Foreign Exchange Market

Dynamics-Types of FX
Transactions (Merchant/Cover/IB)
Exchange Rate Mechanism
(Spot/Cross/Forward)

Arun Misra
Faculty-IIBF
EX DGM, Bank of Baroda
 Live Interactive Learning Session
 Functions
 Determinates of foreign exchange
 Balance of payment position
 Exchange Rate Mechanism
 Types of Forex Transactions
 Merchant/Cover/Inter Bank Transactions
 Spot/Inter Bank/Merchant rates/Cross Rates/Forward
 Interest Parity Theorem and Forward rates
 Premium/Discount
 Basics of hedging (forwards)/IRS/options and derivatives
 Exercises in calculating different rates
 Recent Developments in International Banking
What is Forex Market???

Why Foreign Exchange???

 Forex Market & Its Structure

The market that is common In the forex market, there

to every market player or is no single price. See how a
trader: The stock market. decentralized market works
 Extent of Forex Market
 Forex markets had a daily turnover of $9.6 trillion dollars in April
2025, up from $7.5 trillion in April 2022 as per BIS report.
 Presently the Indian Forex market is the 16th largest Forex market
in the world in terms of daily turnover as the BIS Triennial Survey
report.
 Average daily forex turnover is around 6.25 trillion per day &
estimated daily trading volume of around $ 7 quadrillion.
 India’s Forex Reserve as on October 17, 2025 was $ 702.28 billion.
 Round the clock market starting from Sydney and Tokyo in the east
through Hong Kong, Singapore, Bahrain, London and New York.
 Participants are Central Banks, Commercial Banks, Investment
Funds, Corporate, Individuals and Brokers.
 Over the counter market.
 24 X 7 Market. INDIAN INSTITUTE OF BANKING & FINANCE
 Need for Exchange
No Self sufficiency

Need to exchange
goods and services

Legal Tender

Convenience
INDIAN INSTITUTE OF BANKING & FINANCE
 Forex Market Hierarchy
 On the top of the ladder is Interbank Market.
 Largest banks of the world and some smaller banks.
 Trade directly with each other or electronically through
the innovative Electronic Brokering Services or through the
Reuters Dealing 3000-Spot Matching.
 Medium sized and small banks.
 All the banks that comprise the interbank market can see
the rates that each other is offering, but not all of them
can make deals at those prices.
 Hedge funds
 Corporations
 Retail market makers
 Retail ECNs.
 Retail Traders
 Participants of Forex Market
 The major participants are Central Banking Institutions,
Commercial banks, Investments banks, Foreign Exchange brokers
and Merchants including Corporate.
 All Commercial banks required specific authorization from RBI
for undertaking foreign exchange transactions under FEMA Act
1999.
 The banks which have been approved are known as “Authorized
Dealers Category I Banks (AD Category I).
 All AD Category I banks are required to be the members of
FEDAI.
 All other ADs have to buy or sell the foreign exchange from AD
Category I banks.
 In other words, non AD participants can not buy/sell foreign
exchange amongst themselves.
 Category A, B and C branches of the banks.
 Foreign Exchange & Exchange Rate

What is Foreign Exchange?

What is Exchange Rate?

Conventions in Forex Market – Bid and Offer Rate

Price of Commodity
 What is Foreign Exchange ???
It is the price of an unit of one currency expressed in terms of another
currency.
Definition as per FEMAAct 1999

 “Foreign Exchange” means foreign currency and includes—

 (i) Deposits, credits and balances payable in any foreign currency;

 (ii) Drafts, travelers cheques, letters of credit or bills of exchange,

expressed or drawn in Indian currency but payable in any foreign
currency;

 (iii) Drafts, travelers cheques, letters of credit or bills of exchange

drawn by banks, institutions or persons outside India, but
payable in Indian currency;
 Factors affecting Exchange Rates
Fundamental Factors Technical Factors
Economic Policies Interest Rates
Balance of Payment Position Inflation Rate
Unemployment Exchange Rate Policy
Capacity Utilization Central Bank Interventions
Trends in Imports & Exports

Political Factors Speculation

 Different Terminologies

Market
Market
Maker Direct
Taker
Rates
Quoting
Currency Indirect
Rates
Two Way Base
Quote Currency
 Execution of Deals and Settlement
Two actions – Fixing Exchange Rate / Settlement

