A STUDY OF FX

8/19/2019 A STUDY OF FX

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A STUDY OF

FOREIGN EXCHANGE RISK

AND

ITS MANAGEMENT



OBJECTIVES OF THE STUDY

MAIN OBJECTIVE

This projec !e"p o s#$% he i&ric!cies o' he 'orei(& e)ch!&(e

"!r*e+ The "!i& p#rpose o' his s#$% is o (e ! ,eer i$e! !&$heco"prehe&si-e $e!i.s o' 'orei(& e)ch!&(e ris* "!&!(e"e&+SUB OBJECTIVES

To *&o/ !,o# he -!rio#s co&cep !&$ ech&ic!.iies i&'orei(&e)ch!&(e+ To *&o/ he -!rio#s '#&cio&s o' 'ore) "!r*e+ To (e he *&o/.e$(e !,o# he he$(i&( oo.s #se$ i& 'orei(&e)ch!&(e+

0IMITATIONS OF THE STUDY

Ti"e co&sr!i&+

Reso#rce co&sr!i&+

Bi!s o& he p!r o' i&er-ie/ers+

DATA CO00ECTION The pri"!r% $!! /!s co..ece$ hro#(h i&er-ie/s o'

pro'essio&!.s !&$ o,ser-!io&s+ The seco&$!r% $!! /!s co..ece$ 'ro" ,oo*s1 &e/sp!pers1oher

p#,.ic!io&s !&$ i&er&e+DATA ANA0YSISThe $!! !&!.%sis /!s $o&e o& he ,!sis o' he i&'or"!io&!-!i.!,.e'ro" -!rio#s so#rces !&$ ,r!i&sor"i&(

INTRODUCTION



FOREIGN EXCHANGE MARKET OVERVIE2

I& o$!%3s /or.$ &o eco&o"% is se.' s#''icie&1 so here is &ee$ 'or

e)ch!&(e o' (oo$s !&$ ser-ices !"o&(s he $i''ere& co#&ries+ So

i&

his (.o,!. -i..!(e1 #&.i*e i& he pri"ii-e !(e he e)ch!&(e o'

(oo$s

!&$ ser-ices is &o .o&(er c!rrie$ o# o& ,!rer ,!sis+ E-er%

so-erei(&

co#&r% i& he /or.$ h!s ! c#rre&c% h! is .e(!. e&$er i& is

errior%

!&$ his c#rre&c% $oes &o !c !s "o&e% o#si$e is ,o#&$!ries+ So

/he&e-er ! co#&r% ,#%s or se..s (oo$s !&$ ser-ices 'ro" or o

!&oher co#&r%1 he resi$e&s o' /o co#&ries h!-e o e)ch!&(e

c#rre&cies+ So /e c!& i"!(i&e h! i' !.. co#&ries h!-e he s!"e

c#rre&c% he& here is &o &ee$ 'or 'orei(& e)ch!&(e+

NEED FOR FOREIGN EXCHANGE



0e #s co&si$er ! c!se /here I&$i!& co"p!&% e)pors coo& '!,rics

o

USA !&$ i&-oices he (oo$s i& US $o..!r+ The A"eric!& i"porer

/i..

p!% he !"o#& i& US $o..!r1 !s he s!"e is his ho"e c#rre&c%+

Ho/e-er he I&$i!& e)porer re4#ires r#pees "e!&s his ho"e

c#rre&c% 'or proc#ri&( r!/ "!eri!.s !&$ 'or p!%"e& o he .!,or

ch!r(es ec+ Th#s he /o#.$ &ee$ e)ch!&(i&( US $o..!r 'or r#pee+ I'

he

I&$i!& e)porers i&-oice heir (oo$s i& r#pees1 he& i"porer i&

USA

/i.. (e his $o..!r co&-ere$ i& r#pee !&$ p!% he e)porer+

Fro" he !,o-e e)!"p.e /e c!& i&'er h! i& c!se (oo$s !re ,o#(h

or

so.$ o#si$e he co#&r%1 e)ch!&(e o' c#rre&c% is &ecess!r%+

So"ei"es i !.so h!ppe&s h! he r!&s!cio&s ,e/ee& /o

co#&ries /i.. ,e se.e$ i& he c#rre&c% o' hir$ co#&r%+ I& h!

c!se

,oh he co#&ries h! !re r!&s!ci&( /i.. re4#ire co&-eri&( heir

respeci-e c#rre&cies i& he c#rre&c% o' hir$ co#&r%+ For h! !.so



he

'orei(& e)ch!&(e is re4#ire$+



ABOUT FOREIGN EXCHANGE

MARKET

5!ric#.!r.% 'or 'orei(& e)ch!&(e "!r*e here is &o "!r*e p.!ce

c!..e$ he 'orei(& e)ch!&(e "!r*e+ I is "ech!&is" hro#(h /hich

o&e co#&r%3s c#rre&c% c!& ,e e)ch!&(e i+e+ ,o#(h or so.$ 'orhe

c#rre&c% o' !&oher co#&r%+ The 'orei(& e)ch!&(e "!r*e $oes &o

h!-e !&% (eo(r!phic .oc!io&+

Forei(& e)ch!&(e "!r*e is $escri,e !s !& OTC 6o-er he co#&er7

"!r*e !s here is &o ph%sic!. p.!ce /here he p!ricip!& "ee o

e)ec#e he $e!.s1 !s /e see i& he c!se o' soc* e)ch!&(e+ The

.!r(es 'orei(& e)ch!&(e "!r*e is i& 0o&$o&1 'o..o/e$ ,% he &e/

%or*1 To*%o1 8#rich !&$ Fr!&*'#r+ The "!r*e !re si#!e$

hro#(ho#

he $i''ere& i"e 9o&e o' he (.o,e i& s#ch ! /!% h! o&e "!r*e

is



c.osi&( he oher is ,e(i&&i&( is oper!io&+ There'ore i is s!e$

h!

'orei(& e)ch!&(e "!r*e is '#&cio&i&( hro#(ho# :; ho#rs ! $!%+

I& "os "!r*e US $o..!r is he -ehic.e c#rre&c%1 -i9+1 he c#rre&c%

s#e$ o $o"i&!e i&er&!io&!. r!&s!cio&+ I& I&$i!1 'orei(&

e)ch!&(e

h!s ,ee& (i-e& ! s!#or% $e'i&iio&+ Secio& : 6,7 o' 'orei(&

e)ch!&(e re(#.!io& ACT1<=>? s!es@

Forei(& e)ch!&(e "e!&s 'orei(& c#rre&c% !&$ i&c.#$es @

A.. $eposis1 cre$is !&$ ,!.!&ce p!%!,.e i& !&% 'orei(&

c#rre&c% !&$ !&% $r!'1 r!-e.er3s che4#es1 .eer o'

cre$i !&$ ,i..s o' e)ch!&(e+ E)presse$ or $r!/& i& I&$i!

