[This post contains fundamental aspects of foreign exchange; forex markets; as well as over 100 terminologies used in forex dealings such as direct and indirect Quote;buying rate, selling rate,forward exchange rate, swap rate,spot rate,cross rate, transaction date,value date, Spread, premium, discount, points, arbitrage, Interest arbitrage,Interest parity, future, hedging, Loro account, Nostro Account,Vostro account, etc.]
Foreign exchange is basically associated with the foreign trade. The traders in the foreign-exchange market (Authorized Dealers/brokers) rely on the two basic forms of analysis viz. fundamental analysis and technical analysis. The uses of technical analysis in forex are much like share market where price is assumed to echo all news, and the charts are the objects of analysis. Ultimately, the forces of demand and supply in the local forex market drive the exchange rate of the day.
There are three fundamental aspects in foreign exchange mechanism.
- Every country has its own currency (legal tender).
- The rate of exchange of currency of one country to currency of other country (like barter system) depends upon the demand and supply of specific currency at the place of conversion.
- All most all exchange transactions currencies are routed through banks, which will convert the currency of one country in to its equivalent in the currency of another country and transfer the funds from one country to another. Normally currency of buyer’s country is converted into currency of seller’s country. However many times the funds may be converted into permitted currency of third country ( like USD, Euro, Sterling Pound etc. which are accepted in almost all the countries) acceptable to buyer and the seller/service provider.
Terminologies of in foreign exchange dealing rooms are distinctive. Many of such terms used in dealing rooms are explained here.
Appreciation: Appreciation means strengthening of currency value in response to market demand.
Arbitrage: Buying a currency in one center and selling it in another to take advantage of temporary variance.
Arbitrageur: The dealer who is specialist in arbitrage operation.
Authorised Dealer: Authorised Dealer means any person,( normally includes banks),authorized to deal in foreign exchange or foreign securities by the Central Bank ( Reserve Bank of India in India under Section 10(1) of FEMA, 1999). The Authorised Dealer can handle all kinds of foreign exchange transactions, viz. buying &selling foreign currencies, opening of LC and settlement of LC payment, handling of Inward & outward remittance, arrangement with foreign correspondent, investment in foreign trade etc, as per FER Act 1947 in terms of instructions from Central Bank.
Banking Day: The day on which the sale of a currency against another currency can be settled, is called banking day. The exchange contracts of two currencies can be settled only when the markets of those cities to which the currencies belong are open. Banking day is also known as Business day, clear day, market day and open day.
Bull: Bull refers to a speculator who buys a currency, with an expectation that it will be appreciated or revalued before taking delivery and thereby he would be benefitted.
Business Day: The day on which the sale of a currency against another currency can be settled, is called banking day. The exchange contracts of two currencies can be settled only when the markets of those cities to which the currencies belong are open. Business day is also known as Banking day, clear day, market day and open day.
Buyer’s Option: In buyer’s option the beneficial holder can take delivery at any time between first day and last day of the option. It can be between spot and forward date or between two forward dates.
Buying rate: Buying rate of a currency is the rate at which the market is willing to buy a foreign currency.
Cable: Normally, cable is referred to the spot dollar/sterling pound rate.
Cash transactions: Value today: Any transaction executed for same day settlement. Cash transactions are also called ‘value today’ transactions.
Clear Day: The day on which the sale of a currency against another currency can be settled, is called banking day. The exchange contracts of two currencies can be settled only when the markets of those cities to which the currencies belong are open. Clear day is also known as Business day, banking day, market day and open day.
Clean float: When there is no intervention of Central Bank (RBI) or with little intervention of it, exchanges of foreign currencies take place with normal pressure of demand and supply is called clean float.
Commercial deal/transaction: Commercial deal/transaction is a foreign exchange deal between a bank and non-banking entity.
Commission: Bank charges to execute a foreign exchange transaction with a commercial entity.
Competitive devaluation: Devaluation of a currency in excess of estimated equilibrium rate to gain competitive advantage in the export market.
Confirmation: After the foreign exchange transaction, the parties to the deal send to each other written confirmation giving full details of the transactions.
Convertible currency: Convertible currency is a currency which can be freely convertible to another currency or gold without the special approval from the Central Bank of that country.
Cover: A foreign exchange deal which is protected against fluctuation of exchange rates.
