Students of SYBFM present the topic:-

Foreign Exchange Markets

Introduction
Forex (Foreign Exchange) is the international financial market used for trade of world currencies. It has been working since 70s of the 20th century - from the moment when the biggest world nations decided to switch from fixed exchange rates to floating ones. Daily volume of Forex trade exceeds 4 trillion United States dollars, and this number is always growing. Main currency for Forex operations is the United States dollar (USD). According to Paul Einzig, "The foreign exchange market is the system in which the conversion of one national currency in to another takes place with transferring money from one country to another." According to Kindleberger, "It is place where foreign moneys are bought and sold." In simple words, the foreign exchange market is a market in which national currencies are bought and sold against one another. There are large numbers of foreign transactions such as buying goods abroad, visiting foreign country for any purpose. Corresponding nation in whose currency the transaction is to be fulfilled. The foreign exchange market provides the foreign currency against any national currency. However, it is to be understood that unlike other markets, this market is not restricted to any particular country or any geographic area. There are large numbers of dealers' instruments such as exchange bills, bank drafts, telegraphic transfers (TT), etc. There are certain other dealers such as brokers, acceptance houses as well as the central bank and treasury of the nation. The foreign exchange market is unique because of

Its huge trading volume, leading to high liquidity;

Its geographical dispersion; Its continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday; The variety of factors that affect exchange rates; The low margins of relative profit compared with other markets of fixed income; and The use of leverage to enhance profit margins with respect to account size.

History
Historically the value of goods was expressed through some other goods, for example - a barter economy where individuals exchange goods. The obvious disadvantages of such a system encouraged establishment of more generally accepted and understand means of goods exchange long time ago in history to set a common scale of value. In different places everything from teeth to jewelry has served this purpose but later metals, and especially gold and silver, were introduced as an accepted means of payment, and also a reliable form of value storage. Originally, coins were basically minted from the metal, but stable political systems introduced a paper form of IOUs (I owe you) which gained wide acceptance during the Middle Ages. Such paper IOUs became the basis of our modern currencies. Before First World War most central banks supported currencies with gold. Even though banknotes always could be exchanged for gold, in reality this did not happen that often, developing an understanding that full reserves are not really needed. Sometimes huge supply of banknotes without gold support led to giant inflation and hence political instability. To protect national interests foreign exchange controls were introduced to demand more responsibility from market players.

Closer to the end of World War II, the Bretton Woods agreement was signed as the initiative of the USA in July 1944. The Bretton Woods Conference rejected John Maynard Keynes suggestion for a new world reserve currency in favour of a system built on the US dollar. Other international institutions such as the IMF, the World Bank and GATT (General Agreement on Tariffs and Trade) were created in the same period as the emerging victors of WW2 searched for a way to avoid the destabilising monetary crises which led to the war. The Bretton Woods agreement resulted in a system of fixed exchange rates that partly reinstated the gold standard, fixing the US dollar at USD35/oz and fixing the other main currencies to the dollar - and was intended to be permanent. The Bretton Woods system came under increasing pressure as national economies moved in different directions during the sixties. A number of realignments kept the system alive for a long time, but eventually Bretton Woods collapsed in the early seventies following president Nixon's suspension of the gold convertibility in August 1971. The dollar was no longer suitable as the sole international currency at a time when it was under severe pressure from increasing US budget and trade deficits. The following decades have seen foreign exchange trading develop into the largest global market by far. Restrictions on capital flows have been removed in most countries, leaving the market forces free to adjust foreign exchange rates according to their perceived values. But the idea of fixed exchange rates has by no means died. The EEC (European Economic Community) introduced a new system of fixed exchange rates in 1979, the European Monetary System. This attempt to fix exchange rates met with near extinction in 1992-93, when pent-up economic pressures forced devaluations of a number of weak European currencies. Nevertheless, the quest for currency stability has continued in Europe with the renewed attempt to not only fix currencies but actually replace many of them with the Euro in 2001. The lack of sustainability in fixed foreign exchange rates gained new relevance with the events in South East Asia in the

latter part of 1997, where currency after currency was devalued against the US dollar, leaving other fixed exchange rates, in particular in South America, looking very vulnerable. But while commercial companies have had to face a much more volatile currency environment in recent years, investors and financial institutions have found a new playground. The size of foreign exchange markets now dwarfs any other investment market by a large factor. It is estimated that more than USD 3,000 billion is traded every day, far more than the world's stock and bond markets combined.