c#rre&c% ,# p!%!,.e i& !&% 'orei(& c#rre&c%+

A&% i&sr#"e& p!%!,.e1 ! he opio& o' $r!/ee or

ho.$er hereo' or !&% oher p!r% hereo1 eiher i&

I&$i!& c#rre&c% or i& 'orei(& c#rre&c% or p!r.% i& o&e

!&$ p!r.% i& he oher+

I& or$er o pro-i$e '!ci.iies o "e",ers o' he p#,.ic !&$

'orei(&ers



-isii&( I&$i!1 'ore)ch!&(e o' 'orei(& c#rre&c% i&o I&$i!& c#rre&c%

!&$ -ice-ers!+ RBI h!s (r!&e$ o -!rio#s 'ir"s !&$ i&$i-i$#!.s1

.ice&se o #&$er!*e "o&e%ch!&(i&( ,#si&ess ! se!s!irpor !&$

o#ris" p.!ce o' o#ris i&eres i& I&$i!+ Besi$es cer!i& !#hori9e$

$e!.ers i& 'orei(& e)ch!&(e 6,!&*s7 h!-e !.so ,ee& per"ie$ o

ope&

e)ch!&(e ,#re!#s+

• Fo..o/i&( !re he "!jor ,i'#rc!io&s



F#.. '.e$(e "o&e%ch!&(ers he% !re he 'ir"s !&$ i&$i-i$#!.s

• /ho h!-e ,ee& !#hori9e$ o !*e ,oh1 p#rch!se !&$ s!.e

r!&s!cio& /ih he p#,.ic+

Resrice$ "o&e%ch!&(er he% !re shops1 e"pori! !&$ hoe.sec+

h! h!-e ,ee& !#hori9e$ o&.% o p#rch!se 'orei(& c#rre&c%

o/!r$s cos o' (oo$s s#pp.ie$ or ser-ices re&$ere$ ,% he" or 'or

co&-ersio& i&o r#pees+A#hori9e$ $e!.ers he% !re o&e /ho c!& #&$er!*e !.. %pes o' 'orei(& e)ch!&(e r!&s!cio&+ B!&* !re o&.% he !#hori9e$

$e!.ers+ The o&.% e)cepio&s !re Tho"!s coo*1 /eser& #&io&1UAE e)ch!&(e /hich ho#(h1 !&$ &o ! ,!&* is !& AD+E-e& !"o&( he ,!&*s RBI h!s c!e(ori9e$ he" !s 'o..o/es@Br!&ch A The% !re he ,r!&ches h! h!-e &osro !&$ -osro!cco#&+Br!&ch B The ,r!&ch h! c!& $e!. i& !.. oher r!&s!cio& ,#$o &o "!i&!i& &osro !&$ -osro !c3s '!.. #&$er his c!e(or%+For I&$i!& /e c!& co&c.#$e h! 'orei(& e)ch!&(e re'ers o 'orei(&

"o&e%1/hich i&c.#$es &oes1 che4#es1 ,i..s o' e)ch!&(e1

,!&*,!.!&ce

!&$ $eposis i& 'orei(& c#rre&cies+5!ricip!&s i& 'orei(& e)ch!&(e "!r*eThe main players in foreign exchange market are as follows:

<+ CUSTOMERSThe c#so"ers /ho !re e&(!(e$ i& 'orei(& r!$e p!ricip!e i&

'orei(& e)ch!&(e "!r*e ,% !-!i.i&( o' he ser-ices o' ,!&*s+

E)porers re4#ire co&-eri&( he $o..!rs i& o r#pee !&$ i"poreers

re4#ire co&-eri&( r#pee i& o he $o..!rs1 !s he% h!-e o p!% i&

$o..!rs 'or he (oo$sser-ices he% h!-e i"pore$+



:+COMMERCIA0 BANK

The% !re "os !ci-e p.!%ers i& he 'ore) "!r*e+

Co""erci!.

,!&* $e!.i&( /ih i&er&!io&!. r!&s!cio& o''er ser-ices 'or

co&-ersio& o' o&e c#rre&c% i& o !&oher+ The% h!-e /i$e &e/or*

o'

,r!&ches+ T%pic!..% ,!&*s ,#% 'orei(& e)ch!&(e 'ro" e)porers !&$

se..s 'orei(& e)ch!&(e o he i"porers o' (oo$s+ As e-er% i"e he

'orei(& e)ch!&(e ,o#(h or o-erso.$ posiio&+ The ,!.!&ce !"o#&

is

so.$ or ,o#(h 'ro" he "!r*e+

?+ CENTRA0 BANK

I& !.. co#&ries Ce&r!. ,!&* h!-e ,ee& ch!r(e$ /ih he

respo&si,i.i% o' "!i&!i&i&( he e)er&!. -!.#e o' he $o"esic

c#rre&c%+ Ge&er!..% his is !chie-e$ ,% he i&er-e&io& o' he ,!&*+



EXCHANGE RATE SYSTEM

Co#&ries o' he /or.$ h!-e ,ee& e)ch!&(i&( (oo$s

!&$

ser-ices !"o&(s he"se.-es+ This h!s ,ee& (oi&( o& 'ro" i"e

i""e"ori!.+ The /or.$ h!s co"e ! .o&( /!% 'ro" he $!%s o'

,!rer

r!$e+ 2ih he i&-e&io& o' "o&e% he 'i(#res !&$ pro,.e"s o'

,!rer

r!$e h!-e $is!ppe!re$+ The ,!rer r!$e h!s (i-e& /!% o&

e)ch!&(e$ o' (oo$s !&$ ser-ices 'or c#rre&cies i&se!$ o' (oo$s

!&$

ser-ices+



The r#pee /!s hisoric!..% .i&*e$ /ih po#&$ ser.i&(+

I&$i!

/!s ! 'o#&$er "e",er o' he IMF+ D#ri&( he e)ise&ce o' he

'i)e$

e)ch!&(e r!e s%se"1 he i&er-e&io& c#rre&c% o' he Reser-e

B!&*

o' I&$i! 6RBI7 /!s he Briish po#&$1 he RBI e&s#re$ "!i&e&!&ce

o'

he e)ch!&(e r!e ,% se..i&( !&$ ,#%i&( po#&$ !(!i&s r#pees !

'i)e$

r!es+ The i&er ,!&* r!e here'ore r#.e$ he RBI ,!&$+ D#ri&( he

'i)e$ e)ch!&(e r!e er!1 here /!s o&.% o&e "!jor ch!&(e i& he

p!ri%

o' he r#pee $e-!.#!io& i& J#&e <=+

Di''ere& co#&ries h!-e !$ope$ $i''ere& e)ch!&(e

r!e

s%se" ! $i''ere& i"e+ The 'o..o/i&( !re so"e o' he e)ch!&(e

r!e

s%se" 'o..o/e$ ,% -!rio#s co#&ries+

THE GO0D STANDARD



M!&% co#&ries h!-e !$ope$ (o.$ s!&$!r$ !s heir

"o&e!r%

s%se" $#ri&( he .!s /o $ec!$es o' he <=h ce&#r%+ This s%se"

