FOREX MARKET

Introduction Foreign Exchange:

The term foreign exchange is used to represent the amount of foreign

currency held by the reserve bank of India. But the term foreign exchange
means the conversion of one country’s currency into another country’s
currency as well as to represent the amount of foreign currencies held by
one country.
• Meaning of foreign exchange market:

• The Foreign Exchange Market is a financial market in which currencies are

bought and sold. In typical foreign exchange transaction, a party purchases
some quantity of one currency by paying some quantity of another currency.

• It is a place or an arrangement, where one country’s currency is exchanged

for another country’s currency. The need for the Foreign Exchange Market
(Forex Market)is developed to facilitate International trade. The main
participants are the people who are engaged in import and export activities.
They make payments through this market which facilitates the international
trade. Hence the conversion of one country’s currency into the currency of
another country is essential. Foreign exchange market therefore plays an
extremely important role in facilitating cross-border trade, financial
transactions and investment.
 Major participants in Forex Market:

• The participants or the players in the foreign exchange

market comprise;
•  Corporates
•  Commercial banks
•  Exchange brokers
•  Central banks
• 1. Corporates:
• The business houses, international investors, and
multinational corporations may operate in the market to
meet their genuine trade or investment requirements.
They may also buy or sell currencies with a view to
speculate (guess) or trade in currencies to the extent
permitted by the exchange control regulations. They
operate by placing orders with the commercial banks.
The deals between banks and their clients form the retail
segment of foreign exchange market.
• Commercial Banks
• Commercial Banks are the major players in the Forex
market. They buy and sell currencies for their clients.
They may also operate on their own. They do cover
operation to correct the purchase position arising from
various deals with the customers. A major portion of the
volume is accounted by trading in currencies to gain from
exchange movements. For transactions involving large
volumes, banks may deal directly among themselves.
For smaller transactions, brokers may be the
intermediaries.
• Exchange brokers
• Exchange brokers facilitate deal between banks. In the absence of
exchange brokers, banks have to contact each other for quotes
(estimates). If there are 150 banks at a centre, for obtaining the best
quote for a single currency, a dealer may have to contact 149 banks.
• Exchange brokers ensure that the most favourable quotation is
obtained and at low cost in terms of time and money. The broker
decides the limit as well as the buy or sell rate of the foreign currency
concerned.
• From the intends from the other banks, the broker will be able to match the
requirements of both. The names of the counter parties are revealed to the
banks only when the deal is acceptable to them. Till then privacy is
maintained. Exchange brokers tend to specialize in certain exotic
currencies, but they also handle all major currencies.
• Central Bank
• Central Bank may intervene in the market to influence the exchange rate.
The central bank may transact in the market on its own for the above
purpose on behalf of the government when it buys or sells bonds and settles
other transactions.
• Reserve Bank will not ordinarily buy/sell any other currency from/to
authorized dealers.
• The contract can be entered into on any working day of the dealing room
of Reserve Bank.
• No transaction is entered into on Saturdays.
• The spot value as well as the forward should match the national and
international values. Reserve Bank of India does not enter into the market
in the ordinary but they can intervene with the help of State Bank of
India.
 How does the foreign-exchange market trade 24
hours a day?
• The forex market is open 24 hours a day, five days a
week, because the forex exchanges in North America,
Europe, Asia, and Australia are open at staggered and
often overlapping times.
• There is always a forex exchange somewhere in the world
that is operating during the work week, so the forex
market itself is open from 5:00 p.m. ET on Sunday to 5:00
p.m. ET on Friday.
• Key Takeaways
• Forex can be traded using exchanges in different parts of
the world from 5 p.m. ET on Sunday until 5 p.m. ET on
Friday.
• The ability to trade forex over 24 hours is mostly due
to different international time zones.
• Forex trading opens daily with Australia and Asia, then
Europe, followed by North America.
• As one region's markets close, another's opens or
has already opened and continues to trade in the
forex market.
• Because the forex market operates in multiple time zones with overlap between one region's
market closing and another opening, it can be accessed any time of day during the work
week. It is closed on weekends. The international scope of currency trading means there are
always traders making and meeting demands for a particular currency.
• While the forex market is available 24 hours per day, currencies in several emerging markets are not
traded the entire time the markets are open. As of 2022, the most recent year in survey data released
by the Bank for International Settlements, the eight most traded currencies in the world are the:

• U.S. dollar (88% of trades)

• Euro (31% of trades)
• Japanese yen (17% of trades)
• British pound (13% of trades)
• Chinese yuan renminbi (7% of trades)
• Australian dollar (6% of trades)
• Canadian dollar (6% of trades)
• Swiss franc (5% of trades)
• All eight of these currencies are traded continuously during trading sessions. Only 21 currencies are
traded at least 1% of the time
• The ability of the forex market to trade over a 24-hour
period is mostly due to different international time zones
and the fact that trades are conducted over a network of
computers rather than any one physical exchange that
closes at a particular time.
UTC (Coordinated Universal Time) is not a time zone
; it is a standard time used around the whole world for time zones.
Forex Spot and forward Rates:
The spot rate of exchange refers to the rate or price in terms of home
currency payable for spot delivery (at that moment or present situation)of
a specified type of foreign exchange. If a trader wants to buy or sell any
currency in the spot market (immediate market), the price paid to purchase or
received on sale of the currency is called spot rate.