Functions of Foreign Exchange Market

(A) Transfer Function: As mentioned above, the foreign exchange markets are exchange markets engaged in transferring the purchasing power between two nations and two currencies. It is prime function of this market. In simple terms, it is conversion of one currency into another such as converting Indian Rs. into U.S. $ and vice versa at some rate. Various instruments like bank drafts, exchange bills, are used for transferring the purchasing power. In this regard international clearing to both the direction is important to because it simplifies the conduct of international trade as well as capital movements from one country to another. (B) Credit Function : Under this function the foreign exchange market provides credit to the traders such as exporters and importers. Exporters can get credit such as reshipment and postshipment credit. Recently started Euro-Dollar market is a leading credit market at international level. This function of making credit available plays a crucial role in growth and expansion of the international trade.

(C) Hedging : Hedging is a specific function. Under this function the foreign exchange market tries to protect the interest of the persons dealing in the market from any unforeseen changes in the exchange rate. The exchange rates (price of one currency expressed in another currency) under free market situation can go up and down. This can either bring gains or losses to the concerned parties. Foreign exchange market guards the interest of both exports as well as importers, against any changes in the exchange rate. (D)Primary The primary function of foreign currency exchange markets is to convert the currency of one country into another currency. For example, the U.S. dollar may be changed into Mexican Pesos or English Pounds. The amount of currency converted depends on the exchange rate, which can be fixed or can fluctuate. The U.S. dollar is a currency that has a fluctuating exchange rate that is based on market demand. Some countries, like China, have a fixed exchange rate determined by their central bank.

(E)International Transactions Foreign currency exchange markets serve to facilitate international financial transactions. These transactions may be the purchasing and selling of goods, direct investment in buildings and equipment in a foreign country or the purchase of investment vehicles like foreign bonds. For example, a U.S.-based company may want to purchase goods manufactured in China. The foreign currency exchange market allows them to exchange U.S. dollars and make the purchase in Chinese RMB (renminbi, the currency of the People's Republic of China). (F)Currency Value The value of a country's currency can influence international trade, consumers' purchasing power and inflation. Central banks of a county or region, like the U.S. Federal Reserve, seek to minimize the impact of currency fluctuations. The foreign currency exchange market functions as a tool for central banks

to control the value of their currency by buying or selling currency, which influences the total amount in worldwide circulation. (G)Investment Fund managers and investment professionals use the foreign currency exchange market to help diversify their portfolios and potentially increase their returns. Through calculated risks, investors can bet on a change in the price or exchange rate of a currency. Just like with the stocks, if currency is purchased at a low price and sold at a higher price, the investor makes money. (H)Loss Protection International companies that work in multiple countries are subject to gains and losses based on exchange rate fluctuations. To help prevent losses, companies can make forward transactions where they make a binding agreement to exchange currency for another currency at a fixed rate. This function of the foreign currency exchange market helps a company minimize the risk of foreign exchange on future expenses. For example, if a U.S.-based company places an order with a firm in Taiwan that will be ready in five months, the company can enter a forward transaction agreement that fixes the price based on the current exchange rate at the time of order. The company knows the value and cost of the purchase and will not be hit with a future loss based on a change in exchange rates.