Exchange of Currency

Time Zone differences

Cash Deal or Value To day

Tom Deal

Spot Deal

Forward Deal
Quoting Rates
 By whom quote is given?
 Price of currency in terms of another currency
 Direct Quote, Indirect Quote
 Base Currency used in quote
 USD most widely traded currency – used as vehicle
currency
 Quotes up to four decimals
 Pips / Big figure

INDIAN INSTITUTE OF BANKING & FINANCE

Identify 4 decimals vs 2 decimals, Pips, Points
and Big figure.
Currency Decimals Integer Pips Points Big
Figure
EUR/USD 1.0625 1 5 2 06
GBP/USD 1.2115 1 5 1 21
USD/JPY 135.16 1 6 1 35
USD/INR 81.65 81 5 6 81
USD/ARS 160.05 160 5 0 60
USD/IDR 15,690.50 15,690 0 5 690
USD/RUB 61.75 61 5 7 61
 Pips, Points and Big figure.
Pips are 4th decimal for the currencies that are
quoted in 4 decimals and 2nd decimal for the
currencies that are quoted in 2 decimals.
Points are 3rd decimal for the currencies quoted
in 4 decimals and the first decimal for the
currencies that are quoted in 2 decimals.
Big Figure refers to first 2 decimals that are
quoted with 4 decimals and the first integer for
the currencies that are quoted with decimals.
 Foreign Exchange Terms
Fixed Exchange rate:
 It refers to a rate which the government sets and maintains at the
same level.
 The rate is determined by the Central Bank of the Country.
 The change in currency price is carried out by Devaluation &
Revaluation.

Flexible Exchange rate:

 It is a rate that is varying according to market forces.
 The rate is determined by Demand and Supply.
 The changes in currency price is carried out by Depreciation and
Appreciation.
 The exchange rate is not under the control of the Government or
central bank
 Fundamental Concepts About Rates
 Foreign Exchange is exchanging one currency for another.
 All transactions have three key components namely
(1) Purchase (2) Sale (3) Rate of exchange
 All rates are quoted from Bank’s point of view.
 All transactions are also referred from Bank’s Point
of view.

 The terms “Purchase” and “Sale” are with reference to

foreign exchange.

 These standard reference points and conventions must

be remembered at all times.
FX Rates
What is Exchange Rate ?

 Exchange Rate is a rate at which one currency can be

exchanged into another currency.
 In other words it is value of one currency in terms of other say:
US $ 1 = Rs 83.40
This rate is the conversion rate of every US $ 1 to Rs. 83.40

In such conversions, foreign currency is always treated as

commodity and home currency as the purchasing power.
 Methods of Quotation
 Method – I  Method – II
 One Orange = Rs 2  Rs. 10 = 5 Oranges
 One Apple = Rs 2.50  Rs. 10 = 4 Apples

Price under both the methods is the same though expressed differently

Method - I Method - II
Direct(FC fixed) Indirect( HC fixed)
USD 1 = Rs 83.3841 Rs 100 = USD 1.1193
GBP 1 = Rs.105.7610 Rs 100 = GBP 0.9455
EUR 1 = Rs 89.3567 Rs 100 = EUR 1.1191
With Effect from 02.08.1993, all exchanges are quoted in Direct Method
 Direct And Indirect Rates
 Direct Quotation: In this method, the Home currency
is the variable currency and the Foreign currency is kept
constant.
(e.g) USD/INR= Rs.83.40/83.45
 USD is the base currency and INR is the variable currency.
 In India only Direct quotations are used.
 Indirect quotation: In this method, the Home
currency is kept constant and the foreign currency is
the variable currency.
(e.g) Rs. 100 = USD 1.2307/1.2315
 INR is the base currency and USD is the variable currency.
 Exercises
 Please find out from the following the Base Currency and
Variable Currency

 1. GBP = USD 1.3457

 2. EUR = USD 1.1374

 3. USD = JPY 114.22

 4. USD = CHF 0.9270

 5. AUD = USD 0.7338

 Understanding Two Way Exchange Quotes

It is customary in FOREX market to quote two-way

rates
i.e., one rate for selling and another for buying.

 1 USD = INR 83.20/ 40

 Buying Rate $/Rs = Rs 83.20
 Selling Rate $/Rs = Rs 83.40
 USD/INR: First Currency is the Base Currency-USD
 Second Currency is the Counter Currency-INR
 Two–way Quotations
 Advantages:

 Rates available for both sellers and buyers.