/!s i& -o(#e i.. he o#,re!* o' /or.$ /!r <+ #&$er his s%se" he

p!ries o' c#rre&cies /ere 'i)e$ i& er" o' (o.$+ There /ere /o

"!i&

%pes o' (o.$ s!&$!r$@

<7 (o.$ specie s!&$!r$

Go.$ /!s reco(&i9e$ !s "e!&s o' i&er&!io&!. se.e"e&

'or

receips !&$ p!%"e&s !"o&(s co#&ries+ Go.$ coi&s /ere !&

!ccepe$ "o$e o' p!%"e& !&$ "e$i#" o' e)ch!&(e i& $o"esic

"!r*e !.so+ A co#&r% /!s s!e$ o ,e o& (o.$ s!&$!r$ i' he

'o..o/i&( co&$iio& /ere s!is'ie$@

Mo&e!r% !#hori%1 (e&er!..% he ce&r!. ,!&* o' he co#&r%1

(#!r!&ee$ o ,#% !&$ se.. (o.$ i& #&resrice$ !"o#&s ! he

'i)e$ price+

Me.i&( (o.$ i&c.#$i&( (o.$ coi&s1 !&$ p#i&( i o $i''ere&

#ses

/!s 'ree.% !..o/e$+



I"por !&$ e)por o' (o.$ /!s 'ree.% !..o/e$+

The o!. "o&e% s#pp.% i& he co#&r% /!s $eer"i&e$ ,% he

4#!&#" o' (o.$ !-!i.!,.e 'or "o&e!r% p#rpose+

<7 Go.$ B#..io& S!&$!r$

U&$er his s%se"1 he "o&e% i& circ#.!io& /!s eiher p!r.%

o' e&ire.% p!per !&$ (o.$ ser-e$ !s reser-e !sse 'or he

"o&e% s#pp.%++ Ho/e-er1 p!per "o&e% co#.$ ,e e)ch!&(e$

'or (o.$ ! !&% i"e+ The e)ch!&(e r!e -!rie$ $epe&$i&(

#po& he (o.$ co&e& o' c#rre&cies+ This /!s !.so *&o/& !s

Mi& 5!ri% Theor% o' e)ch!&(e r!es+

The (o.$ ,#..io& s!&$!r$ pre-!i.e$ 'ro" !,o# <> #&i.

<=<;1 !&$ i&er"ie&.% here!'er #&i. <=;;+ 2or.$ 2!r I

,ro#(h !& e&$ o he (o.$ s!&$!r$+

F0OATING RATE SYSTEM



I& ! r#.% '.o!i&( e)ch!&(e r!e re(i"e1 he re.!i-e prices o'

c#rre&cies !re $eci$e$ e&ire.% ,% he "!r*e 'orces o'

$e"!&$ !&$ s#pp.%+ There is &o !e"p ,% he !#horiies o

i&'.#e&ce e)ch!&(e r!e+ 2here (o-er&"e& i&er'eres3

$irec.% or hro#(h -!rio#s "o&e!r% !&$ 'isc!. "e!s#res i&

$eer"i&i&( he e)ch!&(e r!e1 i is *&o/& !s "!&!(e$ o'

$ir% '.o!+

5URCHASING 5O2ER 5ARITY 65557

5ro'essor G#s!- C!sse.1 ! S/e$ish eco&o"is1 i&ro$#ce$

his s%se"+ The heor%1 o p# i& si"p.e er"s s!es h!

c#rre&cies !re -!.#e$ 'or /h! he% c!& ,#% !&$ he

c#rre&cies h!-e &o i&ri&sic -!.#e !!che$ o i+ There'ore1

#&$er his heor% he e)ch!&(e r!e /!s o ,e $eer"i&e$

!&$ he so.e crierio& ,ei&( he p#rch!si&( po/er o' he

co#&ries+ As per his heor% i' here /ere &o r!$e co&ro.s1

he& he ,!.!&ce o' p!%"e&s e4#i.i,ri#" /o#.$ !./!%s ,e

"!i&!i&e$+ Th#s i' < INR ,#% ! 'o#&!i& pe& !&$ he

s!"e& 'o#&!i& pe& c!& ,e ,o#(h 'or USD :1 i c!& ,e

i&'erre$ h! si&ce : USD or < INR c!& ,#% he s!"e

'o#&!i& pe&1 here'ore USD : INR <+



For e)!"p.e I&$i! h!s ! hi(her r!e o' i&'.!io& !s co"p!e$ o

co#&r% US he& (oo$s pro$#ce$ i& I&$i! /o#.$ ,eco"e

cos.ier !s co"p!re$ o (oo$s pro$#ce$ i& US+ This /o#.$

i&$#ce i"pors i& I&$i! !&$ !.so he (oo$s pro$#ce$ i& I&$i!

,ei&( cos.ier /o#.$ .ose i& i&er&!io&!. co"peiio& o (oo$s

pro$#ce$ i& US+ This $ecre!se i& e)pors o' I&$i! !s

co"p!re$ o e)pors 'ro" US /o#.$ .e!$ o $e"!&$ 'or he

c#rre&c% o' US !&$ e)cess s#pp.% o' c#rre&c% o' I&$i!+ This i&

#r&1 c!#se c#rre&c% o' I&$i! o $epreci!e i& co"p!riso& o'

c#rre&c% o' Us h! is h!-i&( re.!i-e.% "ore e)pors+



FUNDAMENTA0S

IN

EXCHANGE RATE

E)ch!&(e r!e is ! r!e ! /hich o&e c#rre&c% c!& ,e e)ch!&(e i& o

!&oher c#rre&c%1 s!% USD Rs+;+ This r!e is he r!e o'