Advantages of Forex trading

High leverage Starting from a minimum of 100:1, Forex markets offer its traders with huge amounts of leverage which means that fat profits can be produced by investing small amounts of deposits. No commission

If dealing with a financial market on daily basis, the regular investors or traders are the ones who are really benefited by the free of commission trading. The currency trading market lets its traders keep a whole 100% of their trading profits. Superior liquidity With most of the currency transactions comprising of 7 main currency pairs, the huge volume and the global trading aspect helps these currencies exhibit price stability, little slippage, narrow spreads and high levels of liquidity. Profitability Being an over the counter market, the trading done at Forex can be known as over the counter trading, wherein, a trader always buys one currency and sells of the other one in real time. There is no organizational prejudice in the market and every investor has the equal prospects for profit in it. 24 hours trading Forex currency trading market offers its traders with a 24 hour trading opening, wherein, a Forex investor can trade any time of the day, whatever suits him/her, as the market is open for trading 24 hours a day, from Sunday 5:00 pm (ET) to Friday 4:30 pm. This gives the Forex traders a choice to opt for timing for the trade according to their convenience.

Disadvantages of Forex trading

High Leverage While high leverage serves as an advantage to attract traders to the market, it can at times also act as a disadvantage for them. With such high levels of leverage available to traders in the Forex market, comes an equally high level of danger.

This can be true for the high stake positions which carry along with them, too much risk, leading to margin calls. This is where efficient money management comes into play for playing safe. 24 hours market Although it is convenient for the trader to trade whenever it is suitable to him, it can be a rather tough job too. This is because, at times, it is not possible for an individual trader to keep track of the Forex market, 24 hours a day. This is where a broker comes into the picture. Retail or individual investors should try taking help from a professional broker rather than doing all the dealings himself straight with the huge market. The broker will be an experienced professional who will act as an equal in your transactions, keeping you informed and updated about minute to minute details and fluctuations, and even guide you about the conditions, when to and when not to trade in the market. Like every other financial market, Forex market also has its share of advantages and disadvantages. But keeping in mind the two can surely help a trader become more vigilant and aware of what to expect while trading Forex.

Market size
As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding market manipulation by banks. According to the Bank for International Settlements, as of April 2010, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume as of April 2007. The $3.98 trillion break-down is as follows:

$1.490 trillion in spot transactions $475 billion in outright forwards $1.765 trillion in foreign exchange swaps $43 billion currency swaps
$207 billion in options and other products

Main foreign exchange market turnover, 19882007, measured in billions of USD. The foreign exchange market is the largest and most liquid financial market in the world. Traders include large banks, central banks, currency speculators, corporations, governments, and other financial institutions. The average daily volume in the global foreign exchange and related markets is continuously growing. Daily turnover was reported to be over US$3.98 trillion in April 2010 by the Bank for International Settlements. Of the $3.98 trillion daily global turnover, trading in London accounted for around $1.85 trillion, or 36.7% of the total, making London by far the global center for foreign exchange. In second and third places respectively, trading in New York City accounted for 17.9%, and Tokyo accounted for 6.2%. In addition to "traditional" turnover, $2.1 trillion was traded in derivatives

Financial instruments
Spot A spot transaction is a two-day delivery transaction (except in the case of trades between the US Dollar, Canadian Dollar, Turkish Lira, EURO and Russian Ruble, which settle the next business day), as opposed to the futures contracts, which are usually three months. This trade represents a direct exchange between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. Forward

One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be one day, a few days, months or years. Usually the date is decided by both parties. Then the forward contract is negotiated and agreed upon by both parties.

Swap The most common type of forward transaction is the currency swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange. Future Foreign currency futures are exchange traded forward transactions with standard contract sizes and maturity dates for example, $1000 for next November at an agreed rate 4.5%. Futures are standardized and are usually traded on an exchange created for this purpose. The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts.

Option A foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date. The FX options market is the deepest, largest and most liquid market for options of any kind in the world.

Forex ETF
Forex Exchange Traded Funds can be thought of as a stock market existing within the forex market. The Forex ETF firms create forex traded funds through buying and holding of foreign currencies. Later on, these funds are sold as shares and traders can buy any number of stocks for that fund. The most commonly used currency is the USD in forex ETF. A shareholder of the forex ETF funds makes money when the prices of the term currency improve against the USD.