 Price limits the profit margin of the quoting bank

& comparison between two banks quotes can be
made.

 Quoting Bank cannot manipulate rates as side of

the other party is not known.

 It ensures alignment of the rate with the market

rate and lends depth & liquidity in market.
 Basics of Foreign Exchange
 When a Bank quotes USD= Rs. 83.20/83.25, it means that the
said Bank is prepared to deal in USD (i.e) the base currency
and the Bank would buy USD 1 at Rs. 83.20 and sell USD 1 at
Rs. 83.25.
 The Market maker(Bank) is willing to buy the Base currency
(USD) by the LHS price and willing to sell the Base currency
(USD) by RHS price.
 The difference between the buying rate (Bid rate) and
selling rate ( ask rate) is called “Spread”.
 In case of direct quote, by convention the First rate is the
buying rate of the Base currency by Market Maker and Second
rate is the selling rate of the base currency by Market Maker.
 In case of Indirect quote, the first rate is selling rate of Base
currency by Market Maker and the second rate is the
buying rate of Base currency by Market Maker.
Exercises (which side you will deal)

Inter Bank Market Situation

 USD = Rs.82.72/82.75  Exporter received USD 100,000

 GBP = USD 1.2540/43  Importer wants GBP 100,000

 EUR = USD 1.0730/32  Exporter received EUR 100,000

 USD = JPY 159.67/70  Importer wants USD 1,000,000

 Answers to Exercise
 Bank (Market Maker) Will Buy Base Currency
USD At Rs. 82.72

 Bank (Market Maker) Will Sell The Base Currency

GBP At USD 1.2543

 Bank (Market Maker) Will Buy The Base Currency

EUR At USD 1.0730

 Bank (Market Maker) Will Sell The Base Currency

USD At JPY 159.70
 Types of rates

Bid Rate - the rate at which the quoting bank is prepared

to buy.

Ask/Offer Rate - the rate at which the quoting bank

is prepared to sell.

Merchant Rates - Exchange rates quoted by the Authorised

Dealers to importers/exporters.

It is important to remember that Bid & Offer in trading

always refers to the BASE CURRENCY.
 Understanding Exchange Quotes
 In the FX market, time is of great importance.
 Therefore, there are short forms for everything.
 While quoting, the dealers use only the third &
fourth decimals.
 USD/CHF 0.8940 / 45
 USD/INR 83.2025 / 30
 GBP/USD 1.2500 / 10
 Big Figure
 In a live dealing scenario dealers would quote only
40/45 , 25/30 , figure/10 and the market assumes
that all players already know the Big Figure
 Spreads and Pips
Spread:
 1 USD = Rs. 83.40/83.45
 The difference between the Bid rate and ask rate (i.e) 5
paise is called the Spread.
Pip:
 1 GBP = USD 1.2540 rate changes to USD 1.2542 in few
seconds USD has moved by 2 Pips (i.e) .0002 change in
the Fourth Decimal Point.
 1USD = JPY 159.74 rate changes to JPY 159.70 then JPY
has moved by 4 pips (i.e) .04. Here the change is in the
second decimal point.
Hence Pips definition may vary among currencies.
 Exercise
Please find out which currency has strengthened and
which currency has weakened at the end of the day.
 1. USD = Rs. 82.7200 (opening) and Rs. 82.7650 ( closing)

 2. GBP = USD 1.2540 (opening) and USD 1.2500 (Closing)

 3. EUR = USD 1.0730 (Opening) and USD 1.0720 (closing)

 4. USD = JPY 159.74 (opening) and JPY 159.50 (closing)

 Points to Remember
 It may be noted that EURO,GBP,AUD & NZD are quoted Indirect quotes against USD
and all other major currencies are quoted as Direct quotes against USD.
 So for instant calculation of indirect quotes, multiply the rate quoted with Rupee
rate. For all other remaining currencies' (Direct quote) divide Rupee rate with
the rate quoted for respective currency.

Example: Rate of JPY Vs Rupee

1 USD = Rs 83.20/40
1 USD = Yen 157.50/58
How many Rs = 1 Yen (Buying/Selling)
Buying:
If 157.50 Yen = 1 USD
If 1 USD = Rs 83.20
Rate of Yen/Rs is 83.20/157.50= 0.5282
Yen is always quoted in 100 units against rupees so the rate for 100 yen would be Rs
52.82
 Chain Rule
It is used for comparison or ratio between two quantities which are linked together
through another quantity. It is based on common sense approach.