co&-ersio&

o' US $o..!r i& o I&$i!& r#pee !&$ -ice -ers!+

METHODS FOR OUTING EXCHANGE RATES



EXCHANGE UOTATION

DIRECT

INDIRECT

VARIAB0E UNIT

VARIAB0E UNIT

HOME CURRENCY

FOREIGN CURRENCY

METODS OF OUTING RATE

There !re /o "eho$s o' 4#oi&( e)ch!&(e r!es+

<7 Direc "eho$s @Forei(& c#rre&c% is *ep co&s!& !&$ ho"e c#rre&c% is *ep

-!ri!,.e+ I& $irec 4#o!io&1 he pri&cip.e !$ope$ ,% ,!&* is o

,#% ! ! .o/er price !&$ se.. ! hi(her price+

:7 I& $irec "eho$@Ho"e c#rre&c% is *ep co&s!& !&$ 'orei(& c#rre&c% is *ep

-!ri!,.e+ Here he sr!e(% #se$ ,% ,!&* is o ,#% hi(h !&$

se.. .o/+

I& I&$i! /ih e''ec 'ro" !#(#s :1 <==?1!.. he e)ch!&(e r!es !re

4#oe$ i& $irec "eho$+

I is c#so"!r% i& 'orei(& e)ch!&(e "!r*e o !./!%s 4#oe /o

r!es "e!&s o&e 'or ,#%i&( !&$ !&oher r!e 'or se..i&(+ This he.ps



i& e.i"i&!i&( he ris* o' ,ei&( (i-e& ,!$ r!es i+e+ i' ! p!r% co"es

o *&o/ /h! he oher p!r% i&e&$s o $o i+e+ ,#% or se..1 he

'or"er c!& !*e he .eer 'or ! ri$e+

There !re /o p!ries i& !& e)ch!&(e $e!. o' c#rre&cies+ To i&ii!e

he $e!. o&e p!r% !s*s 'or 4#oe 'ro" !&oher p!r% !&$ oher

p!r% 4#oes ! r!e+ The p!r% !s*i&( 'or ! 4#oe is *&o/& !s3

!s*i&( p!r% !&$ he p!r% (i-i&( ! 4#oes is *&o/& !s 4#oi&(

p!r%+

The !$-!&!(e o' /o/!% 4#oe is !s #&$er

i+The "!r*e co&i&#o#s.% "!*es !-!i.!,.e price 'or ,#%ers or

se..ers

ii+T/o /!% price .i"is he pro'i "!r(i& o' he 4#oi&( ,!&* !&$

co"p!riso& o' o&e 4#oe /ih !&oher 4#oe c!& ,e $o&e

i&s!&!&eo#s.%+

iii+

As i is &o &ecess!r% !&% p.!%er i& he "!r*e o i&$ic!e

/heher he i&e&$s o ,#% or s!.e 'orei(& c#rre&c%1 his

e&s#res h! he 4#oi&( ,!&* c!&&o !*e !$-!&!(e ,%

"!&ip#.!i&( he prices+



i-+I !#o"!ic!..% i&s#res h! !.i(&"e& o' r!es /ih "!r*e

r!es+

-+T/o /!% 4#oes .e&$ $eph !&$ .i4#i$i% o he "!r*e1 /hich

is so -er% esse&i!. 'or e''icie& "!r*e+

I& /o /!% 4#oes he 'irs r!e is he r!e 'or ,#%i&( !&$ !&oher

'or

se..i&(+ 2e sho#.$ #&$ers!&$ here h!1 i& I&$i! he ,!&*s1 /hich

!re!#hori9e$ $e!.er1 !./!%s 4#oe r!es+ So he r!es 4#oe$

,#%i&( !&$se..i&( is 'or ,!&*s poi& o' -ie/ o&.%+ I "e!&s h! i'

e)porers /!&o se.. he $o..!rs he& he ,!&* /i.. ,#% he $o..!rs

'ro" hi" so /hi.ec!.c#.!io& he 'irs r!e /i.. ,e #se$ /hich is

,#%i&( r!e1 !s he ,!&*is ,#%i&( he $o..!rs 'ro" e)porer+ The

s!"e c!se /i.. h!ppe&i&-erse.% /ih i"porer !s he /i.. ,#% $o..!rs

'ro" he ,!&* !&$ ,!&* /i.. se.. $o..!rs o i"porer+



FACTORS AFFECTING EXCHANGE RATE

I& 'ree "!r*e1 i is he $e"!&$ !&$ s#pp.% o' he c#rre&c%

/hich sho#.$ $eer"i&e he e)ch!&(e r!es ,# $e"!&$ !&$

s#pp.% is he $epe&$e& o& "!&% '!cors1 /hich !re #.i"!e.%

he c!#se o' he e)ch!&(e r!e '.#c#!io&1 so"e i"es /i.$+

The -o.!i.i% o' e)ch!&(e r!es c!&&o ,e r!ce$ o he si&(.e

re!so& !&$ co&se4#e&.%1 i ,eco"es $i''ic#. o precise.% $e'i&e

he '!cors h! !''ec e)ch!&(e r!es+ Ho/e-er1 he "ore

i"por!& !"o&( he" !re !s 'o..o/s@



1. Differentials in Inflation

As ! (e&er!. r#.e1 ! co#&r% /ih ! co&sise&.% .o/er i&'.!io& r!e

e)hi,is ! risi&( c#rre&c% -!.#e1 !s is p#rch!si&( po/er i&cre!ses

re.!i-e o oher c#rre&cies+ D#ri&( he .!s h!.' o' he /e&ieh

ce&#r%1 he co#&ries /ih .o/ i&'.!io& i&c.#$e$ J!p!&1 Ger"!&%

!&$ S/i9er.!&$1 /hi.e he U+S+ !&$ C!&!$! !chie-e$ .o/ i&'.!io&

o&.% .!er+ Those co#&ries /ih hi(her i&'.!io& %pic!..% see

$epreci!io& i& heir c#rre&c% i& re.!io& o he c#rre&cies o' heir

r!$i&( p!r&ers+ This is !.so #s#!..% !cco"p!&ie$ ,% hi(her



i&eres r!es+ 6To .e!r& "ore1 see Cost-Push Inflation Versus

Demand-Pull Inflation+7

2. Differentials in Interest Rates

I&eres r!es1 i&'.!io& !&$ e)ch!&(e r!es !re !.. hi(h.% corre.!e$+

B% "!&ip#.!i&( i&eres r!es1 ce&r!. ,!&*s e)er i&'.#e&ce o-er

,oh i&'.!io& !&$ e)ch!&(e r!es1 !&$ ch!&(i&( i&eres r!es

i"p!c i&'.!io& !&$ c#rre&c% -!.#es+ Hi(her i&eres r!es o''er

.e&$ers i& !& eco&o"% ! hi(her re#r& re.!i-e o oher co#&ries+

There'ore1 hi(her i&eres r!es !r!c 'orei(& c!pi!. !&$ c!#se he

e)ch!&(e r!e o rise+ The i"p!c o' hi(her i&eres r!es is

"ii(!e$1 ho/e-er1 i' i&'.!io& i& he co#&r% is "#ch hi(her h!&

i& ohers1 or i' !$$iio&!. '!cors ser-e o $ri-e he c#rre&c% $o/&+

The opposie re.!io&ship e)iss 'or $ecre!si&( i&eres r!es h!

is1 .o/er i&eres r!es e&$ o $ecre!se e)ch!&(e r!es+ 6For '#rher

re!$i&(1 see What Is Fiscal Policy?7

3. Current!ccount Deficits

The c#rre& !cco#& is he ,!.!&ce o' r!$e ,e/ee& ! co#&r% !&$

is r!$i&( p!r&ers1 re'.eci&( !.. p!%"e&s ,e/ee& co#&ries 'or

(oo$s1 ser-ices1 i&eres !&$ $i-i$e&$s+ A $e'ici i& he c#rre&

!cco#& sho/s he co#&r% is spe&$i&( "ore o& 'orei(& r!$e h!& i

is e!r&i&(1 !&$ h! i is ,orro/i&( c!pi!. 'ro" 'orei(& so#rces o

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"!*e #p he $e'ici+ I& oher /or$s1 he co#&r% re4#ires "ore

'orei(& c#rre&c% h!& i recei-es hro#(h s!.es o' e)pors1 !&$ i

s#pp.ies "ore o' is o/& c#rre&c% h!& 'orei(&ers $e"!&$ 'or is

pro$#cs+ The e)cess $e"!&$ 'or 'orei(& c#rre&c% .o/ers he

co#&r%Ls e)ch!&(e r!e #&i. $o"esic (oo$s !&$ ser-ices !re

che!p e&o#(h 'or 'orei(&ers1 !&$ 'orei(& !sses !re oo e)pe&si-e

o (e&er!e s!.es 'or $o"esic i&eress+ 6For "ore1

see Understanding The Current Account In The Balance f

Payments+7

". #u$lic De$t

Co#&ries /i.. e&(!(e i& .!r(esc!.e $e'ici 'i&!&ci&( o p!% 'or

p#,.ic secor projecs !&$ (o-er&"e&!. '#&$i&(+ 2hi.e s#ch

!ci-i% si"#.!es he $o"esic eco&o"%1 &!io&s /ih .!r(e p#,.ic

$e'icis !&$ $e,s !re .ess !r!ci-e o 'orei(& i&-esors+ The

re!so& A .!r(e $e, e&co#r!(es i&'.!io&1 !&$ i' i&'.!io& is hi(h1

he $e, /i.. ,e ser-ice$ !&$ #.i"!e.% p!i$ o'' /ih che!per re!.