Types of Forex ETFs

Forex market deals in many currencies. Therefore, many specialized or diversified forex ETFs have emerged with a focus on different number of currencies. They are: Forex ETFs which track single currency: These firms buy only one currency and their share represents a fixed amount of that currency. One can invest in the: Canadian Dollar Trust (FXC) British Pound Trust (FXB) Euro Currency Trust (FXE) Currency Swiss Franc Trust (FXF) Australian Dollar Trust (FXB) Forex ETFs that track a number of currencies based on their correlation: Funds like PowerShares DB U.S. Dollar Bearish (UDN) and PowerShares DB U.S. Dollar Bullish (UUP) invest in currencies like:

Japanese Yen Euro Swedish Krona British Pound Canadian Dollar Swiss Franc

In these ETFs, the ratio of currencies differs from one fund to another. Forex ETFs that track currency indexes: There are very few firms that operate under this category. The DB G10 Currency Harvest Fund (DBV) is a popular example.

Currencies traded in the markets Majors

European Union Euro EUR

United States Dollar USD $ United Kingdom Pound Sterling GBP Japanese Yen JPY Switzerland Swiss Franc CHF Sfr.

Minors
Australia Australian Dollar AUD A$ New Zealand New Zealand Dollar NZD NZ$ Canada Canadian Dollar CAD C$

Exotic Currencies
Many other countries exist in the world, and most of them have their own currencies. Outside of the major and minor currencies is the large group of the so-called "exotic currencies". Exotic currencies are made up of the hundreds of currencies not in the major or minor leagues, but which are nevertheless important as well, especially in international commerce and finance. The exotics include: RUB - the Russian Ruble CNY - the Chinese Yuan or Remnimbi BRL - the Brazilian Real MXN - the Mexican Peso CLP - the Chilean Peso INR - the Indian Rupee IRR - the Iranian Rial These make up just a few of the most actively traded exotic currencies. In some cases, a country will use U.S. Dollars as their currency, such as countries like Haiti for example.

Working of forex market

Quotes of trades
For example, the exchange rate between US dollars and the Swiss franc is normally stated: SF 1.6000/$ (European terms) However, this rate can also be stated as: $0.6250/SF (American terms) Excluding two important exceptions, most interbank quotations around the world are stated in European terms. Forward rates are typically quoted in terms of points. A forward quotation is expressed in points is not a foreign exchange rate as such. Rather, it is the difference between the forward rate and the spot rate. Interbank quotations are given as a bid and ask (also referred to as offer).A bid is the price (i.e. exchange rate) in one currency at which a dealer will buy another currency. An ask is the price (i.e. exchange rate) at which a dealer will sell the other currency. Dealers bid (buy) at one price and ask (sell) at a slightly higher price, making their profit from the spread between the buying and selling prices. A bid for one currency is also the offer for the opposite currency.

Foreign exchange transactions are settled through Nostro and Vostro accounts. Nostro: our account with banks abroad. Reserve Bank of India (RBI) maintains various Nostro accounts in a number of countries.

Vostro: their account with us. Many multilateral agencies (e.g. IMF, World Bank) maintain their Nostro accounts at Reserve Bank of India (RBI). SWIFT (Society for Worldwide Interbank Financial Telecommunications) Price maker and Price Taker The bank quoting the price is price maker or market maker. The bank asking for the price or quote is the price taker or user. NET OPEN POSITION- (NOP) A measure of foreign exchange risk NOP is the Net Asset/Net Liability position in all FCs together (Both B/S & Off B/S). Net Asset Position is also called LONG or Overbought position. Net liability Position is also called SHORT or Oversold position. NOP is a single statistic that provides a fairly good idea about exchange risk assumed by the bank. Its major flaw is that FX exposures in third currencies remain hidden.

