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FOREIGN EXCHANGE MARKET
#1
FOREIGN EXCHANGE MARKET
Foreign Exchange as defined in FEMA means foreign currency and includes: I) All deposits, credits, balances
payable in any foreign currency and any drafts, travelers cheques, letters of credit and bills of exchange
expressed or drawn in Indian currency and payable in foreign currency; ii) Any instruments payable at the option
of the drawee or holder, thereof or any other party thereto, either in Indian currency or in foreign currency or
partly in one and partly in ttie other. In short, the term 'Foreign Exchange' means the process of converting one
national currency into another national currency and transferring money. In such conversions, the foreign
currency is always treated as a commodity and the home currency as the medium of purchasing power.

Foreign Exchange Market and its Participants

Banks and Customers who have to buy or sell foreign exchange.Inter-Bank dealings where sale and purchase
business is transacted between the banks themselves within the country. Dealings between domestic banks and
foreign banks.

TYPES OF FOREIGN EXCHANGE TRANSACTIONS

Inter-Bank Transactions: Sale or Purchase of FX between Banks and other Financial Institutions (Market
Participants).

Merchant Transactions: Sale or Purchase transactions with the customers are called merchant transaction.

FACTORS AFFECTING EXCHANGE RATES: Exchange rates in the market are the outcome of the combined
effect of a multiple of factors. They can be classified as Fundamental, Technical and Speculative factors. The
factors are:

BoP: Surplus BOP in a country strengthens its currency.

Economic growth rate: High growth rate fuels imports and weakens the local currency.

Fiscal Policy: An expansionary policy, normally leads to a higher economic growth which in turn fuels imports.

Monetary Policy: Central banks determine monetary measures to influence and control interest and money supply.

Interest Rates: Domestic interest rates if high, attracts overseas capital (FDI, FII) leading to an excess supply of
foreign currencies resulting into appreciation of domestic currency in the short term. However if high interest
rates continue for a long term, economy will slow down, weakening the currency.

Political Issues: Without Political stability, there can be no economic stability (detrimental to the value of the
currency).
Technical reasons in Exchange Rate determination: Government controls, which determine the inflow and
outflow of capital, are considered technical reasons.
Speculation - a major factor in Exchange Rate determination: Speculative trading is a reality in Forex
markets. It is estimated that the speculative trade to daily forex turnover is above 90%.

CORRESPONDENTS OF ACCOUNTS

Banks dealing in international trade and foreign exchange maintain accounts in various foreign countries for the
purposes of settlements. They also enter into drawing arrangements such as overnight or regular overdrafts
limits, agency arrangements for international remittances, collection of cheques / bills etc. The international
banks involved are termed as foreign correspondents and the concept of providing such services is called as
Correspondent Banking. In a Correspondent banking relation, it is not always necessary that an account
relationship should exist. Some of the services can be rendered without an account. However, for arrangements
like Cheque clearing, OD arrangements, accounts are needed. The accounts when maintained by
banks in a Correspondent Relationship are classified as follows:

NOSTRO ACCOUNTS: NOSTRO Account means "OUR ACCOUNT WITH YOU". It is a foreign currency account
maintained by a bank in domestic country with a bank in foreign country.

VOSTRO ACCOUNT: VOSTRO Account means, "YOUR ACCOUNT WITH US". It is an account of a foreign bank
being maintained in our country and with our bank. When. Vostro accounts are opened, KYC norms are compulsory in
India. Vostro accounts are to be operated in line with RBI guidelines.

LORO ACCOUNT: LORO Account means "THEIR ACCOUNT WITH THEM" This is an account of a third bank being
maintained by another or our bank.

MIRROR ACCOUNTS: These are dummy accounts maintained by banks to know actual position of their accounts
with the foreign correspondent banks. We may call it a pass-book of our accounts maintained with the
correspondents.
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