$o..!rs i& he '##re+

I& he /ors c!se sce&!rio1 ! (o-er&"e& "!% pri& "o&e% o p!%

p!r o' ! .!r(e $e,1 ,# i&cre!si&( he "o&e% s#pp.% i&e-i!,.%

c!#ses i&'.!io&+ Moreo-er1 i' ! (o-er&"e& is &o !,.e o ser-ice is

$e'ici hro#(h $o"esic "e!&s 6se..i&( $o"esic ,o&$s1 i&cre!si&(



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he "o&e% s#pp.%71 he& i "#s i&cre!se he s#pp.% o' sec#riies 'or

s!.e o 'orei(&ers1 here,% .o/eri&( heir prices+ Fi&!..%1 ! .!r(e

$e, "!% pro-e /orriso"e o 'orei(&ers i' he% ,e.ie-e he co#&r%

ris*s $e'!#.i&( o& is o,.i(!io&s+ Forei(&ers /i.. ,e .ess /i..i&( o

o/& sec#riies $e&o"i&!e$ i& h! c#rre&c% i' he ris* o' $e'!#. is

(re!+ For his re!so&1 he co#&r%Ls $e, r!i&( 6!s $eer"i&e$ ,%

Moo$%Ls or S!&$!r$ 5oorLs1 'or e)!"p.e7 is ! cr#ci!.

$eer"i&!& o' is e)ch!&(e r!e+

%. Terms of Tra&e

A r!io co"p!ri&( e)por prices o i"por prices1 he er"s o' r!$e

is re.!e$ o c#rre& !cco#&s !&$ he ,!.!&ce o' p!%"e&s+ I' he

price o' ! co#&r%Ls e)pors rises ,% ! (re!er r!e h!& h! o' is

i"pors1 is er"s o' r!$e h!-e '!-or!,.% i"pro-e$+ I&cre!si&(

er"s o' r!$e sho/s (re!er $e"!&$ 'or he co#&r%Ls e)pors+

This1 i& #r&1 res#.s i& risi&( re-e&#es 'ro" e)pors1 /hich

pro-i$es i&cre!se$ $e"!&$ 'or he co#&r%Ls c#rre&c% 6!&$ !&

i&cre!se i& he c#rre&c%Ls -!.#e7+ I' he price o' e)pors rises ,% !

s"!..er r!e h!& h! o' is i"pors1 he c#rre&c%Ls -!.#e /i..

$ecre!se i& re.!io& o is r!$i&( p!r&ers+

'. #olitical (ta$ility an& )conomic #erformance

Forei(& i&-esors i&e-i!,.% see* o# s!,.e co#&ries /ih sro&(

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eco&o"ic per'or"!&ce i& /hich o i&-es heir c!pi!.+ A co#&r%

/ih s#ch posii-e !ri,#es /i.. $r!/ i&-es"e& '#&$s !/!% 'ro"

oher co#&ries percei-e$ o h!-e "ore po.iic!. !&$ eco&o"ic ris*+

5o.iic!. #r"oi.1 'or e)!"p.e1 c!& c!#se ! .oss o' co&'i$e&ce i& !

c#rre&c% !&$ ! "o-e"e& o' c!pi!. o he c#rre&cies o' "ore

s!,.e co#&ries+

EX5ACTATION OF THE FOREIGN EXCHANGE MARKET

5s%cho.o(ic!. '!cors !.so i&'.#e&ce e)ch!&(e r!es+

These '!cors i&c.#$e "!r*e !&icip!io&1 spec#.!i-e press#res1

!&$ '##re e)pec!io&s+

A 'e/ 'i&!&ci!. e)pers !re o' he opi&io& h! i&

o$!%3s

e&-iro&"e&1 he o&.% r#s/orh%3 "eho$ o' pre$ici&( e)ch!&(e

r!es ,% (# 'ee.+ Bo, E-e.i&(1 -ice presi$e& o' 'i&!&ci!. "!r*es

!

SG1 is corpor!e 'i&!&ce3s op 'orei(& e)ch!&(e 'orec!ser 'or <===+



e-e.i&(3s (# 'ee.i&( h!s1 $e'i&e$ co&-e&io&1 !&$ his "eho$

pro-e$

#&c!&&i.% !cc#r!e i& 'orei(& e)ch!&(e 'orec!si&( i& <==+SG

e&$e$

he corpor!e 'i&!&ce 'orec!si&( %e!r /ih ! :+P error o-er!..1

he

"os !cc#r!e !"o&( <= ,!&*s+ The secre o e-e.i&(3s i&#iio& o&

!&% c#rre&c% is *eepi&( !,re!s o' /or.$ e-e&s+ A&% e-e&1'ro" !

$ec.!r!io& o' /!r o ! '!i&i&( po.iic!. .e!$er1 c!& !*e is o.. o& !

c#rre&c%3s -!.#e+ To$!%1 i&se!$ o' 'or"!. "o$!.s1 "os 'orec!sers

re.% o& !& !"!.(!" h! is p!r eco&o"ic '#&$!"e&!.s1 p!r "o$e.

!&$ p!r j#$("e&+

Fisc!. po.ic%

I&eres r!es

Mo&e!r% po.ic%

B!.!&ce o' p!%"e&

E)ch!&(e co&ro.