Market participants
The foreign exchange market consists of two tiers: The interbank or wholesale market (multiples of $1MM US or equivalent in transaction size) The client or retail market (specific, smaller amounts) Five broad categories of participants operate within these two tiers; bank and nonbank foreign exchange dealers, individuals

and firms, speculators and arbitragers, central banks and treasuries, and foreign exchange brokers.

1. Bank and Nonbank Foreign Exchange Dealers Banks and a few nonbank foreign exchange dealers operate in both the interbank and client markets. The profit from buying foreign exchange at a bid price and reselling it at a slightly higher offer or ask price. Dealers in the foreign exchange department of large international banks often function as market makers.These dealers stand willing at all times to buy and sell those currencies in which they specialize and thus maintain an inventory position in those currencies. 2. Individuals and Firms Individuals (such as tourists) and firms (such as importers, exporters and MNEs) conduct commercial and investment transactions in the foreign exchange market. Their use of the foreign exchange market is necessary but nevertheless incidental to their underlying commercial or investment purpose. Some of the participants use the market to hedge foreign exchange risk. 3. Speculators and Arbitragers Speculators and arbitragers seek to profit from trading in the market itself. They operate in their own interest, without a need or obligation to serve clients or ensure a continuous market. While dealers seek the bid/ask spread, speculators seek all the profit from exchange rate changes and arbitragers try to profit from simultaneous exchange rate differences in different markets.

4. Central Banks and Treasuries Central banks and treasuries use the market to acquire or spend their countrys foreign exchange reserves as well as to influence the price at which their own currency is traded. They may act to

support the value of their own currency because of policies adopted at the national level or because of commitments entered into through membership in joint agreements such as the European Monetary System. The motive is not to earn a profit as such, but rather to influence the foreign exchange value of their currency in a manner that will benefit the interests of their citizens. As willing loss takers, central banks and treasuries differ in motive from all other market participants 5. Foreign Exchange Brokers Foreign exchange brokers are agents who facilitate trading between dealers without themselves becoming principals in the transaction. For this service, they charge a commission. It is a brokers business to know at any moment exactly which dealers want to buy or sell any currency. Dealers use brokers for their speed, and because they want to remain anonymous since the identity of the participants may influence short term quotes.

RBIs role in forex market

To manage the exchange rate mechanism. Regulate inter-bank forex transactions and monitor the foreign exchange risk of the banks. Keep the exchange rate stable. Manage and maintain country's foreign exchange reserves. 1. Exposure limits RBI has imposed foreign exchange exposure limits on banks (FE 12 of 1999).The limits are tied with the Paid up capital of the bank. Previously banks had NOP limit, which was based on foreign exchange volume handled by the bank. 2. Treasury operations at RBI All Central Banks have treasuries to implement policy objectives vis a vis EXCHANGE RATE & INTEREST RATES Dealing room catered to the FX market only. Money market was being looked after by the Securities department. It soon became apparent that the two cannot work in isolation with each other as the linkage between the money market & exchange market became

pronounced .Finally the dealing room and securities department were merged to form EDMD to form first ever Treasury of RBI. 3. RBIs monitoring

NOP report.

FX inflow/outflow statements. Oil payments, Forward transactions.

Market monitoring Market Flows and their impact on exchange rate.

Money Market liquidity Forward rates Market activity if required

Rates Preparation M2M (Marked to Market), Wtd. Avg(Weighted Average), FCA Conversion.

4. Intervention To keep exchange rate in line with macro objectives RBI has to intervene from time to time. Intervention is a process where FX is sold or purchased to keep the right amount of liquidity available in the FX market so that demand / supply equilibrium is maintained. Intervention can be in READY or FORWARD 5. Other Functions OFFSITE MONITORING DAILY RATES FOR MARKET

THIRD CURRENCY ACTIVITY FOR BO PAYMENTS

RESERVE MANAGEMENT 6. A Quantitative function to regulate banks

Foreign Exchange Exposure Limit (FEEL) Basically restricts the banks to keep a net asset (long) or net liability (short) position in foreign currencies. Presently FEEL for each bank is set at 10 % of its paid up capital. In the presence of FEEL, banks net purchases or net sales in foreign exchange on a given day have to be within their FEEL.