STEP I : Write the question to be answered i.e. How many Rs…= EURO 1

STEP II: Second equation begins with the currency in which the first equation ended
and provides information that we have i.e. 1 EURO=1.0730 USD. i.e., now we have
USD after buying EURO from the market.

STEP III : Third equation begins with the currency in which the second equation
ended,
i,e, USD and provides whatever information we have on the currency.
Here we want to sell INR to get USD. ( i.e. buy USD 1. We can buy USD 1 for
Rs.83.20) Thus, how many Rs…..= EURO 1
If 1 Euro= 1.0730 USD
And 1 USD = 83.20
Therefore, 1 EURO = 1.0730 USD = (1.0730*83.20 ) = 89.2736 INR.
INDIAN INSTITUTE OF BANKING & FINANCE
 Base Rate
 Base Rate forms the basis for arriving at Merchant Rates
and is derived from the ongoing spot Market rates for
each of the currencies.

 While arriving at the Merchant Spot TT Sale and

purchase rates from the base rate, it should be ensured
that the maximum spread between the two TT rates is
within the range prescribed by FEDAI from time to time.
It should be in line with the ongoing market rate.

INDIAN INSTITUTE OF BANKING & FINANCE

 Purchase & Sale Transactions
▶ All Purchase/Sale transactions are not alike and hence attract different
rates.
▶ Both Outward Remittance and payment of Import Bill are sale
transactions but work involved is not the same.
▶ Similarly in case of Export bill and Inward Remittance also due to the
difference in quality and nature of instruments
▶ The basic principle is that an instrument involving little expense and
risk will be more valuable than an instrument costing more to collect
and involving greater risk.
▶ Example:
The rate quoted by an AD to his customer on 01/06/2024 were (Rupees per
US$)
Buying Selling
TT 83.10 82.30
Bill 83.30 83.40
There are two aspects in a sale or purchase transaction:
(i) Rate for conversion and (ii) The date of delivery i.e. date on which the
transaction is completed.
 Types of Transaction: Value Date Concept
Due to vastness of the market operating in different time zones, most of the times
deal dates and settlement date differs. Market uses different terminology which
are used universally to avoid conflict.

Type of TXN Date of Deal Value Date

Cash/Ready 24.06.2024 24.06.2024
Monday Monday
TOM 24.06.2024 25.06.2024
Monday Tuesday
Spot 24.06.2024 26.06.2024
Monday Wednesday
Forward 24.06.2024 Any day after
Monday 26.06.2024
 Cross Rates

 It is the price of one FCY in terms of another FCY.

 It excludes the currency of the country where the rate
is offered.

Example: We intend to quote for GBP/Rs.

Now, GBP/USD(1.2710/20) as well as USD/INR (83.20/30)
are readily available quotes in the market. So,
for arriving at the
GBP/INR rate we cross out USD from both the quotes
we get GBP/INR i.e.105.75/105.95
 Cross Rates in Exchange
 US dollar is the intervention currency when USD/Rupee exchange rate
is available in the Indian forex market.
 Exchange Rate of all other foreign currencies are derived through
crosses.
 (e.g.) A export customer has received EURO 100,000. He wants to
convert into Rupees. The rates are as under: 1USD=Rs. 82.72/82.73 at
Mumbai and 1 EURO = USD 1.0730/1.0734 in overseas Market.

The customer first sells EURO and buy USD at 1.0730 (the Market
maker at overseas will by at LHS) and these USD will be sold in
Mumbai Inter bank Market. The Market Maker will again buy the Base
currency at LHS (i.e.) Rs. 82.72.