Ce&r!. ,!&* i&er-e&io&

Spec#.!io&

Tech&ic!. '!cors



FACTORS TO OVERCOME FROM THE RISK 6HEDGING TOO0S7

Co&si$er ! h%poheic!. si#!io& i& /hich ABC r!$i&( co+ h!s o

i"por ! r!/ "!eri!. 'or "!&#'!c#ri&( (oo$s+ B# his r!/

"!eri!.

is re4#ire$ o&.% !'er hree "o&hs+ Ho/e-er1 i& hree "o&hs he

price o' r!/ "!eri!. "!% (o #p or (o $o/& $#e o 'orei(&

e)ch!&(e

'.#c#!io&s !&$ ! his poi& o' i"e i c!& &o ,e pre$ice$ /heher

he price /o#.$ (o #p or co"e $o/&+ Th#s he is e)pose$ o ris*s

/ih '.#c#!io&s i& 'ore) r!e+ I' he ,#%s he (oo$s i& !$-!&ce he&

he /i.. i&c#r he!-% i&eres !&$ sor!(e ch!r(es+ Ho/e-er1 he

!-!i.!,i.i% o' $eri-!i-es so.-es he pro,.e" o' i"porer+ He c!&

,#% c#rre&c% $eri-!i-es+ No/ !&% .oss $#e o rise i& r!/ "!eri!.

price /o#.$ ,e o''se ,% pro'is o& he '##res co&r!c !&$

-ice-ers!+ He&ce1 he $eri-!i-es !re he he$(i&( oo.s h! !re



!-!i.!,.e o co"p!&ies o co-er he 'orei(& e)ch!&(e e)pos#re

'!ce$ ,% he"+

De'i&iio& o' Deri-!i-es

Deri-!i-es !re 'i&!&ci!. co&r!cs o' pre$eer"i&e$ 'i)e$ $#r!io&1/hose -!.#es !re $eri-e$ 'ro" he -!.#e o' !& #&$er.%i&( pri"!r%'i&!&ci!. i&sr#"e&1 co""o$i% or i&$e)1 s#ch !s @ i&eres r!e1e)ch!&(e r!es1 co""o$iies1 !&$ e4#iies+

Deri-!i-es !re ris* shi'i&( i&sr#"e&s+ I&ii!..%1 he% /ere #se$ore$#ce e)pos#re o ch!&(es i& 'orei(& e)ch!&(e r!es1 i&eresr!es1

or soc* i&$e)es or co""o&.% *&o/& !s ris* he$(i&(+ He$(i&( ishe"os i"por!& !spec o' $eri-!i-es !&$ !.so is ,!sic eco&o"ic

p#rpose+ There h!s o ,e co#&er p!r% o he$(ers !&$ he% !respec#.!ors+

Deri-!i-es h!-e co"e i&o e)ise&ce ,ec!#se o' he pre-!.e&ce o'ris* i& e-er% ,#si&ess+ This ris* co#.$ ,e ph%sic!.1 oper!i&(1i&-es"e&

!&$ cre$i ris*+

Deri-!i-es pro-i$e ! "e!&s o' "!&!(i&( s#ch ! ris*+ The &ee$ o"!&!(e e)er&!. ris* is h#s o&e pi..!r o' he $eri-!i-e "!r*e+5!ries/ishi&( o "!&!(e heir ris* !re c!..e$ he$(ers+

The co""o& $eri-!i-e pro$#cs !re 'or/!r$s1 opio&s1 s/!ps !&$F##res+



<+ For/!r$ Co&r!cs

For/!r$ e)ch!&(e co&r!c is ! 'ir" !&$ ,i&$i&( co&r!c1e&ere$i&o ,% he ,!&* !&$ is c#so"ers1 'or p#rch!se o' speci'ie$!"o#&o' 'orei(& c#rre&c% ! !& !(ree$ r!e o' e)ch!&(e 'or $e.i-er% !&$

p!%"e& ! ! '##re $!e or perio$ !(ree$ #po& ! he i"e o'e&eri&(i&o 'or/!r$ $e!.+

The ,!&* o& is p!r /i.. co-er ise.' eiher i& he i&er,!&*

"!r*eor ,% "!chi&( ! co&r!c o se.. /ih ! co&r!c o ,#%+ Theco&r!c

,e/ee& c#so"er !&$ ,!&* is esse&i!..% /rie& !(ree"e& !&$ ,!&* (e&er!..% s!&$ o "!*e ! .oss i' he c#so"er $e'!#.s i& '#.'i..i&(hisco""i"e& o se.. 'orei(& c#rre&c%+

A 'orei&( e)ch!&(e 'or/!r$ co&r!c is ! co&r!c #&$er /hichhe ,!&* !(rees o se.. or ,#% ! 'i)e$ !"o#& o' c#rre&c% o or 'ro"he co"p!&% o& !& !(ree$ '##re $!e i& e)ch!&(e 'or ! 'i)e$!"o#& o' !&oher c#rre&c%+ No "o&e% is e)ch!&(e$ #&i. he'##re $!e+

A co"p!&% /i.. #s#!..% e&er i&o 'or/!r$ co&r!c /he& i*&o/shere /i.. ,e ! &ee$ o ,#% or se.. 'or !& c#rre&c% o& ! cer!i& $!ei&he '##re+ I "!% ,e.ie-e h! o$!%3s 'or/!r$ r!e /i.. pro-e o ,e



"ore '!-o#r!,.e h!& he spo r!e pre-!i.i&( o& h! '##re $!e+A.er&!i-e.%1 he co"p!&% "!% j#s /!& o e.i"i&!e he#&cer!i&i%!ssoci!e$ /ih 'orei(& e)ch!&(e r!e "o-e"e&s+

The 'or/!r$ co&r!c co""is ,oh p!ries o c!rr%i&( o# hee)ch!&(e o' c#rre&cies ! he !(ree$ r!e1 irrespeci-e o' /h!e-er h!ppe&s o he e)ch!&(e r!e+

The r!e 4#oe$ 'or ! 'or/!r$ co&r!c is &o !& esi"!e o' /h!he e)ch!&(e r!e /i.. ,e o& he !(ree$ '##re $!e+ I re'.ecs hei&eres r!e $i''ere&i!. ,e/ee& he /o c#rre&cies i&-o.-e$+ The'or/!r$ r!e "!% ,e hi(her or .o/er h!& he "!r*e e)ch!&(e r!eo&

he $!% he co&r!c is e&ere$ i&o+

For/!r$ r!e h!s /o co"po&e&s+ Spo r!e For/!r$ poi&sFor/!r$ poi&s1 !.so c!..e$ !s 'or/!r$ $i''ere&i!.s1 re'.ecs hei&eres $i''ere&i!. ,e/ee& he p!ir o' c#rre&cies pro-i$e$ c!pi!.

'.o/ !re 'ree.% !..o/e$+ This is &o r#e i& c!se o' US Q r#pee r!e!shere is e)ch!&(e co&ro. re(#.!io&s prohi,ii&( 'ree "o-e"e& o' c!pi!. 'ro" i&o I&$i!+ I& c!se o' US Q r#pee i is p#re $e"!&$!&$ s#pp.% /hich $eer"i&es 'or/!r$ $i''ere&i!.+

For/!r$ r!es !re 4#oe$ ,% i&$ic!i&( spo r!e !&$ pre"i#" $isco#&+

I& $irec r!e1

For/!r$ r!e spo r!e pre"i#" $isco#&+

A corpor!e c!& 'ree.% c!&ce. ! 'or/!r$ co&r!c ,oo*e$ i' $esire$ ,%i+ I c!& !(!i& co-er he e)pos#re /ih he s!"e or oherA#horise$De!.er+ Ho/e-er co&r!cs re.!i&( o &o&r!$e r!&s!cio&i"pors



/ih o&e .e( i& I&$i!& r#pees o&ce c!&ce..e$ co#.$ &o ,e re,oo*e$i..&o/+ This re(#.!io& /!s i"pose$ o se" ,o.!i.i% i& he 'orei(&e)ch!&(e "!r*e1 /hich /!s $ri-i&( $o/& he r#pee+ Th#s he