Cross Rate: Generally, exchange rate between two foreign currencies is called cross rate. Even exchange of other currencies against US dollars outside the United States is also called cross rate. For example: A dealer in Mumbai sells or buys Euro against US Dollars, he uses cross rates.
Currency Band: In a regulated market, margin within which the currency is allowed to fluctuate by the monetary authority.
Daylight exposure Limit: The limit within which a foreign exchange dealer is allowed to run to overall foreign exchange exposure in a day. It is also called intraday position.
Intraday position: The limit within which a foreign exchange dealer is allowed to run to overall foreign exchange exposure in a day. It is also called daylight exposure limit.
Dealer (Trader): A person who is authorized to effect foreign exchange transaction in a bank or commercial organization and he may be allowed to take speculative positions to make money to his organisation.
Depreciation: When a currency loses in value against one or more currencies without forced devaluation by the monetary authorities.
Details: All the information required to complete the foreign exchange transaction viz. name, rate, dates and destination where the payment to be made.
Devaluation: Devaluation refers to deliberate downward adjustment of a currency in relation to gold or other currencies. The devaluation is applicable only when a currency has fixed parity with other currencies.
Devaluation prone currency: Devaluation prone currency means the currency which is susceptible to devaluation and which has been devalued number of times in the past.
Direct Quotation: The direct method of rate quotation is called direct quote or home currency quotation. In this quote, the home currency is quoted per unit of foreign currency. In the other words it is a quote where home currency is the variable unit.
For example: I USD = Rs.60.33
Dirty Float: The Central Bank (RBI in India) sometime intervenes in the volatile market to influence the value of a floating currency. Such intervention of Central bank is called “Dirty Float”.
Discount: When a currency is cheaper to buy in the forward market, compared to spot rate.
End/end: End/end indicates that both the spot and forward maturity, or two forward maturities in a swap transactions, fall due on the last business day of appropriate calendar month.
Equilibrium Rate: Exchange rate, at which buyers and sellers are willing to transact business, with supply and demand in balance, possibly only requiring marginal intervention by the monetary authorities.
Exotic Currencies: Currencies in which there is no active exchange market. Currencies of developing countries mostly fall under this category.
Euro-Dollars: There is no such a thing as a Euro-Dollar Currency. It is US dollars invested by non-residents of US in European Market, more so in London. Euro dollars settlements are taking place over banking accounts in the United States and it is a part of the US money supply.
Exchange Contract: Exchange contract is an agreement between two parties either in writing or verbal to deliver one currency in exchange of another currency for a specific value, date or as in the case of an option contract, for a specific period.
Firm Quote: Firm quote is the rate quoted by AD branch of the bank offering a firm buying or selling or both for immediate response or within a definite time limit from their clients.
Fixed Exchange rate: The exchange rate of one or more currencies fixed by monetary authorities is called Fixed Exchange rate. In most occasions, fixed rates are also allowed to fluctuate between a upper rate and lower rate.
Fixing: Exchange rate set in some European countries at a specific time, particularly for commercial transactions.
Flexible Exchange rate: It is a fixed exchange rate set in monetary authorities for one or more currencies but with frequent up or down valuations of the currencies.
Floating exchange rate: The exchange rate is decided by the market in response to demand and supply of a currency, is called floating exchange rate.
Fluctuation: The up and down movement of the currency rates depending upon to demand and supply of the currency.
Forward book: In terms of policy decision or owing to dealing activities of a bank various net exposures for forward maturities which bank has incurred is called forward book.
Forward Contract: Forward Contract is an agreement between two parties to deliver a currency, in exchange of another, at a future (forward) date.
Forward Exchange: When the delivery is later than ‘Spot’ for buying and selling a currency, it is called forward exchange. Forward exchange is also called “Future”.
Forward/forward: Buying and selling of same currency for different maturity dates in the forward market.
Forward margins: Forward margin is the discount or premium between the spot rate and the forward rate for a currency.
Forward Purchase: Forward Purchase means an agreement to buy a currency, in exchange of another, at a future (forward) date.
Forward rates: Forward rates are rates of a currency at a future (forward) date. The forward rates are arrived adding premium to or deducting discount from spot rate, as the case may be.
Forward Sale: Forward sale is an agreement to deliver a currency, in exchange of another, at a future (forward) date.