From the above, We find that 1 Euro fetches USD 1.0730 and 1
USD fetches Rs. 82.72 , Hence 1 EURO= 1.0730 * 82.72 (i.e) Rs.
 88.7585
 say Rs. 88.76. EURO 100000 will fetch Rs. 88,76,000
 Find out the rate if the customer has to pay an outward Remittance of
EUR 100,000 ? Ignore exchange Margin.
 Merchant rates
 Reserve Bank of India, being the central bank of the country does not
buy/sell from/to the customers (exporters and importers and others)
 The importers/exporters/others who are required to buy/sell
foreign exchange are popularly called as “ Merchants”
 RBI has authorized Banks in India to undertake FX transactions
with Merchants
 Foreign exchange Dealers Association of India (FEDAI) acts as a
facilitating body and in consultation with RBI frames
rules/regulations for AD (Authorized dealers) in India, for transactions
with merchants, which are known as “ Merchant rates”
 The rates quoted by Banks for dealing in Inter bank Market are known
as “ Inter Bank rates”
 All Merchant quotation is to be quoted in four decimal places with the
last two digits in the multiple of 25.
 (For example TT buying for 1 USD = Rs. 83.0625)
 Card/Cover/Base Rates
 Card rates are the rates applied by AD for small
value transactions as to avoid Dealer being disturbed
every now and then. Each Bank is free to fix the limit on
the amount to fix the card rates.
 Cover Rate is the rate at which the AD can cover
the merchant transaction in the inter bank Market
without any profit or loss.
 Base rate is the rate which forms the basis of
computation of both Spot and forward rates and the same
is arrived from the cover rate. This is done by loading
some cushion, in the cover rate, for guarding against any
adverse movement in the exchange rate after committing
a rate till the position is covered.
 Computation of Merchant Rates
 TT Buying Rate  Example:
 Step 1:  Spot USD 82.5050-82.5525
 Select Appropriate Base Rate  Find TT Buying Rate
(Market Buying Rate)
 Answer:
 Step 2 :
 Base Rate: Deduct some cushion from the
 Deduct exchange margin as cover rate.
per your Bank’s internal
 Cover rate : 82.5050
guidelines
 Deduct Cushion: 00.1000
 Step 3:
 Base Rate: 82.4050
 Round off the Quote as per FEDAI
guidelines in four decimal places  Less Exchange Margin (Profit): 00.1000
and the last two digits should be in  TT Buying Rate: 82.3050
the multiple of 25 (.0025)
 Computation of Merchant Rates
 TT Selling Rate  Example:
 Step 1:  Spot USD 82.5050-82.5525
 Select Appropriate Base Rate  Find TT Selling Rate
(Market Selling Rate)
 Answer:
 Step 2 :
 Base Rate: Add some cushion from the
 Add exchange margin as per your cover rate.
Bank’s internal guidelines
 Cover rate : 82.5525
 Step 3:
 Add Cushion: 00.1000
 Round off the Quote as per FEDAI
 Base Rate: 82.6525
guidelines in four decimal places
and the last two digits should be in  Add Exchange Margin (Profit): 00.1000
the multiple of 25 (.0025)  TT Selling Rate: 82.7525
 Bill Buying Rate
 In case of exports, the exporter send the goods and draws
documents like Bill of exchange(draft) against which the
payment is to be received from abroad as per the agreement
entered by the Buyer and Seller.
 The exporter is not offering FX immediately rather offer
documents for his claim to get the FX in a future date.
 Hence the document is either purchased, discounted negotiated
by the authorized Dealer.
 Hence, the AD can dispose of the FX after receipt of the same
in his NOSTRO account.
 Hence while quoting the Bill buying rate the AD has to take into
consideration the notional due date or already fixed due date.
Accordingly the AD will add forward margin for the period
after adjusting in the SPOT rate.
 Merchant Rates
Applicable Rate Nature of transaction

TT buying rate 1 Clean Inward remittance TT/ MT/ DD for which cover has already been provided by credit to the Nostro
account of the Bank

2 conversion of Proceeds of instruments sent on collection basis

3 cancellation of o utw ard TT/ MT/ DD/ PO etc.,

4 Cancellation of forward sale contract

Bill buying rate 1 purchase/discount/negotiation of export bills ( where Bank has to Process the Bill)

TT selling rate 1 Clean outward remittance in foreign currency by TT/MT/DD/PO

2 cancellation of purchase (i.e)

Bill Purchased earlier is returned unpaid
bill Purchased earler transferred to collection account
inward remittance returned to remitting bank

3 Cancellation of forward Purchase contract

4 import documents received directly by the importer

Bill Selling rate 1 Transaction involving remittance for import bill except the 4th point mentioned in TT selling rate

INDIAN INSTITUTE OF BANKING & FINANCE

 Interest Parity Principle
 Forward rates are linked to Interest rate differential.
 Otherwise, it can provide an arbitrage opportunity to make
risk less profit.
 The inference we learnt that the currency carrying a
lower rate of interest will be at Premium, while the
currency carrying a higher rate of interest will be at
Discount.
 This relationship is called Interest rate parity.
 This Parity will hold good where there are no capital account
controls and capital can move freely across borders.
 In India, the forward rate is a function of Demand and supply
rather than interest rate differentials.
 Interest Parity Theorem Example
 Consider a Person wants to Borrow USD 100,000 for one year at the rate of
0.17% p.a and by converting into Indian rupees wants to invest the amount in
Fixed deposit at the rate 4% p.a.