RISK MANAGEMENT
Risk aversion in the forex is a kind of trading behavior exhibited by the foreign exchange market when a potentially adverse event happens which may affect market conditions. This behavior is caused when risk averse traders liquidate their positions in risky assets and shift the funds to less risky assets due to uncertainty. In the context of the forex market, traders liquidate their positions in various currencies to take up positions in safe haven currencies, such as the US Dollar. Sometimes, the choice of a safe haven currency is more of a choice based on prevailing sentiments rather than one of economic statistics. An example would be the Financial Crisis of 2008. The value of equities across world fell while the US Dollar strengthened. This happened despite the strong focus of the crisis in the USA.

Hedging with Forwards

Hedging refers to managing risk to an extent that makes it bearable. In international trade and dealings foreign exchange play an important role. Fluctuations in the foreign exchange rate can have significant impact on business decisions and outcomes. Many international trade and business dealings are shelved or become unworthy due to significant exchange rate risk embedded in them. Historically, the foremost instrument used for exchange rate risk management is the forward contract. Forward contracts are customized agreements between two parties to fix the exchange rate for a future transaction. This simple arrangement would easily eliminate exchange rate risk,

but it has some shortcomings, particularly getting a counter party who would agree to fix the future rate for the amount and time period in question may not be easy. In Malaysia many businesses are not even aware that some banks do provide forward rate arrangements as a service to their customers. By entering into a Forward rate agreement with a bank, the businessman simply transfers the risk to the bank, which will now have to bear this risk. Of course the bank in turn may have to do some kind of arrangement to manage this risk. Forward contracts are somewhat less familiar, probably because there exists no formal trading facilities, building or even regulating body.

An Example of Hedging Using Forward Agreement

Assume that a Malaysian construction company, Bumiways just won a contract to build a stretch of road in India. The contract is signed for 10,000,000 Rupees and would be paid for after the completion of the work. This amount is consistent with Bumiways minimum revenue of RM1,000,000 at the exchange rate of RM0.10 per Rupee. However, since the exchange rate could fluctuate and end with a possible depreciation of Rupees, Bumiways enters into a forward agreement with First State Bank of India to fix the exchange rate at RM0.10 per Rupee. The forward contract is a legal agreement, and therefore constitutes an obligation on both sides. The First State Bank may have to find a counter party for this transaction either a party who wants to hedge against the appreciation of 10,000,000 Rupees expiring at the same time or a party that wishes to speculate on an upward trend in Rupees. If the bank itself plays the counter party, then the risk would be borne by the bank itself. The existence of speculators may be necessary to play the counter party position. By entering into a forward contract Bumiways is guaranteed of an exchange rate of RM0.10 per Rupee in the future irrespective of what happens to the spot Rupee exchange rate. If Rupee were to actually depreciate, Bumiways would be protected. However, if it were to appreciate, then Bumiways would have to forego this favorable movement and hence bear some implied losses. Even though this favourable movement is

still a potential loss, Bumiways proceeds with the hedging since it knows an exchange rate of RM0.10 per Rupee is consistent with a profitable venture.