Future: The other word for ‘future’ is forward exchange. When the delivery is later than ‘Spot’ for buying and selling a currency, it is called Future or forward exchange.
Hedging: Act of buying or selling the currency equivalent of a foreign asset or liability in the order to protect its value against depreciation (appreciation) or devaluation (revaluation) .
Commodity hedging: A person resident in India, who has a commodity exposure and faces risks due to volatile commodity prices, can hedge the price risk in the International Commodity Exchanges/Markets, using hedging products such as, futures and options, which are exchange traded and Over the Counter (OTC) derivatives as permitted by the Reserve Bank from time to time. Prior approval from the Reserve Bank / an AD Category – I bank is required.
Hot Money: Short term funds moving from one place to another in search of better returns are called Hot Money
Inconvertible Currency: A currency which cannot be exchanged for other currencies is called inconvertible currency. This happens when such currency is forbidden by the foreign exchange regulation or there is no buyer for that currency.
Indication/indication rate: The rate indicated by the dealer only for information and not for transactions.
Indirect Quotation: The indirect method of rate quotation is called indirect quote wherein foreign currency is the variable unit against fixed amount of home currency.For example: Rs.100= USD 1.5240
Interest arbitrage: In order to obtain a higher interest yield, the traders in foreign exchange switch to another currency by way of buying spot and investing the bought currency to get higher interest yield. The exchange currencies may be from local currency to foreign currency or from foreign currency to local one.
Interest parity: When difference in interest rate for one currency to other is equalized by exchange rate margin. Suppose interest rate in US is 3.5% and in India 4.5% a forward premium of one percent for USD against Indian Rupees would bring in interest parity.
Intervention: Intervention means intervention of Central Bank (RBI in India) in the exchange market to stabilize the rates of home currency or to influence the external value of a currency.
Intraday position: The overall position of various currencies a dealer is permitted to hold during the dealing day for a specified period.
Leads and lags: When currency adjustment seems to be apparent, to take profit or avoid imminent loss, the foreign exchange cover is either accelerated or delayed. The method of accelerating or delaying foreign exchange cover is called leads and lags.
LIBOR: LIBOR is the short form of London Interbank Offered Rate.
Limit Order: Placing buy or sell order at a specific rate or better rate than the specific rate.
Limited convertibility: Where foreign currency cannot either be bought or can be bought only to a limit from the national currency, with the permission from the Central Bank.
Loro account: Loro account is an account maintained by a foreign bank or its branch in a bank, even though they have no correspondent transactions with that bank. (see Nostro and Vostro)
Long Position (Long): Long Position is a situation when dealer purchases a currency more than his immediate requirement. Naturally when one currency is in long some other currency will be in short which can be a local currency.
Market Day: The day on which the sale of a currency against another currency can be settled, is called banking day. The exchange contracts of two currencies can be settled only when the markets of those cities to which the currencies belong are open. Market day is also known as Business day, clear day, banking day and open day.
Managed Float: It is the situation where the Central Bank intervene in the exchange market, to stabilize the rates of home currency or to influence the exchange rate in a particular direction is called Managed float.
Margin (Spread): The difference between the buying rate and selling rate is referred as spread or margin.
Maturity Date: Due date of an exchange contract. It is the date of which effective settlement of contract between two parties.
Mine: Earlier days, the telephonic expression some time used to indicate that the contracting party is willing to buy at the rate offered by the quoting bank. The term can lead to misunderstanding some dealer used to indicate that “I buy” or “I take”
Nostro Account: Nostro stands for ‘our account’. Nostro account is an account maintained by a bank or an institution of one country with a correspondent bank in a foreign country. The account is usually maintained in the currency of the country where the correspondent bank is situated. (see Loro and Vostro)
Odd-dates: Odd-dates refer to Non-Standard days in the forward market.
Open Day: The day on which the sale of a currency against another currency can be settled, is called banking day. The exchange contracts of two currencies can be settled only when the markets of those cities to which the currencies belong are open. Open day is also known as Business day, clear day, market day and banking day.
One-way market: In one-way market, the participants are either only sellers or only buyers.
Outright: A normal foreign exchange transaction involving either purchase or sale of a currency.
Outright limit: Outright limit is a limit where a dealer is allowed to carry over net long or short position in one or more currencies into next dealing day.