 Suppose the current rate of 1 USD=Rs.83 and the investor is investing

Rs.83,00,000 for one year in FDR at the rate of 4%

 After one year the dollar borrowing stands at USD 100,170 (including int.) and
rupee investment brings Rs. 86,32,000 ( including int.)

 The parity theorem formula is Spot Price *(1+local interest rate)/ (1+foreign
interest rate) ^1

 This leads to Rs. 83.00 * (1.0400/1.0017)^1 = Rs. 83.00*1.03823= Rs.86.17

 Now rupee forward can also be arrived out by dividing Rs. 86,32,000/USD
100170 which fetches 1 USD = Rs. 86.1735 (say Rs 86.17) at the end of one year
which is the same arrived by the theorem in the earlier step.

 From the above we understand that one year dollar is costlier in forward by
317 paise compared to spot price.
 General Principles of Forward
Rates
 Foreign currencies earning higher interest rates are traded
at a forward rate below the spot rate (i.e.) at a discount to
their spot prices.

 The forward price of the lower interest rate currency is

always above the spot rate (i.e., at premium to their spot
prices)

 The currency which commands higher interest rate is always

at a discount in relation to the other that commands a lower
interest rate.
 Calculating Forward Rate
 The rate of exchange for any date other than spot is a function of
spot and the relative interest rate in each currency as discussed in
interest parity theorem.
 Forward rate has two components:
 Spot rate , and
 Forward points
 Forward points are also called as forward differentials which
reflect the interest rate differentials between the pair of
currencies provided capital flows are freely allowed.
 However in USD/INR rate as there are exchange control
regulations prohibiting free movement of capital from/into
India. In India free convertibility is allowed only in current
account transactions.
 Hence in case of USD/INR it is pure demand/supply which
determines the forward differentials.
 Foreign Exchange Terms
 Premium: When a currency is costlier in
future(forward) as compared to Spot, the currency is
said to be at a Premium vis-à-vis another currency.
 In “ Direct Quote” premium is always added to
both buying and selling rate and in “ Indirect Quote”
premium is always deducted from both buying and
selling rate.
 Discount: When a currency is cheaper in
future(forward)as compared to spot, the currency is
said to be at a discount vis-à-vis another currency.
 In “Direct Quote” discount is always deducted from
both buying and selling rate and in “ Indirect Quote”
discount is always added to both buying and selling
rate.
 Forward Rate Quotations
 Forward rates is quoted in terms of forward differentials also called as forward
margins.
 Mumbai Inter bank Market quotes as under:
 Spot: USD = Rs. 75.70-75.75
 Spot/June = 0.4700/0.4900 ( means 47/49 paise)
 Spot/July = 0.7000/0.7300 (means 70/73 paise)
 Spot/August = 0.9600/0.9900 (means 96/99 paise)
 Kindly note that the forward differentials are in ascending order in each of
these months. The first figure is lower than the second figure. This means the
base currency (USD) is at Premium. The rupee (INR) is at discount.
 Please also note that if the forward differentials are in descending order, the
base currency is at discount.
 Now calculate the forward rates for USD/INR for all 3 months.
 Forward Rates Calculation Examples
 Consider EURO = USD 1.0818/22  Consider USD = JPY 107.02/05
 Spot/June = 2/3  Spot/June = 4/3
 Spot/July = 4/5  Spot/July = 10/9
 Spot/ Aug = 19/22  Spot/Aug = 15/14
 Spot/ Nov = 49/51  Spot/Nov = 34/33
 Here the forward points are to be  Here the forward points are to be considered as
considered as under: under:
 0.0002/0.0003 for June  0.04/0.03 for June
 0.0004/0.0005 for July  0.10/0.09 for July
 0.0019/0.0022 for Aug  0.15/0.14 for Aug
 0.0049/0.0051 for Nov  0.34/0.33 for Nov
 Please note that forward points are in  Please note that forward points are in
ascending order. Hence the base currency descending order. Hence the base currency USD
EUR is at Premium and other currency USD is at Discount and other currency JPY is at
is at discount. Premium.
 Please calculate the forward rates for all  Please calculate the forward rates for all
months. months.
 General Principles of Forward Rates

 Fixed Date Foreign exchange Forward contract

 Option Foreign exchange Forward contract
 FEMA and FEDAI guidelines
 Contract Amount
 Option of Delivery
 Ready/TOM/Spot/forward
 Place of delivery
 Date of delivery
 Choice of Exercising Option
Calculation of exchange rates for forward exchange contracts

 We see earlier that in case of direct quote, the Premium is added to

spot rate and discount is deducted from the spot rate.

