Currency Markets September 03, 2018 - PowerPoint Presentation

1. Currency MarketsSeptember 03, 2018Babar Ali, CFASenior Joint Director,Domestic markets & Monetary Management DepartmentState Bank of Pakistan

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3. Why Foreign Exchange Unlike barter system, currencies ensure smooth transactionsMultiplicity of currencies involved in international trade and financeNot practical and feasible for a country to produce all the goods and services it needsFinancial interaction between the countries is inevitable

4. FX Market ParticipantsCommercial Banks Exchange CompaniesFX Market BrokersCentral BanksCorporate TreasuriesImport/ExportFinancingInvestment/ Profit RemittanceOther Financial InstitutionsPublic Sector/GovernmentIndividuals

5. Types of TransactionsOutright TransactionsReady: Settlement: Same DayTom: Settlement: T+1Spot: Settlement: T+2Forward: Settlement date more than two day aheadFX Swap TransactionAn FX Swap is a deal involving two transactions. The first transaction is to exchange currencies in one value date at an agreed rate. The second transaction is to reverse the first transaction for an other vale date at an agreed rate

6. Factors influencing FX MarketBalance of paymentsImport/ExportForeign InvestmentForeign DebtPolitical DevelopmentsEconomic IndicatorsEconomic GrowthInflationInterest RatesGovernment policiesCentral Bank interventionMarket sentiment

7. Foreign Exchange Risk Exposure to exchange rate movement Any sale or purchase of foreign currency entails foreign exchange riskCarrying net assets or net liability position in any currency gives rise to exchange riskTransaction Exposure: Exposure due to an expected transaction Translation Exposure: Exposure due change in value of assets/liabilitiesEconomic Exposure: Exposure of competitive position to exchange rate movement

8. Foreign Exchange Risk Risk management is a process of identifying, measuring and controlling riskForeign Exchange Risk is not additiveForeign Exchange Risk reduces in the longer runRisk is diversified while investing in multiple currenciesRisk can be hedged through Various derivatives:Forwards/FuturesOptionsSwaps

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10. Exchange Rate QuotesExchange rate is price of one currency against another expressed as a ratioRate is always quoted between two currencies (A currency pair)One currency is called base currency and the other is called quoted currencyAn exchange rate is the price of one unit of base currency in terms of quoted currency

11. Base and Quoted CurrencyIn an FX quote first currency is called base currency and the second currency is called quoted currency Base Currency Quoted CurrencyExample: USD/PKR = 123.50123.50 is the price of one unit of USD (Base Currency) in terms of PKR (Quoted Currency)USD/PKR

12. Direct and Indirect QuotationDirect QuotationQuotes using a country's home currency as the quoted currency. USD/PKR = 123.50Mostly currencies are quoted in as a Direct quotation.Indirect QuotationQuotes using a country's home currency as the base currency: EUR/USD = 1.1600Currencies with Indirect quotation: EUR, GBP, AUD, and NZD.

13. Bid/Offer RateAn exchange rate quote consists of two parts: Bid/ Buying RateOffer/ Selling RateParty asking for quote is called ‘Market taker’ while party giving the rate or quote is called ‘Market maker’ USD/PKR 123.50/55123.50 is the buying rate at which market maker wants to buy USD i.e. base currency123.50 is the selling rate at which market maker wants to sell USD i.e. the base currency

14. Cross RatesFX rates typically involve currencies quoted against the US dollar Cross rate is the rate between two currencies where neither of the two currencies is the US dollar For example: EUR/PKR EUR/GBP EUR/CHF GBP/JPY CHF/JPY

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16. Forward MarketThe forward FX Market is where parties buy and sell currencies for delivery at some future date. For example a forward transaction dealt today could have value date of 1 month laterOne month, Two months, Three months, six months and one year forward dates are called Fixed Periods. Any value date falling between the fixed dates is called Broken Date or Odd Date.Periods above are known collectively as run. If a dealer asks for a run through, you would quote prices for all these fixed periods.