/ho.eo,jeci-e ,ehi&$ his /!s o s!.. spec#.!io& i& he c#rre&c%+

B# &o/ he RBI h!s .i'e$ he ;%e!ro.$ ,!& o& co"p!&ies re ,oo*i&( he 'or/!r$ r!&s!cio&s 'or i"pors !&$ &o&r!$e$r!&s!cio&s+ I h!s ,ee& $eci$e$ o e)e&$ he 'ree$o" o' re

,oo*i&(he i"por 'or/!r$ co&r!c #p o <P o' #&he$(e$ e)pos#res'!..i&( $#e /ihi& o&e %e!r1 s#,jec o ! c!p o' Q < Mio i& !'i&!&ci!.%e!r per corpor!e+

The re"o-!. o' his ,!& /o#.$ (i-e 'ree$o" o corpor!eTre!s#rers/ho so#.$ ,e i& !pposiio& o re$#ce heir 'orei(& e)ch!&(e ris*s

,%c!&ce.i&( heir e)isi&( 'or/e!r$ r!&s!cio&s !&$ re,oo*i&( he"!

,eer r!es+ Th#s his i& &o .i,er!.i9!io&1 ,# i is resor!io& o'hes!#s 4#o !&e+A.so he De!i.s o' c!&ce..e$ 'or/!r$ co&r!cs !re &o "orere4#ire$ o

,e repore$ o he RBI+The 'o..o/i&( !re he (#i$e.i&es h! h!-e o ,e 'o..o/ee i& c!se o'

c!&ce..!io& o' ! 'or/!r$ co&r!c+

<+7 I& c!se o' c!&ce..!io& o' ! co&r!c ,% he c.ie& 6he re4#essho#.$ ,e "!$e o& or ,e'ore he "!#ri% $!e7 he A#horise$De!.er sh!.. reco-erp!% he1 !s he c!se "!% ,e1 he $i''ere&ce ,e/ee&heco&r!ce$ r!e !&$ he r!e ! /hich he c!&ce..!io& is e''ece$+The

reco-er%p!%"e& o' e)ch!&(e $i''ere&ce o& c!&ce.i&( he co&r!c"!% ,e #p 'ro& or ,!c* e&$e$ i& he $iscreio& o' ,!&*s+



:+7 R!e ! /hich he c!&ce..!io& is o ,e e''ece$ @ 5#rch!se co&r!cs sh!.. ,e c!&ce..e$ ! he co&r!ci&(A#horise$ De!.ers spo T+T+ se..i&( r!e c#rre& o& he $!e o'c!&ce..!io&+

S!.e co&r!c sh!.. ,e c!&ce..e$ ! he co&r!ci&( A#horise$De!.ers spo T+T+ se..i&( r!e c#rre& o& he $!e o' c!&ce..!io&+ 2here he co&r!c is c!&ce..e$ ,e'ore "!#ri%1 he!ppropri!e'or/!r$ T+T+ r!e sh!.. ,e !pp.ie$+?+7 E)ch!&(e $i''ere&ce &o e)cee$i&( Rs+ < is ,ei&( i(&ore$ ,%he co&r!ci&( B!&*+

;+7 I& he !,se&ce o' !&% i&sr#cio&s 'ro" he c.ie&1 he co&r!cs1/hich h!-e "!#re$1 sh!.. ,e !#o"!ic!..% c!&ce..e$ o& <h $!%'!..s o& ! S!#r$!% or ho.i$!%1 he co&r!c sh!.. ,e c!&ce..e$ o& he&e) s#ccee$i&( /or*i&( $!%+

I& c!se o' c!&ce..!io& o' he co&r!c<+7 S/!p1 cos i' !&% sh!.. ,e p!i$ ,% he c.ie& #&$er !$-ice ohi"+

:+7 2he& he co&r!c is c!&ce..e$ !'er he $#e $!e1 he c.ie& is&o e&i.e$ o he e)ch!&(e $i''ere&ce1 i' !&% i& his '!-or1 si&ce he

co&r!c is c!&ce..e$ o& !cco#& o' his $e'!#.+ He sh!.. ho/e-er1 ,e .i!,.e o p!% he e)ch!&(e $i''ere&ce1 !(!i&s hi"+

E!r.% De.i-er%

S#ppose !& E)porer recei-es !& E)por or$er /orh USD o&

?: !&$ e)pecs ship"e& o' (oo$s o !*e p.!ce o&?=:+ O& ?: he se..s USD -!.#e ?=:oco-er his FX e)pos#re+

D#e o cer!i& $e-e.op"e&s1 i&er&!. or e)er&!.1 he e)porer &o/is i& ! posiio& o ship he (oo$s o& ?:+ He !(rees hisch!&(e /ih his 'orei(& i"porer !&$ $oc#"e&s i+ The pro,.e"!rises /ih he B!&* !s he e)porer h!s !.re!$% o,!i&e$ co-er 'or

?=:+ He &o/ h!s o !"e&$ he co&r!c /ih he ,!&*1



/here,% he /o#.$ (i-e e!r.% $e.i-er% o' USD o he ,!&*'or -!.#e ?:+ i+e+ he &e/ $!e o' ship"e&+

Ho/e-er1 /he& he so.$ USD -!.#e ?=:1 he ,!&* $i$ he

s!"ei& he "!r*e1 o co-er is o/& ris*+ B# ,ec!#se o' e!r.% $e.i-er% ,%he c#so"er1 he ,!&* is .e' /ih ! .o&( "is"!ch o' '#&$s?: !(!i&s ?=:1 i+e+ USD -!.#e?:6c#so"er $e!. !"e&$e$7 !(!i&s he $e!. he ,!&* $i$ i& he i&er

,!&* "!r*e o co-er is ori(i&!. ris* USD -!.#e ?=: oco-er his "is"!ch he ,!&* /o#.$ "!*e #se o' !& FX s/!p+

The s/!p /i.. ,e

<+7 Se.. USD -!.#e ?:+

:+7 B#% USD -!.#e ?=:

The opposie /o#.$ ,e r#e i& c!se o' !& i"porer recei-i&($oc#"e&s

e!r.ier h!& he ori(i&!. $#e $!e+ I' ori(i&!..% he i"porer h!$ ,o#(hUSD -!.#e ?=: o& ope&i&( o' he 0C !&$ &o/ e)pecsreceipo' $oc#"e&s o& ?:1 he i"porer /o#.$ &ee$ o !*e e!r.%$e.i-er% o' USD 'ro" he ,!&*+ The B!&* is .e' /ih ! shor"is"!ch o' '#&$s ?: !(!i&s ?=:+ i+e+ USD-!.#e 6c#so"er $e!. !"e&$e$7 !(!i&s he $e!. he ,!&* $i$ i& he

i&er ,!&* "!r*e o co-er is ori(i&!. ris* USD

To co-er his "is"!ch he -!&* /o#.$ "!*e #se o' !& FX s/!p1/hich/i.. ,e <+ B#% USD -!.#e ?:+:+ Se.. USD -!.#e ?=:+