 If a forward contract is fixed date contract, then it is easy for

the Bank to cover the transaction in the Inter bank Market.

 But in the case of an option forward contract, the right for exercising
option lies with the purchaser of the contract (customer). Hence
it is difficult for the Bank to know the date of exact delivery of
Foreign exchange and as a Thumb rule he goes by the “Worst Case
Scenario” approach and takes a very conservative approach while
computing the forward rate in the option forward contract.
 Steps in computing forward exchange rate
 Take the appropriate spot rate;
 Arrive at the base rate by deducting or adding to the spot rate the
appropriate forward differentials(margins).
 As the period of delivery of foreign exchange is at the option of the
customer, the bank would take a conservative view while charging or
conceding the forward margin.
 Generally the view taken by the banker is that customer will give/take
the delivery of Foreign Exchange at the date which will be most
favourable to the customer and consequently, most unfavourable to
the bank.

 The Bank will take a conservative view and quote a rate after ensuring
that Bank will not suffer a loss on account of the option exercised by
the customer any time during the currency of the option period.
 Holgate’s rule
 The rule which is applied for arriving at the forward
rates
is known as Holgate’s Rule and is summarized as under:
 In case of Direct Rates:

Discount Premium
(Deduct) (Add)

Forward Purchase Maximum discount Minimum Premium

Latest Period Earliest Period

Forward sale Minimum Discount Maximum Premium

Earliest Period Latest Period
 Forward rate example-Premium

Inter Bank Market:

 USD = Rs. 75.5025/75.5575

 Forwards
 Spot/June: 24/26
 Spot/July : 46/48
 Spot/Aug : 71/73

 An export customer likely to receive USD amount in

July.

 What is the Rate AD will quote?

 Forward rate example-Premium-Solution

 Base rate: Rs. 75.5025

 (Mind that the customer has the option to deliver the
foreign exchange to the Bank any time in July)
 Presuming the customer will deliver the FX on 1st
July, only Premium up to June 30th will be
added. (conservative view by Bank)
 Forward rate= 75.5025+0.2400
 Less appropriate margin as per Bank’s
internal guidelines.
Forward rate: 75.7425- 0.1000 (i.e.) Rs. 75.6425
 Forward rate example-Discount
 Inter Bank Market  Base rate: Rs. 75.5025
 Deduct July Forward Margin (Mind
 USD = Rs. 75.5025/75.5575 that the customer has the option to
deliver the foreign exchange
 Forwards to the Bank any time between 1st July
 Spot/June: 26/24 to 31st July)
 Presuming the customer will deliver
 Spot/July : 48/46 the FX on 31st July, only discount up to
 Spot/Aug : 73/71 July 31st will be deducted. (
conservative view by the Bank)
 An export customer likely  Forward rate= 75.5025- 0.4800
to  Less appropriate margin as per
receive USD amount in July.
 your Bank’s internal guidelines.
 What is the Rate AD will  Forward rate: 75.0225-0.1000
quote?
 (i.e) Rs. 74.9225
 Forward - Cross Rates
 A customer of your Bank wants to book a forward contract for selling GBP
against rupees for August 30. If the exchange rates as on 1st June 2022 as
follows, what rate you will quote to him. Profit is taken as 5 paise.