17. Forward Premium/DiscountThe difference between the forward and spot price is called Forward Premium/DiscountCurrency with higher forward rate than its spot rate is said to be traded at premium in forwardCurrency with lower forward rate than its spot rate is said to be traded at discount in forward

18. Forward PointsForward rates are quoted in forward points. For most currencies one point equals 0.0001 because currencies are quoted to four decimal placesForward rate is calculated by adding or deducting the forward points to or from the spot rateUSD/PKR forward points are quoted in paisas

19. Forwards and Interest RateThe difference between the forward and spot rates for two currencies is based on the difference between the interest rate of two currenciesThe currency with higher interest rate is traded at discount in forwardThe currency with lower interest rate is traded at premium in forwardFor example, an importer needs USD 100 Million after six months. It has two options:Buy USD 100 Million spot and invest for six monthsBuy USD 100 Million for delivery six months forwardThe two options above should produce same result otherwise there would be arbitrage opportunities

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21. Domestic FX MarketThe FX market of the country can be seen as segmented into banks, and Exchange companies marketInterbank market is the mainstream market and interbank rate is the benchmark rateBanks’ foreign exchange activity can be bifurcated into Interbank and retail (customers) transactions Banks can cover their transactions with customers back-to-back in interbank market or can keep the exposure on their own books

22. Bank Branch OperationsBank’s two important units as far as its FX operations are concerned are Branches and TreasuryBanks cater to the foreign exchange requirements of its customers though network of branchesBanks’ foreign exchange activities are primarily generated through import, export, remittances, investments, profit repatriation/ dividends etcMargin between buying and selling rate for customers should not exceed 20 paisa Branches buying/selling of FX is off-loaded/covered from their treasury

23. Treasury’s FX OperationsA bank’s treasury trades in interbank market to manage its positionBanks have to manage their:Foreign Exchange Exposure/ Net Open Position (NOP)Nostro AccountsForeign Exchange Exposure/ NOP refers to net asset or liability position in foreign currenciesNostro accounts: An entity’s accounts in foreign currencies in countries of respective currenciesFEEL is 20% of paid-up capital with maximum of PKR 3,500 million

24. Exchange CompaniesMinimum paid-up capital: Rs. 200 millionStatutory Liquidity Reserve (SLR) : 25 percent of the Capital, in the form of unencumbered approved government securitiesBuying/SellingBuy and sell foreign exchange from/to individuals in Ready value only Buy and sell foreign exchange in Ready, Tom and Spot value dates from/to other Exchange CompaniesSell foreign exchange to companies for remittance on account of royalty, Franchise, technical fee, repair and maintenance etc Sell foreign exchange in Ready, Tom and Spot value dates to banks

25. Exchange CompaniesInward/Outward RemittancesExchange Companies shall take prior approval of State Bank before commencing inward home remittances operations All inward home remittance transactions shall be routed through foreign currency accounts of the Exchange Companies maintained with banks in Pakistan Minimum 15% of inward home remittances, must be sold in the interbank market on an ongoing basis Outward remittances are allowed only on personal account of individuals i.e. personal financial transactions and not those related to an individual's trade or business requirements

26. Exchange Companies Inward/Outward RemittancesCorporate clients may effect outward remittances through an Exchange Company only on account of payment of royalty, technical/Franchise feeExchange Companies are not allowed to effect outward remittances on account of trade related activities/payments against services/commission etc., whether on account of individual or on behalf of corporate clients

27. Exchange Companies ‘B’ CategoryMinimum paid-up capital: Rs. 25 million.Statutory Liquidity Reserve (SLR) : 10 percent of the Capital, in the form of cash or unencumbered approved government securitiesAuthorized to buy and sale foreign currency notes and coins from/to individuals, Exchange Companies and Exchange Companies of B category in Ready value only Allowed to sell foreign exchange in Ready value only to the banks as counter party Exchange Companies of B Category are prohibited from engaging in any other activity such as remittances, transfers, deposit taking, lending etc., directly or indirectly

28. Exchange Rate Data published by SBPWeighted Average Customer Exchange Ratehttp://www.sbp.org.pk/ecodata/rates/war/WAR-Current.aspThese rates are compiled from the Exchange Rate sheets issued daily by various Commercial Banks providing their indicative Exchange Rates for commercial transaction with customersExchange Rate for Mark-to-market revaluationhttp://www.sbp.org.pk/ecodata/rates/m2m/M2M-Current.aspThese Exchange Rates are issued for Authorized Dealers to revalue their books daily on Mark-to-Market basis. These are compiled on the basis of closing Exchange rates prevailing in Inter Bank Foreign Exchange Market.Other External Sector Datahttp://www.sbp.org.pk/ecodata/index2.asp

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