business days ahead – a deal done on this
basis is called a Spot deal.

In a Spot transaction the Currency that is bought will be receivable in two days whilst the
Currency that is sold will be payable in two days. This applies to all major currencies.
However most market participants want to exchange the currencies at a time other than
two days in advance but would like to know the rate of exchange now. This rate is referred
to as the forward rate.

Inter bank quotations are given a Bid and ask (offer) price. A Bid is the price in one
Currency at which a dealer will buy another Currency. An offer or ask is the price at which
a dealer will sell the other Currency. As the Bid-ask spread between leading currencies is
quite small, it allows market participants to implement sophisticated risk management
strategies.
3.5 Keywords

Arbitrage: Arbitrage is the practice of taking advantage of a price differential between two or
more markets.

Cross Rate: The exchange rate between any two non-dollar currencies is referred to as a cross
rate.
Cross Rate of Exchange: An exchange rate between two currencies that is derived from the
exchange rates of those currencies with a third Currency.

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