The forward rate of exchange refers to the price at which a transaction will
be executed at some specified time in future. The rate at which the future
and forward transactions are executed is called as forward rate. If a future
contract is entered for the purchase of US dollar at Rs.48 after three months,
the rate is called as forward rate.
• Mutual Funds

• A mutual fund is an investment vehicle that pools funds from investors and invests in
equities, bonds, government securities, gold, and other assets. Companies that qualify to
set up mutual funds, create Asset Management Companies (AMCs) or Fund Houses, which
pool in the money from investors, market mutual funds, manage investments, and enable
investor transactions.

• Mutual funds are managed by sound financial professionals known as fund managers, who
have the expertise in analyzing and managing investments. The funds collected from
investors in mutual funds are invested by the fund managers in different financial assets
such as stocks, bonds, and other assets, as defined by the fund’s investment objective.
Where and when to invest are some of the things taken care of by the fund managers,
amongst many other responsibilities.
• For the fund’s management, the AMC charges a fee to the
investor known as the expense ratio. It is not a fixed fee and
varies from one mutual fund to another. SEBI has defined the
maximum limit of the expense ratio that can be charged
based on the total assets of the fund.
• Types of Mutual Funds

• There are multiple ways in which mutual funds can be categorized, for example, the way they are
structured, the kind of securities they hold, their investment strategies, etc. The Securities and
Exchange Board of India (SEBI) has classified mutual funds based on where they invest, some of which we
have listed below.

• Based on the structure:

1. Open-ended funds are mutual funds that allow you to invest and redeem investments at any time, i.e.
they are perpetual in nature. They are liquid in nature and don’t come with a specific investment
period.

2. Close-ended schemes have a fixed maturity date. You can only invest at the time of the new fund offer
and redemption can only be done on maturity. You cannot purchase the units of a close-ended mutual
fund whenever you please.
• Based on asset classes:
• Equity Mutual Funds invest at least 65% of their assets in stocks of companies listed on the stock
exchange. They are more suitable as long-term investments (> 5 years) as stocks can be volatile in
the short term. They have the potential to offer higher returns but also come with high risk.

• Debt Mutual Funds primarily invest in fixed-income instruments like Government securities,
corporate bonds, and other debt instruments. They are not affected by stock market volatility and
hence, can offer more stable returns compared to equity mutual funds. The types of debt mutual funds
are differentiated on the basis of the maturity period of the securities they hold.

• Hybrid Mutual Funds invest in both equity and debt in varying proportions depending on the
investment objective of the fund. Thus, hybrid funds give you diversified exposure to various asset
classes. Hybrid funds are categorized on the basis of their allocation to equity and debt
 Ways/modes of Mutual Fund Investment

1. Lumpsum: When you want to invest a significant amount in a mutual

fund in one go.

2. For example, if you had a sum of Rs 1 lakh to invest then you could go in
for lumpsum investment and invest the entire amount of Rs 1.0 lakh at
one go in a mutual fund of your choice. The units allotted to you will
depend on the NAV of that fund on that particular day. If the NAV is Rs
1000, you will end up getting 100 units of the mutual fund.
 SIP: You also have the option to invest small amounts periodically.
• In the above example, say, you don’t have Rs 1 Lakh but can commit to an
investment of Rs 10,000 per month for 10 months, and you can align your
investments with your cash flows. This way of investing is known as a Systematic
Investment Plan (SIP). SIP encourages regular investment of fixed amounts bi-
monthly, monthly, quarterly and so on depending on your need and the options
available with the mutual fund.