The s/!p &ecessi!e$ ,ec!#se o' e!r.% $e.i-er% "!% h!-e ! s/!pcosor ! s/!p $i''ere&ce h! /i.. h!-e o ,e ch!r(e$ p!i$ ,% hec#so"er+ The $ecisio& o' e!r.% $e.i-er% sho#.$ ,e !*e& !s soo& !s

i ,eco"es *&o/&1 '!i.i&( /hich !& FX ris* is cre!e$+ This "e!&sh!he res#.!& s/!p c!& ,e spo -ers#s 'or/!r$ 6/here e!r.% $e.i-er%co-er is .e' i.. he -er% e&$7 or 'or/!r$ -ers#s 'or/!r$+ There ise-er%.i*e.ihoo$ h! he ori(i!. co-er r!re /i.. ,e 4#ie $i''ere& 'ro"he"!*e r!es /he& e!r.% $e.i-er% is re4#ese$+ The $i''ere&ce i&

r!es/i.. cre!e ! c!sh o#.!% 'or he ,!&*+ The i&eres cos or (!i& o&hecos o#.!% /i.. ,e ch!r(e$ p!i$ o he c#so"er+

S#,si#io& o' Or$ers

The s#,si#io& o' 'or/!r$ co&r!cs is !..o/e$+ I& c!se ship"e&#&$er ! p!ric#.!r i"por or e)por or$er i& respec o' /hich'or/!r$

co-er h!s ,ee& ,oo*e$ $oes &o !*e p.!ce1 he corpor!e c!& ,e per"ie$ o s#,si#e !&oher or$er #&$er he s!"e 'or/!r$co&r!c1 pro-i$e$ h! he proo' o' he (e&#i&e&ess o' her!&s!cio&is (i-e&+

A$-!&!(es o' #si&( 'or/!r$ co&r!cs @ The% !re #se'#. 'or ,#$(ei&(1 !s he r!e ! /hich heco"p!&%

/i.. ,#% or se.. is 'i)e$ i& !$-!&ce+ There is &o #p'ro& pre"i#" o p!% /h& #si&( 'or/!r$co&r!cs+ The co&r!c c!& ,e $r!/& #p so h! he e)ch!&(e !*es p.!ceo& !&% !(ree$ /or*i&( $!%+Dis!$-!&!(es o' 'or/!r$ co&r!cs @ The% !re .e(!..% ,i&$i&( !(ree"e&s h! "#s ,e ho&o#re$re(!r$.ess o' he e)ch!&(e r!e pre-!i.i&( o& he !c#!. 'or/!r$co&r!c $!e+ The% "!% &o ,e s#i!,.e /here here is #&cer!i&% !,o#'##re



c!sh '.o/s+ For e)!"p.e1 i' ! co"p!&% e&$ers 'or ! co&r!c !&$he e&$er is #&s#ccess'#.1 !.. o,.i(!io&s #&$er he For/!r$Co&r!c "#s si.. ,e ho&o#re$+

:+ O5TIONS

A& opio& is ! Co&r!c#!. !(ree"e& h! (i-es he opio& ,#%er he ri(h1 ,# &o he o,.i(!io&1 o p#rch!se 6i& he c!se o' ! c!..opio&7 or o se.. 6i& he c!se o' p# opio&7 ! speci'ie$ i&sr#"e&! !speci'ie$ price ! !&% i"e o' he opio& ,#%er3s choosi&( ,% or

,e'ore! 'i)e$ $!e i& he '##re+ Upo& e)ercise o' he ri(h ,% he opio&ho.$er1 !&$ opio& se..er is o,.i(e$ o $e.i-er he speci'ie$

i&sr#"e&! ! speci'ie$ price+

The opio& is so.$ ,% he se..er 6/rier7

To he ,#%er 6ho.$er7

I& re#r& 'or ! p!%"e& 6pre"i#"7

Opio& .!ss 'or ! cer!i& perio$ o' i"e he ri(h e)pires !

is

"!#ri%Opio&s !re o' /o *i&$s<+7 5# Opio&s:+7 C!.. Opio&s 5UT O5TIONSThe ,#%er 6ho.$er7 h!s he ri(h1 ,# &o !& o,.i(!io&1 o se..he #&$er.%i&( !sse o he se..er 6/rier7 o' he opio&+ CA00 O5TIONS

The ,#%er 6ho.$er7 h!s he ri(h1 ,# &o he o,.i(!io& o ,#%he #&$er.%i&( !sse 'ro" he se..er 6/rier7 o' he opio&+



STRIKE 5RICESri*e price is he price ! /hich c!..s p#s !re o ,e e)ercise$

AMERICAN EURO5EAN O5TIONS

A"eric!& Opio&s

The ,#%er h!s he ri(h 6,# &o o,.i(!io&7 o e)ercise he

opio& ! !&% i"e ,e/ee& p#rch!se o' he opio& !&$ is "!#ri%+

E#rope!& Opio&sThe ,#%er h!s he ri(h 6,# &o o,.i(!io&s7 o e)ercise heopio& ! "!#ri% o&.%+UNDER0YING ASSETS @ 5h%sic!. co""o$iies1 !(ric#.#re pro$#cs .i*e /he!1 p.#s"e!.1 oi.+ C#rre&cies+ Soc* 6E4#iies7

INTRINSIC VA0UE @

I is he -!.#e or he !"o#& ,% /hich he co&r!c is i& he opio&+

2he& he sri*e price is ,eer h!& he spo price 'ro" he ,#%ers3

perspeci-e+E)!"p.e @

I' he sri*e price is USD !&$ he spo price is USD ; he& he ,#%er o' p# opio& h!s i&ri&sic -!.#e+ B% he e)ercisi&( he opio&1 he

,#%er o' he opio&1 c!& se.. he #&$er.%i&( !sse ! USD /here!si&he spo "!r*e he s!"e c!& ,e so.$ 'or USD ;+

The ,#%er3s i&ri&sic -!.#e is USD < 'or e-er% #&i 'or /hich heh!s !



ri(h o se.. #&$er he opio& co&r!c+

IN1 OUT1 AT THE MONEY @

I&he"o&e% @ A& opio& /hose sri*e price is "ore '!-or!,.e h!&

he c#rre& "!r*e e)ch!&(e r!e is s!i$ o ,e i& he "o&e% opio&+

I""e$i!e e)ercise o' s#ch opio& res#.s i& !& e)ch!&(e pro'i+O#o'he"o&e% @ I' he sri*e price o' he opio& co&r!c is.ess +'!-or!,.e h!&he c#rre& "!r*e e)ch!&(e r!e1 he opio& co&r!c is s!i$ o ,eo#o'he

"o&e% o is "!r*e price+

Ahe"o&e% @ I' he "!r*e e)ch!&(e r!e !&$ sri*e prices !rei$e&ic!. he&he opio& is c!..e$ o ,e !he"o&e% opio&+ I& he !,o-ee)!"p.e1 i' he"!r*e price is < US Q <+1 he opio& co&r!c is s!i$ o ,e! he "o&e%o is "!r*e p.!ce+

A STUDY OF FX

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