Know on Foreign Exchange & Trade Profitably in the FX Market

Forex- Meaning

A plain definition of the term Foreign Exchange would imply, trading of one currency for another by the governments, businesses and residents in two countries. The exchange of currency into another is done at a specific rate as it depends on the value of the currency. As far as the valuation of currency is concerned, it depends on a number of factors such as - trade, investment, tourism, and geopolitical risk. The foreign exchange market also represents central banks, commercial banks, brokers, exporters & importers, immigrants, investors, and tourists.

Structurally, India’s foreign exchange market is not different from that of the global foreign exchange market. When represented hierarchically, the main players of this market and their position, as well as place, can be best described through pictorial representation. Take a look below

Key Points on Foreign Exchange

1. Foreign exchange in simple words implies exchange of native currency to foreign currency of another nation or economic zone. Foreign exchange is closely linked with the global market and the currencies.
2. The process includes management of foreign exchange, methods and the instruments that are used to adjust the payment of debts between two nations, employing norms of different currency systems.
3. The FX market is considered to be an Over the Counter (OTC) market in which trading is done directly between two parties without actually having the need for an exchange.
4. It is one of the largest markets in terms of trading volume as it includes a large spectrum of participants such as banks, international corporations, central banks, investment management firms, hedge funds, retail forex brokers and investors.

As far as the Foreign Exchange Rate is concerned, although most of the exchange rates are free-floating and therefore rise or fall based on supply and demand in the market. There are however some currencies which have restrictions because they are not free floating. Developing countries most often fear free floating of currencies and so the restrictions are prevailing in those countries in order to maintain their exchange rate at the desired level among other things.

In India, for the sake of correct condition related to operation of foreign exchange transactions, an Act by the Reserve Bank of India was introduced. This act is commonly known as FEMA which implies, Foreign Exchange Management Act. The act merges as well as amends law which is related to foreign exchange. The purpose of the act is also to facilitate external trade and payments to further the orderly development and maintenance of foreign exchange market in the country.

Important Features of FEMA

This act extends to the whole of India and applies to all branches, offices, and agencies outside India. It is basically owned as well as controlled by a resident of India and is not applicable to Indian citizen’s resident outside of India. It is also applicable to any violation that’s there under committed outside India by any two people whom this Act is applicable.

1. It is mainly consistent with full current account convertibility and contains provisions for progressive liberalization of capital account transactions.
2. Transparency has come to the fore with this act. It lays down the areas requiring specific permissions of the Reserve Bank/Government of India on acquisition/holding of foreign exchange.
3. It classified the foreign exchange transactions in two categories, namely capital account and current account transactions.
4. It gives power to the Reserve Bank for specifying, in, consultation with the central government, the classes of capital account transactions and limits to which exchange is admissible for such transactions.
5. The act accords complete freedom to a person who is a resident of India or one who was an NRI to control/ own/ transfer any sort of foreign security or for that matter any immovable property that’s situated outside India that the individual acquired while living out of India.
6. The act is a civil law and therefore, breach of this act clearly lays issuance of arrest orders in exceptional cases only. In India the foreign exchange market is a vibrant market has been there for over four decades now and the market is fast growing due to various forward looking steps in economic reforms lately. Today, the Indian foreign exchange market has multiple players who facilitate services related to the exchange of currencies. The number of listed brokers as well as authorized institutions in this line is also increasing with the market widening up with time. One finds many non-bank financial institutions that are however legally authorized to offer trade in the Indian market. By and large, this market is strictly regulated by the Central Government and all the aspects of the trade.

The Indian foreign exchange market consists of 3 tiers. In the first tier, it mainly comprises of transactions between the RBI and the authorized dealers (AD). In the second tier, it mainly comprises the interbank market in which the AD’s deal with each other takes place. The third segment, however, comprises of the transactions between AD’s and their corporate customers.

Types of Foreign Market Operations

1. Spot/ Current Market- In this kind of market, forex operation is of daily basis. In this kind of market, only spot transactions or current transactions are handled.
2. Forward/Derivative Market- In this type of market, the foreign exchange forwards is honored. Aspects such as foreign exchange forwards, currency futures, currency swaps, and currency options are instrumental in this area.
3. Exchange Settlement and Dealings- Here Nostro and Vostro account comes at play. It is through these kinds of accounts that settlement of foreign exchange transaction materializes.

The Nostro account is a kind of account where foreign currency account is maintained by an Indian bank with another bank in abroad. On the other hand, a Vostro account is a type of account which is maintained by a rupee account of a foreign bank abroad with a bank in India.

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Effect of foreign exchange fluctuation on Cross border payments

(This Article was first published by Myforexeye Fintech Pvt Ltd)

Economies across the globe are connected more than ever and cross border trades have become the norm of the day. Most economies are run by selling their produce to other countries while many import oil for their regular running of economies. In either case, there is cross border transaction. The opportunities which a corporate reaches out to are more than the trouble they go through to ensure their payment is made in a complex international system which is governed by many a policy.

What is cross border payment?

A cross border payment refers to transactions which are operated in atleast two different countries. The operations may be between individuals, corporates or financial institutions. These countries can be geographically sharing a border or far from each other. The transactions are completed when the entities exchange foreign currency. The daily volume of transaction for a multinational company is huge making them rely on efficient supply chain. Also if payment is to be made to multiple foreign suppliers, then cross border transactions become important. Thus need for automation of cross border payments is high.

Many countries have policies which involve processes which have to be followed while transacting across borders. For example, the European Union has a regulation wherein banks are to charge same to cross border transactions as those applied to domestic transaction where the payments are in Euro. But if the currency is different, then foreign exchange rate is applicable.

With ever changing regulations and policies, and also evolving digitalization the cross border payment scenario is ever changing. The banks generally have fees which are not clearly visible or one has difficulty in tracing the payments. Online payments made though SWIFT (Society for Worldwide Interbank Financial Telecommunications) made the payment fast, but effective payment processes and support are some reasons why one chooses one bank over another.

Each time a payment is made or received, the transaction is exposed to foreign exchange risk. This transaction exposure has to be managed by leveraging on the digital technology. This ensures the real-time payments are made keeping in mind compliance and regulatory security. The technology has reduced the transaction time to a few minutes if not seconds.

Foreign exchange risk

The cross border payments being exposed to Foreign Exchange Risk calls for keeping abreast of the markets with which the deal is made. But simply tracking the economies of both nations is not justified now as the markets are more interlinked than ever before. Social media and news reporters have made the availability of information faster. Thus an event in say Saudi Arabia will affect the movement of currency in Japan. Even though they are not directly connected to each other. Thus Transaction Exposure calls for a closely knitted understanding of the foreign exchange market along with other markets.

Timely tracking of the currencies one is exposed to gives a better understanding of when and how to hedge to ensure foreign exchange risk is mitigated and costing is not affected. One needs to assign the forex treasury portfolio to advisors who would manage this Foreign Exchange Fluctuation.

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