- Concept of Foreign currency Exchange Rate:
Foreign currency exchange rate is the price at which one currency can be changed into some other. It endures for the rate at which a firm may change one currency for another. Thus, the exchange rate is simply the amount of a nation’s currency that can be bought at a given time for a specified amount of the currency of another country.
The actual quantity received at conversion or the effective interchange rate, usually differs from the stated rate because it packs into account all taxes, commissions and other costs that the public must pay to complete the transaction and actually meet the foreign funds.
2- Cases of Foreign currency Exchange Rate:
1-Fixed and Floating Rates:
Fixed currency exchange rate :
When Government of a country determines the rate of exchange in its own currency, it is termed as ‘Fixed Exchange Rate’. This is likewise known as the official rate of exchange. Fixed exchange rates are determined by the respective Governments from time to time for the melioration of their economic system.
On the contrast exchange rates move, as in any other marketplace, depending on the demand and supply pressure and are further determined by the market forces and economic conditions of the respective states.
Floating currency exchange rate :
The floating exchange rate may be
- Free floating
- Managed floating.
A currency is freely floating if there does not exist a system of fixed exchange rates and if the Central Bank of the country in question does not seek to determine the value of the currency. Yet, in reality, this kind of situation has not survived.
In most of the countries Governments attempt to determine movements of currency exchange rate either through direct intervention in the exchange market or through a mixture of fiscal and monetary policies. Under such conditions, floating is called as ‘managed’ or ‘dirty float’.
A turn of countries uses a pegged float as a scheme of exchange rates. The value of one currency is pegged to the value of any other currency that it drifts. In a joint float, currencies in a particular group have a fixed exchange value in terms of each other, only the group of currencies floats in relation to other currencies outside the group.
The fixed exchange rate system has inbuilt advantage of simplifying exchange transactions. It imbibes self-discipline for economic policies by participating nations. In India the exchange rate regime of rupee has evolved over a period of time travelling in the way of less exchange controls and current account accountability. The RBI manages the exchange rate of the rupee.
In recent few years the RBI has been very actively intervening in the securities industry to keep the rupee-dollar rates within tight bounds while rupee rates in relation to other currencies fluctuate in correspondence with the fluctuation of this US dollar against them. In improver, the RBI took several steps to relax exchange control and liberalize foreign trade.
2. Spot and Forward Rates:
Spot rates refer to those rates, which are applicable on the day of transaction in which physical delivery is reached within two working days after the date of the transaction the spot exchange between two currencies should be the same across the various banks engaged in providing foreign exchange services.
In the event of large discrepancy customers or other depository financial institutions would buy large quantities of a currency from whatever banks quoting relatively low price and sell the same forthwith to a bank quoting a relatively high cost. This will cause modifications in the exchange rate quotations that would cancel the existing discrepancy.
In Forward rates, exchange rates are geared up in advance for a transaction which matures at some fixed future date. The interchange at the date in the future will be at the cost agreed upon at present. Foreign exchange rates are functions of forward demand and forward supply of several currencies.
A foreign currency is supposed to be at a forward premium if its future value exceeds its present value in terms of domestic currency and it is supposed to be at a price reduction if the opposite is true. For example spot rate between rupees and dollars is S (Rs/$) = Rs. 46.6 and three months forward are F3 (Rs. /$) = Rs. 47.60/$; these rates signify that dollar is at a premium and rupee is at a discount in the forward.
Forward exchange rates are cited in most major currencies for different maturities. Standard maturities quoted by banks are about 1, 3, 6, 9 and 12 months. Maturities beyond one year are now getting more usual. Maturity extending to 5 and beyond 5 years is also possible for good bank customers.
What is spot trade (Forex)?
A spot trade is the buying or selling of a foreign currency, financial instrument or commodity for instant delivery. Most spot contracts include physical delivery of the currency, commodity or instrument; the deviation in price of a future or forward contract versus a spot contract takes into account the time value of the payment, based on interest rates and time to maturity.
A spot trade can be contrasted with a forward or futures trade.
The Basics of a Spot Trade (FOREX)
Foreign exchange spot contracts are the most common and are usually for delivery in two business days, while most other financial instruments settle the next business day. The spot foreign exchange (forex) market trades electronically around the globe. It is the world's biggest market, with over $5 trillion traded daily; its size dwarfs the interest rate and commodity markets.
The current price of a financial instrument is called the spot price. It is the price at which an instrument can be sold or bought at immediately. Buyers and sellers create the spot price by posting their buy and sell orders. In liquid markets, the spot price may change by the second, as orders get filled and new ones go into the market.
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