• This method of investing inculcates a discipline of investment and also eliminates

any need to look for the right time to invest. Many investors try to time the market
which generally requires considerable time and expertise. What a SIP does instead is
to average out your costs and the investor doesn’t need to time the market. When
the NAV is low, it gets you higher units and vice versa. SIPs, when done
regularly over the long term, can help you build a more considerable mutual fund
investment corpus.
• The minimum amount for a lump sum and SIP investments are defined by mutual fund companies
and can vary but can start at as low as Rs 100.
• NAV stands for Net Asset Value. It refers to the per-unit or per-share value of a
mutual fund scheme. It is generally used as an indicator of the fund’s overall
performance. It is calculated by subtracting the mutual fund’s liabilities and
expenses from its total asset value and dividing the result by the number of
outstanding units. It usually starts with ₹10 when an NFO is launched.
• NAV is important in mutual funds as it can give you a sense of how it has
performed in the past.
• The NAV of the fund is typically declared on a daily basis for open-end mutual
funds, which shows the value of the fund at the end of each trading day. For
closed-end funds, the NAV is usually calculated less frequently, such as weekly or
monthly.
 Features & Benefits of Mutual Funds

• Diversification: The saying ‘do not put all your eggs in one basket’ perfectly fits
mutual funds as spreading investment across multiple securities and asset
categories lowers risk. For example, compared to direct equity investing, where your
funds are deployed in individual company stocks, equity mutual funds invest in a
basket of stocks across sectors, thereby reducing risk.
• Professional management: Mutual funds are managed by full-time, professional
fund managers who have the expertise, experience, and resources to actively
buy, sell, and manage investments. A fund manager continuously monitors
investments and rebalances the portfolio accordingly to meet the scheme’s objectives.
• Transparency: Every mutual fund has a Scheme Information Document readily
available on the fund house’s website that can give you all the details about its
holdings, fund manager, etc. In addition, the portfolio investment value (NAV) is
published daily on the AMC site, and AMFI site for investors to track the
portfolio of the mutual fund.
• Liquidity: You can redeem your investments on any business/working day at the
NAV of the day of your redemption. So, depending on the type of mutual fund you
have invested in, you will receive your invested funds in your bank account in 1-3 days.
However, close-ended funds allow redemption only at the time of the maturity of the
mutual fund. Similarly, ELSS mutual funds have a lock-in period of three years
1. Tax Savings: Investment of up to Rs. 1,50,000 in ELSS mutual funds (Equity Linked
Savings Schemes )qualifies for tax benefit under section 80C of the Income Tax Act,
1961. Mutual fund investments, when held for a longer term, are tax-efficient.

2. Choice: There are many options to invest in mutual funds to meet your different needs.
To name a few- Liquid funds, are for investors looking to benefit from the safety of
debt and low-interest rate risk, flexi-cap funds if you are looking for stock
diversification, and solution-oriented mutual funds if you are looking to invest for a
particular goal like retirement or children’s education, etc.
• Cost-effective: Mutual funds are a low-cost investment
vehicle. The pooled investments from several investors in a
mutual fund enable the fund to invest in a basket of stocks
and debt securities which otherwise may be out of reach
for the ordinary investor or require a higher investment
amount. Thus, these pooled investments provide advantages
of economies of scale. In return, lower costs to investors,
such as brokerage, etc., are addressed in the minor form of
fund expenses. This is why investing in direct mutual funds
through ET Money makes sense because that helps you
decrease the cost further.
1. Returns: Mutual fund returns are not assured by mutual funds and are subject to
market risks. But over the long term, equity mutual funds have the potential
to deliver double-digit returns annually. Debt funds can also offer higher
returns as compared to bank deposits. You can also calculate your potential
returns, using a mutual fund calculator.

2. Well Regulated: In India, the mutual fund industry is regulated by the capital
market regulator Securities and Exchange Board of India (SEBI). Therefore,
mutual funds must follow stringent rules and regulations, ensuring investor
protection, risk mitigation, liquidity, and fair valuation.
 Disadvantages of Mutual Funds

• Exit Load: Mutual funds generally levy an exit load (fee) for redeeming investments
within a specified period, for example, one year from the date of investment. This is done
to refrain the investor from exiting the scheme too early, as it impacts both the
fund’s performance and the investor’s goal achievement. When investing directly in
stocks, say, you do not face any exit load and in comparison, this may seem like an added
expense. However, this has been introduced in the investors’ interest.
• High cost: SEBI has defined the maximum limit of expense ratios that mutual fund
houses can charge and they depend on the mutual fund’s size. As the size grows, the
expense tends to come down. The maximum expense ratio that is chargeable for an
equity-oriented mutual fund is 2.25%. And you have to bear this charge irrespective
of the performance of the fund. When compared to another mode of investment, say,
direct stocks, you may find the expense ratio to be higher than the brokerage you pay. But
then it is being paid for the convenience and expertise, so, it is a balance that you need to
achieve.
1. Over-diversification: In the quest to diversify your investments, you may invest in
mutual funds, which invest in a vast number of stocks, leading to over-
diversification. Not all the stocks of a portfolio would deliver high returns all the
time. You may end up investing in two mutual funds holding similar portfolios
which may then lead to over-diversification. It is advisable to study the mutual fund
portfolio before you invest.