Over-valuation: Over-valuation refers to the exchange rate of a currency, which is in excess of its actual purchasing power parity. If a national currency is overvalued the demand for goods of that country in a competitive market will be reduced.
Package deal: A deal in which number of exchange/or deposit orders have to be simultaneously fulfilled.
Pip: The fifth place after the decimal point. Example $/ £ = 1.55692 (it means $1.55692=1£)
Point: The fourth place after the decimal point. Example $/ £ = 1.5569 (it means $1.5569=1£).
Premium: When a currency is costlier to buy in the forward market, compared to spot rate.
Roll-over: Extension of maturity date of a contract by swapping it into a forward date.
Revaluation: The monitory authority of a country sometime deliberately up-rates the value of the home currency. The process of value of currency getting officially up-rated is called revaluation.
Seller’s option: Seller’s option is a forward contract which allows the seller to deliver the foreign currency on any date within the option period.
Selling Rate: It is the rate at which a foreign currency is sold on a suitable maturity date.
Short forward (Shorts): Short forward (Shorts) refers to the contract period less than two months.
Short position: Short Position is a situation when dealer purchases a currency less than his immediate requirement.
Stop-loss order: A order given by higher authority to the dealer (trader) to make sure that the short position of a currency is covered in spite of taking a loss, when that currency is weakening to certain percentage.
Spread: The margin between the buying rate and selling rate is referred as spread or margin.
Support level: It is in a situation of appreciation or depreciation of a currency, where the monetary authority intervenes in the exchange market to stop any further up or downward movement.
SWAP transaction: When buying and selling of a foreign currency with different delivery dates simultaneously take place, it is called SWAP transaction. Currency swaps are used to hedge interest rate risk and exchange rate risk.
Swap margin: Swap margin is the discount or premium between the spot rate and the forward rate for a currency.
Swap rate: See swap margin.
Thin Market: In a dull market, there is a little activity. In the thin market, even small orders will affect the rate structure.
Today/Tomorrow (Overnight): Today/Tomorrow is also known as ‘Overnight’ where buying and selling of a foreign currency takes place simultaneously for value same day against the next or vice versa.
Tomorrow next (TOM Next): Tomorrow next is also known as ‘Tom next’ where buying of a foreign currency for delivery the following day against selling for the spot day or vice versa.
Transaction date: The day on which the foreign exchange transaction is entered into.
Transaction Loss or profit: Transaction Loss or profit may arise due to a foreign exchange transaction on goods or services or because of cancellation of another foreign exchange transaction. The transaction loss or profit may occur real or an opportunity missed.
Translation Loss/profit: It is an estimated loss or profit on account of revaluation of assets and liabilities, made for the purpose of balance sheet.
Speculation: Act of buying and or selling a currency, hoping that a favourable exchange rate adjustment would take place before the payment to be made or currency to be delivered
Speculator: An individual who buys a currency, with an expectation that it will be appreciated or revalued before taking delivery and thereby he would be benefitted
Spot: Generally, if spot rate is today and then settlement falls on second succeeding working day (two business days after the transaction date). However in some markets spot transactions may be executed for value next day.
Spot deals: Spot deals refer to foreign currency purchase or sale effected for spot value.
Spot rate: Spot rate is the exchange rate of the currency, which will be calculated on the basis of appreciation or depreciation of the currency on the date of settlement.
Square: Purchase and sales are in balance and the dealer maintains no position.
Under-valuation: When a currency is exchanged at a rate below its purchasing power parity. The goods exported from the country of under-valued currency are normally very cheap.
Valeur compansee: The meaning of ‘Valeur compansee’ is compensated value or ‘here and there’. In principle, payment of foreign exchange transactions takes place at both the centers, without time lag. In reality it is impossible to effect payment from both the parties simultaneously as, for instance, the New York banks open for business at the time banks in India closed.
Value date: Maturity date of a spot or forward contract.
Value today: Any transaction executed for same day settlement, which is called cash transaction.
Value tomorrow: Any transaction executed for settlement next day.
Vostro Account: Vostro stands for ‘your account’. Vostro account is an account maintained by a foreign bank or other correspondent bank with a domestic bank. The account is usually maintained in the currency of the country where the domestic bank is situated. (see Nostro and Loro)