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Local Foreign Exchange Market

Presented to Sir Adnan Presented by Shaista Hussain 1215 Naeem 1253

Structure of the Presentation


Basic Concepts, Terminologies, Instruments & Mechanism. Exchange Rate Regimes Foreign Exchange Trading & rate quotations Role of SBP in the FX Market.

BASIC CONCEPTS/TERMINOLOGIES
Foreign Currency v/s Foreign Exchange

As per Foreign Exchange Act, (Section 2), 1947.


(c)

"Foreign Currency" means any currency other than Pakistan currency;


(d)

"Foreign Exchange" means includes any instrument drawn, accepted, made or issued under clause (8) of section 17 of the State Bank of Pakistan Act, 1956, all deposits, credits and balance payable in any foreign currency, and any drafts, travelers cheques, letters of credit and bills of exchange, expressed or drawn in Pakistan currency but payable in any foreign currency;

Financial Markets

Financial market is a place where Resources/funds are transferred from those having surplus/excess to those having a deficit/shortage.

Foreign Exchange Markets

The market where the commodity traded is Currencies. Price of each currency is determined in term of other currencies.

What is an Exchange Rate ?


Exchange Rate is the price of one country's currency expressed in another country's currency. In other words, the rate at which one currency can be exchanged for another. e.g. Rs. 59.50 per one USD Major currencies of the World
USD EURO YEN POUND

STERLING

What is a Foreign Exchange Transaction ?


Any financial transaction that involves more than one currency is a foreign exchange transaction. Most important characteristic of a foreign exchange transaction is that it involves Foreign Exchange Risk.

PARTICIPANTS IN THE FOREIGN EXCHANGE MARKET

All Commercial Banks (Authorized Dealers only). State Bank of Pakistan. Corporate Treasuries. Public Sector/Government. Inter Bank Brokerage Houses. Resident Pakistanis Non Residents Exchange Companies Money Changers

FOREIGN EXCHANGE REGIMES

FIXED MANAGED FLOAT FREE FLOATING

Components of a Standard FX Transaction


Base Currency (USD/PKR) Dealt or Variable Currency Exchange Rate Amount Deal Date Value Date

Settlement Instructions

Value Date Conventions


Currencies are traded both in Ready and forward value dates.
1) Ready: Settlement on the deal date. e.g. Pakistan 2) Value Tom : Settlement on next day. e.g. Canada 3) Spot Transaction : settlement usually in two working days. In international FX transactions, Spot is the Standard value date.

Why Spot Date ?

Time Zone Difference

4) Forward Transaction: Settlement at some future date ahead of the spot.


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Price maker Vs. 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.

RATE QUOTATION CONVENTIONS


IN-DIRECT QUOTATION:
Price of one Unit of Foreign Currency in terms of Domestic Currency
e.g. USD/PKR = 59.45/50 Buy One USD at Sell One USD at Spread 59.45 59.50 00.05

In the international market, almost all currencies are quoted indirectly.


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RATE QUOTATION CONVENTIONS DIRECT QUOTATION:


Price of one Unit of Domestic Currency in terms of Foreign Currency e.g. EURO= 1.2805/12

Buy One Euro at 1.2805 Sell One Euro at 1.2812 Spread 0.0007

Five Currencies are quoted in Direct Terms


1) Pound Sterling 2) Euro 3) Australian Dollar 4) New Zealand Dollar 5) Irish Punt

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FORWARD TRANSACTIONS
1. Out right sale/purchase of a currency against the other for settlement at a future date at the predetermined exchange rate. Forward rates are quoted as premium or discount over spot rate. Forward rates depend upon interest rate differential between the two currencies. Currency with higher interest rates is at discount wrt currency having lower interest rate. Currency with lower interest rates is at premium wrt currency having higher interest rate.

2. 3. 4. 5.

FX SWAP Transaction
An FX swap is a contract to buy an amount of currency for one value date at an agreed rate, and to simultaneously resell the same amount of currency for a later value date, also at an agreed rate, to the same counter party. FX swap is essentially a funding or Money Market transaction and does not involve exchange risk.

Foreign exchange transactions are settled through Nostro and Vostro accounts.

Nostro: our account with banks abroad. SBP 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 SBP.

SWIFT (Society for Worldwide Interbank Financial Telecommunications)

Deals are done over Telephone, REUTERS dealing system etc REUTERS
Dealing Terminal

Industry Standard for FX trading. Security guaranteed by Reuters Int. Password Protected. Maintains record of all transactions. SBPK (SBPs REUTERS address)

News Terminal

Domestic Market Data/ news available on line. Real Time Exchange Rate quotes of all major Currencies. Data about Interest Rates (e.g. LIBOR) Various SBP pages on REUTERS.

Post detonation crisis (May 98) and move towards market based ERM. In early 98, Pakistan was making gradual moves towards market based ERM. Third currency rates to be quoted by banks. SBP also stopped giving customers buying and selling rate and gave a 1% band to the market, quoting its buying and selling rates for ADs. The target was to put the currency on free float.

Forex Transactions
The Demand Side of inter-bank market importers buying foreign exchange to finance their imports. A host of regulations governing imports into Pakistan. Out ward remittances for debt servicing. Out ward remittances for services.

Forex Transactions
The Supply Side of inter-bank market Exports regulations governing export receipts. Foreign Direct Investment. Capital account receipts.

Foreign Exchange Risk


Exposure to exchange rate movement. 1. Any sale or purchase of foreign currency entails foreign exchange risk. 2. Foreign exchange transaction affects the net asset or net liability position of the buyer/seller. 3. Carrying net assets or net liability position in any currency gives rise to exchange risk.

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.

Foreign Exchange Markets Role of SBP and linkages with economy

SBPs Role in the 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.

SBPs Role in the Forex Market


SBP 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.

TREASURY OPERATIONS AT SBP


1.

2. 3.

4.

5.

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 from first ever Treasury of SBP.

Functions of DMMD

Market Monitoring
Pro active monitoring of interbank MM & FX market by Front Office. Prepare demand/supply forecast. Gather data from various Sources. Real time feedbck to management. Real time remedial measures to remove distortions in the market.

OTHER FX RELATED FUNCTIONS


OFFSITE MONITORING DAILY RATES FOR MARKET THIRD CURRENCY ACTIVITY FOR GoP PAYMENTS RESERVE MANAGEMENT

Off Site monitoring of banks by SBP


Inputs of Computerized Reporting System (CRS)
All individual foreign exchange transactions reported by each bank on daily basis on a floppy diskette

Amount Counter Party Type of Deal

Currency
Rate Maturity Date

Posting date Deal Date Mode of Deal

Off Site monitoring of banks by SBP


Reports from CRS Contd

Reports for research & statistical purposes

Types of transactions/customers/currency Business volume - banks/customers/currency Broker wise market volume report History of exchange rates - trend analysis

How does SBP manages exchange rate in the interbank market?


Non-Quantitative Tools Quantitative Tools

Non-Quantitative Tools

Moral suasion facilitating large commercial outflows Relaxation in FEEL

Thank You