2. Risk: Investments in mutual funds are subject to market risk. The risk of losses
faced by all types of securities in the financial markets cannot be reduced by
diversification. Market risks may occur due to many macro and microeconomic
factors. For example, equity mutual funds are subject to volatility risk owing to
fluctuations in the stock market whereas debt mutual funds are subject to interest
rate risk which is caused by fluctuations in the interest rates and so on.
• Mutual Fund Objectives

• Mutual funds seek to fulfill the following objectives for their unitholders:

• Diversification: It is usually advised not to put all your eggs in one basket. Doing so
can disproportionately increase your risk. Mutual funds are inherently diversified.
They diversify across securities, assets, and even geographies. Hence, they help
lower the risk.

• Capital protection: Some mutual funds, such as money-market funds and liquid
funds, aim to protect your capital. However, while they are relatively safer, they
also have lower returns.
• Capital growth: Certain mutual funds, such as equity funds,
focus on growth to protect your investment against
inflation. These funds invest in stocks and have higher returns
but also come with higher risks.

• Saving tax: A certain class of mutual funds, called equity-linked

savings schemes (ELSS) or tax-saving funds, also provide
income-tax deductions up to Rs 1.5 lakh in a financial year in
the old income-tax regime.
• What Is A Currency Hedge?
• A currency hedge is a strategy used to reduce the risk
of loss from fluctuations in currency exchange rates.
This is achieved by investing in financial instruments
that protect against unfavorable movements in a
specific currency. It is used to mitigate the risk of
currency fluctuations and protect against potential
losses in international transactions.
• The goal of a currency hedge is to minimize the impact
of currency fluctuations on an investment portfolio or
business operations. This is typically done using
currency forward contracts, currency options, or other
financial instruments to offset the risk of changes in
currency exchange rates.
• Currency hedging is a strategy used to manage the risks associated with fluctuations in currency
exchange rates.
• Active currency hedging involves taking specific actions to manage currency exposure. Passive
currency hedging involves accepting natural currency exposure that results from investing in foreign
assets.
• The choice between active and passive currency hedging depends on investment objectives, risk
tolerance, and financial situation and should be discussed with a financial advisor.
• Currency hedging can help reduce the impact of currency fluctuations on investment returns, making
investment portfolios more stable.
• The goal of a currency hedge is to minimize the impact
of currency fluctuations on an investment portfolio or
business operations. This is typically done using
currency forward contracts, currency options, or other
financial instruments to offset the risk of changes in
currency exchange rates.
• Currency hedging is an important aspect of managing
financial risk, particularly for companies and
investors who operate in multiple countries or have
investments denominated in foreign currencies.
Without hedge, exchange rate fluctuations can
significantly impact the value of investments or business
operations.
• However, it is important to understand that hedging is not
a guarantee against loss and that there may be costs
associated with implementing a hedge. As such, investors
and businesses should consult with a financial advisor to
determine the best approach for their specific
circumstances.
• Common types of currency hedging instruments:

• #1 - Forward Contracts:
• A forward contract is an agreement between two parties to buy or sell a
specified amount of currency at a predetermined exchange rate at a
future date. This allows businesses and investors to lock in an exchange
rate and reduce exposure to currency fluctuations.

• #2 - Currency Options:
• Currency options are contracts that give the holder the right, but not the
obligation, to buy or sell a specified amount of currency at a
predetermined exchange rate within a specified period.
• Currency Swaps:
• A currency swap is an agreement between two parties to
exchange a specified amount of one currency for another
currency at a predetermined exchange rate. This allows
businesses and investors to exchange one currency for
another and reduce exposure to currency fluctuations.
• Futures Contracts:
• A futures contract is a standardized agreement to buy
or sell a specific asset at a predetermined price and date
in the future. For example, currency futures contracts to
hedge against currency fluctuations by allowing
businesses and investors to lock in an exchange rate
for a future transaction.
• Example #1
• For example, consider a company that exports goods from the United States to Europe. If the
euro value decreases relative to the U.S. dollar, the company will receive fewer euros for
each dollar of goods it sells. This can result in lower profits and a decrease in the value of
the company's investments. The company can use a currency hedge to mitigate this risk by
entering into a forward contract. For example, it can be to sell euros at a predetermined
exchange rate, effectively locking in a certain price for the euros it will receive for its exports.

• Similarly, foreign currency-denominated investors can also use currency hedging to reduce
their exposure to currency risk. This is done by investing in financial instruments such as
currency-hedged exchange-traded funds (ETFs) or currency-hedged mutual funds.
These instruments allow investors to hold foreign assets while minimizing the impact of
fluctuations in the foreign currency's value relative to the investor's home currency.