Hedging with Futures

Noting the shortcomings of the forward market, particularly the need and the difficulty in finding a counter party, the futures market came into existence. The futures market basically solves some of the shortcomings of the forward market. A currency futures contract is an agreement between two parties a buyer and a seller to buy or sell a particular currency at a future date, at a particular exchange rate that is fixed or agreed upon today. This sounds a lot like the forward contract. In fact the futures contract is similar to the forward contract but is much more liquid. It is liquid because it is traded in an organized exchange the futures market (just like the stock market). Futures contracts are standardized contracts and thus are bought and sold 4 just like shares in the stock market. The futures contract is also a legal contract just like the forward, but the obligation can be removed before the expiry of the contract by making an opposite transaction. As for hedging with futures, if the risk is an appreciation of value one needs to buy futures and if the risk is depreciation then one needs to sell futures. Consider our earlier example, instead of forwards, Bumiways could have thus sold Rupee futures to hedge against Rupee depreciation. Lets assume accordingly that Bumiways sold Rupee futures at the rate RM0.10 per Rupee. Hence the size of the contract is RM1,000,000. Now say that Rupee depreciates to RM0.07 per Rupee the very thing Bumiways was afraid of. Bumiways would then close the futures contract by buying back the contract at this new rate. Note that in essence Bumiways basically bought the contract for RM0.07 and sold it for RM0.10. This would give a futures profit of RM300,000 [(RM0.10-RM0.07) x 10,000,000]. However in the spot market Bumiways gets only RM700,000 when it exchanges the10,000,000 Rupees contract value at RM0.07. The total cash flow however, is RM1,000,000 (RM700,000 from spot and RM300,000 profit from futures). With perfect hedging the cash flow would be RM1 million no matter what happens to the exchange rate in the spot market. One

advantage of using futures for hedging is that Bumiways can release itself from the futures obligation by buying back the contract anytime before the expiry of the contract. To enter into a futures contract a trader needs to pay a deposit (called an initial margin) first. Then his position will be tracked on a daily basis so much so that whenever his account makes a loss for the day, the trader would receive a margin call (also known as variation margin), i.e. requiring him to pay up the losses. 5 Economic Events When Currency Rocked the World These are changes in the currency markets which caused substantial impact in the world economy. It is important that people learn about currency movements and how the occurrence of such events provide lucrative opportunities for currency investors to profit from the forex markets. Free Market Capitalism is Born On August 15 1971, this date marked the end of the Bretton Woods system, a system that used to fix the value of a currency to the value of gold. The United States pulled out of the Bretton Woods Accord and took the US off the established Gold exchange Standard. US were running a balance of payments deficit and a trade deficit back in the early 1970s due to the costs of Vietnam War and increased domestic spending has accelerated inflation. The US government used up almost all of his reserves and gold reserves by that time. Hence it began to print more dollars to supplement its expenditure. In short, most countries lost faith in the dollar as it is overvalued against gold. The international community dumped their dollars in exchange for gold. The fact is there was not enough gold in the US vault to pay back the international community. US government had printed too much dollar and they were broke. Following that, President Nixon shocked the world. The event was informally named Nixon Shock because President Nixon

and 15 advisors removed US from the Gold Exchange System without consulting the members of the international monetary system. US dollars was the first currency to be floated- that is, exchange rates were no longer the principal method used by governments to administer monetary policy but is solely determined by supply and demand market forces. By 1976, all the major currencies were floated. The forex markets were started. Devaluation of U.S Dollar Plaza Accord In the early 1980s, the US Federal Reserve System under Paul Volcker had overvalued the dollar enough to make US exports in the global economy less competitive. The U.S government faced a large and growing current account deficit, while Japan and Germany were facing large and growing surpluses. This imbalance could create a serious economic disequilibrium which would result in a distortion of the foreign exchange markets and thus the global economy. The result of current account imbalances and the possibility of foreign exchange distortion brought ministers of the worlds leading economies France, Germany, Japan, the United Kingdom, and the United States together in New York City. The Plaza Accord was signed on September 22, 1985 at the Plaza Hotel in New York City, agreeing to depreciate the US dollar in relation to the Japanese yen and German Deutsche Mark by intervening in currency markets. The effects of the Plaza Accord agreement were seen immediately within 2 years. The dollar fell 46 percent and 50 percent against the deutsche mark and the Japanese Yen. Devaluation of the dollar stabilise the growing US trade deficit with its trading partners for a short period of time. As a result, U.S. economy became more export-oriented while Germany and Japan became more import-oriented. The signing of the Plaza Accord was significant in that it reflected coordinated actions with respective governments were able to regulate the value of the dollar in the forex market. Values of

