Forex Market Participants

The participants in the forex market can be classified under four broad categories

1. Non bank entities who wish to exchange currencies to meet or hedge there commitments
2. Banks which exchange currencies to meet client requirements
3. Speculators buying or selling currencies in the hope of profiting from price movements.
4. Arbitragers who take advantage of price disparities on a fully hedged basis.

Exchange Rate Quotes

Direct and Indirect Rates

1. Under direct rate system, the exchange rate for a foreign currency is expressed in terms of units of local currency equal to one unit of foreign currency. For example USD 1.00 = INR 43.20
2. Under Indirect Systems, the exchange rate is quoted in terms of the number of units of foreign currency equal to a unit of local currency. For example USD 2.3148 = INR 100

Bid and Offered Rates

Normally in inter bank market the rate will be quoted in two way pricing. For example USD/INR will be quoted as 43.20/21. It indicates the buying and selling of USD against INR. The buying and selling rates are also referred to as the bid and offered rates

1.BID : Consider the above example of USD/INR 43.20/21. In this quotation, the
bid rate for dollar is 43.21. Now consider the quote of GBP/USD 1.7090/98. In this quotation, the bid rate(buying) for dollars is 1.7098. The meaning of this quote is that if u want to buy 1 GBP from market you have pay 1.7098 Dollars.

2. Offer : Consider the example of USD/INR 43.20/21. In this quotation, the offered rate for dollar is 43.20. Now consider the quote of GBP/USD 1.7090/98. In this quotation, the offered rate (selling) for dollars is 1.7090. The meaning of offer is that if u want to sell 1 GBP to the market u will get 1.7090 dollars

The term bid and offered rates is also prevalent in the money market. For example if a bank quotes an interest rate of 3.65/75 for six-month dollar deposits, it conveys that the bank is willing to accept a six-month dollar deposit at 3.65 per cent while it is willing to place deposit of the same duration at 3.75 per cent per annum. In the market jargon, it is bidding for deposits at 3.65 while offering deposits at 3.75

Spot and Forward Rates : Value Dates

Every forex transaction involves exchange of two currencies by the counter parties to the transactions. One party, for example, receives dollars in New York and pays out rupees in Mumbai. The counter party pays out dollars and receives rupees in respective centers. The date on which the exchange of currencies is to take place is the value date of the transaction. In practice this is not possible because of time differences in the two countries. Hence the use of value dates ie currencies must be paid and received on the same day.

There are standard nomenclatures and practices prevalent to determine the value date of exchange contracts, namely the dates on which the two currencies involved in an exchange transaction change hands.

For example Rupee being Paid in Bombay and dollar being received in New York. If either of the two centers has a holiday on a particular day, its date cannot be a proper value date for dollar.

The Standard nomenclatures for value dates are

1. Ready or Cash – Value Today – Here currency will change hands on the same day where transaction done

2. Tom (Tomorrow) – Value Tomorrow or next working day – Here currency will change hands tomorrow or the next working day

3. Spot- Value two business days after the trading date – For spot transaction done Monday, currency will change hands the following Wednesday assuming this is a working day in both centers. Similarly for spot transaction done on Thursday, currencies will change hands following Monday, there being no forex transaction on Saturdays and Sundays.

4. Forward – Any value date beyond spot – The rules for determining value dates of standard maturities of forward transactions are as follows. In general the value date of a one-month forward contract will be the date in the next month corresponding to the spot value date. For example Let us consider a transaction done on 22nd July 2005. The value date for a spot transaction will be 26th July 2005 and the value date of a one-month forward transaction undertaken on 22nd July 2005 will be 26th August 2005. Forward transaction can also be structured to give one of the parties to the transaction an option to determine any value date within a prescribed period. On example of this would be an exporter desiring to sell forward foreign currency to his bank, but not knowing in advance the exact date of receipt or shipment. In this case he can book forward with an option of delivering the dollar say September 15th to September 30th.

Interbank Market, LIBID and LIBOR

Apart from customer transactions there is an extremely active inter-bank market in offshore currencies. The two rates are referred to as bid and offer rates – hence the terms, London Inter- Bank Rate (LIBID) and London Inter- Bank Offer Rate (LIBOR). Since LIBID and LIBOR are the rates at which a bank is bidding for and offering deposits in the market, the actual quotations on a given day, and indeed time, can differ from bank to bank. As LIBOR is the most common floating rate benchmark used in interest rate swap agreement, the bank specific LIBORs could lead to dispute about the amounts to be exchanged under the swap agreements. To avoid such disputes, the LIBOR used in many case is that published by the British Bankers Association.