 Mumbai Inter Bank quotes are as follows:

 Spot USD = Rs. 77.1000-77.1300
 Spot/June 2500/2700
 Spot/July 5200/5500
 Spot/August 7700/8200
 London Market
 Spot GBP = USD 1.2200/1.2205
 Spot/1 month 2/1
 2 month 3/2
 3 month 5/4
 Answer
 Market will buy the Base currency (GBP) and give
 The customer is having GBP and dollar as under:
wants to covert into rupees on  1GBP = USD 1.2200
August 30 ( fixed date)
 Less 0.0005 (Discount)
 Market will take GBP from the  1 GBP = USD 1.2195
customer and give equivalent
 We are taking 3 months forward points which is at
dollar to customer. discount. Hence you have to deduct from the Base
currency and give less dollars. Base currency (GBP) is
 By selling that dollar in inter Bank at discount and Variable currency (USD) is at Premium.
market, the Bank will fetch  Mumbai inter Bank Market gives rates as under:
rupees for the customer.
 1 USD = Rs. 77.1000
 While calculating the forward  Add = Rs. 00.7700 (Premium)
rates, the Bank will take into
1 USD = Rs. 77.8700
Premium/Discount of the base 

currency while quoting the rate.  Here USD at Premium and rupee is at discount.
 Forward rate will be
 1 GBP=USD 1.2195 and I USD= Rs. 77.87
 Hence 1 GBP= 1.2195*77.87= Rs. 94.96246 (say Rs.
94.9625)
 Less: Profit Rs. 00.0500
 Quote to customer is 1GBP= Rs. 94.9125
 Forward Rates

What is a Forward Rate ?

 Rate agreed for settlement on an agreed date in the

future
 All rates are derived from Spot rates
 Forward rate is the spot rate adjusted for the premium
/ discount
 Forward Rate = Spot Rate + / - premium or discount
 Example

Your esteemed importer approaches you for retirement

of an import bill of GBP 100,000.00.

What rate will you quote to him to get the business?

Suppose GBP/USD = 1.010/20

USD/INR = 74.20/30.

You have to load a margin of 0.15.

INDIAN INSTITUTE OF BANKING & FINANCE

Specialised Integrated Treasury Branch
Answer
For retirement of Import bill in GBP you need to
buy GBP and sell USD and then for USD you need to
sell INR and buy USD.

GBP can be bought at 1.3020 USD.

USD can be bought at 74.30 INR.
The GBP/INR rate would be 96.7385 (1.3020*74.30)
Margin 0.1500.
Rate for the customer should be
96.7385+0.1500= Rs. 96.8885 or say 96.89 for
effective import payment. (TT Selling rate).

INDIAN INSTITUTE OF BANKING & FINANCE

Specialised Integrated Treasury Branch
 Example
On 10 Oct, a customer requests you for booking of a
forward contract for export bill of USD 150,000.00 to
be realised in the month of November.

Given that USD/INR spot= 74.20/30

Forward premium is: November = 44/46 paise
December = 73/75 paise.

Margin to be charged 0.05 paise only.

INDIAN INSTITUTE OF BANKING & FINANCE

Specialised Integrated Treasury Branch
 Answer
For calculating rate for forward purchase contract
we need to take forward premium for Nov, the one that the
market
would pay i.e., 44 Paisa.

Spot rate is 74.20, getting the forward interbank

rate is 74.64.

Deduct 0.05 paisa as margin to arrive at 74.59

INDIAN INSTITUTE OF BANKING & FINANCE

Specialised Integrated Treasury Branch
 Forward Contracts
Forward Exchange Contract is a contract wherein two
parties (in India one party has to be compulsorily a bank)
agree to deliver a certain amount of foreign exchange at an
agreed rate Either at a fixed future date or during a future
period.

They are OTC derivatives involving the fixation of rates

in advance for deliveries in future.

INDIAN INSTITUTE OF BANKING & FINANCE

Cancellation of Forward Contract

In the absence of any instructions

from the customer, contracts which
have matured will be automatically
cancelled on the 03rd day from the
date of maturity. Exchange
difference will be recovered.

INDIAN INSTITUTE OF BANKING & FINANCE

Specialised Integrated Treasury Branch
 Documents from Customers
Corporate must produce following documents without any fail:

 A declaration from the client that the exposure is not

hedged yet and hasn’t been hedged with any other bank.
 Annual certificate that derivative transactions are
authorized and that the Board is aware of the same.
 An undertaking that the same underlying exposure has
not been covered with any other bank/s.
 Quarterly certificates from the CFO of the companies, that
the contracts outstanding at any point of time with all
banks during the quarter did not exceed the value of the
underlying exposures.
 Any Question please ???

Thank you for patience listening

Arun Misra
Faculty-IIBF
EX DGM-Bank of Baroda
E Mail-fm.trg4@[Link]
Contact Number-9175178993/7506078993