floating currencies were determined by supply and demand, but such forces were insufficient, and it was the responsibility of the worlds central banks to intervene on behalf of the international community when necessary. To date, we still see countries that continue to regulate value of its currency within a certain band in the forex market. Example of one country is Japan. Black Wednesday The Man Who Broke the Bank Black Wednesday refers to the events on 16th September 1992 when George Soros placed a $10 billion speculative bet against the U.K. pound and won. He became the man who broke the Bank of England. In 1990, U.K. joined the Exchange Rate Mechanism (ERM) at a rate of 2.95 deutsche marks to the pound and with a fluctuation band of +/- 6 percent. ERM gave each participatory currency a central exchange rate against a basket of currencies, the European Currency Unit (ECU). This system prevents the exchange rate of participatory currencies from too much fluctuation with the basket of currencies. Until mid 1992, economy began to change in Germany. Following reunification of 1989, German government spending surged, forcing the Bundesbank to print more money. German economy experienced inflation and interest rates were raised to curb inflation. Other participatory countries in the ERM were also forced to raise interest rates so as to maintain the pegged currency exchange rate. The rate hike led to severe repercussions in the United Kingdom. At that time, U.K. had a weak economy and high unemployment rate. Maintaining high interest rates is not sustainable for U.K. in the long term, and George Soros stepped into action. George Soros was said to profit $2 billion from the Black Wednesday. This single event showed that with knowledge and experience, investors could profit from the forex market. No central banks can control the forex markets.

Asia Currency Crisis Leading up to 1997, investors were attracted to Asian investments because of their high interest rates leading to a high rate of return. As a result, Asia received a large inflow of money. In particular, Thailand, Malaysia, Indonesia, Singapore and South Korea experienced unprecedented growth in the early 1990s. These countries fell one after another like a set of dominos on July 2, 1997, showing the interdependence of the Asian 5 Tigers economies. Many economists believe that the Asian Financial Crisis was created not by market psychology but by shrouded lending practices and lack of respective government transparency. In early 1997, Thailand current account deficit has grown consistently up to a level that is believed to be unsustainable. Shrouded lending practices oversupplied the country with credit and in turn drove up prices of assets. The same type of situation happened in Malaysia, and Indonesia. Levels were reached where price of assets were overvalued and coupled with a unsustainable trade deficit, international investors and hedge fund managers began to sell Thai baht and neighboring countries currencies hoping to profit from the plunge. Following mass short speculation and attempted intervention, the Asian economies were in shambles. Thai baht was sharply devalued by as much as 48 percent and Indonesian rupiah fell 228 percent from its previous high of 12,950 to the fixed U.S. dollar. The financial crisis of 1997-1998 revealed the interconnectivity of economies and their effects on the global currency markets. The inability of central banks to intervene in currency markets provided yet another lucrative opportunity for currency investors to profit. The Euro: Best Reserve Currency after Dollar

The name Euro was officially adopted on 16 December 1995. The Euro is the official currency of 16 of the 27 Member States of the European Union. Euro is the second largest reserve currency and the second most traded currency in the world after the U.S. dollar. As of November 2008, with more than 751 billion in circulation, the euro is the currency with the highest combined value of cash in circulation in the world, having surpassed the U.S. dollar. Based on IMF estimates of 2008 GDP and purchasing power parity among the various currencies, the Euro zone is the second largest economy in the world. Value of Euro and the U.S. dollar are inversely correlated. Should the dollar fall, value of Euro currency will rise. Euro will be the best choice to shift money to, should the value of U.S. dollar continue to fall. This makes the Euro the best substitute currency for the dollar.

Conclusion
Seeing the above data about the foreign exchange market we could conclude that the market in India is not still developed but is on the growing path. Foreign exchange market plays a major and important role in global financial services acting as an indicator to the development of the global economy. We hereby conclude that if India needs to develop its foreign market it needs to develop the exchange currency market so as more investor invests in India.