Forex Market: Comprehensive Notes with Advanced Examples | MODULE D: FINANCIAL PRODUCTS AND SERVICES

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Forex Markets: A Comprehensive Study

Forex Market: Comprehensive Notes with Advanced Examples | MODULE D: FINANCIAL PRODUCTS AND SERVICES

Profile of Foreign Exchange (Forex) Market

The Foreign Exchange (Forex) market is the world's largest financial market where currencies are bought and sold. It operates 24 hours a day, five days a week, facilitating international trade, investment, and speculation.

Evolution of the Forex Market in India

In India, the Forex market evolved post-1991 economic reforms. The liberalization led to market-determined exchange rates in 1993 and development of derivative products such as forwards, swaps, and options under RBI regulations.

Characteristics of the Forex Market

  • High liquidity and 24/5 operation.
  • Decentralized and Over-the-Counter (OTC) market.
  • Highly volatile and influenced by macroeconomic factors.
  • Driven by supply and demand for currencies globally.

Market Participants

Participants include Central Banks, Commercial Banks, Financial Institutions, Corporations, Hedge Funds, Retail Investors, and Brokers.

LIBOR and Alternate Reference Rates (ARRs)

LIBOR (London Interbank Offered Rate) was historically used as a benchmark interest rate. Post-2021, it is being replaced by ARRs such as SOFR (Secured Overnight Financing Rate) in the U.S., and SONIA (Sterling Overnight Index Average) in the U.K.

Example:

Suppose a floating rate loan is tied to 6-month LIBOR + 2% spread:

If LIBOR = 1.5%, Total Interest Rate = 1.5% + 2% = 3.5%

Under ARRs, if SOFR = 0.5%, Total Interest Rate = 0.5% + 2% = 2.5%

Mathematical Representation:

    Interest = Benchmark Rate + Spread

    New Interest = SOFR + Spread

    = 0.5% + 2% = 2.5%

Foreign Exchange Dealers Association of India (FEDAI)

FEDAI was established in 1958 to regulate and guide India's Forex transactions among banks. It frames rules for interbank dealings, commissions, and fees on forex business.

Foreign Exchange Management Act (FEMA), 1999

FEMA replaced FERA (1973) and liberalized the Indian Forex market. It focuses on facilitating external trade, promoting orderly forex management, and enhancing the efficiency of the Forex market.

Key Provisions:

  • Current Account Transactions are generally permitted.
  • Capital Account Transactions are regulated.
  • Residents must follow RBI guidelines for forex dealings.

FX-Retail Platform

Launched by the Clearing Corporation of India Ltd. (CCIL) and approved by the RBI, the FX-Retail platform allows retail participants direct access to Forex transactions at market rates, enhancing transparency and competition.

US Dollar Index (USDX)

The USDX measures the value of the U.S. Dollar against a basket of six major world currencies: Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and Swiss Franc.

Formula:

    USDX = 50.14348112 × (EUR/USD)^-0.576 × (USD/JPY)^0.136 × (GBP/USD)^-0.119 × (USD/CAD)^0.091 × (USD/SEK)^0.042 × (USD/CHF)^0.036

Example:

Suppose:

  • EUR/USD = 1.10
  • USD/JPY = 135
  • GBP/USD = 1.25
  • USD/CAD = 1.30
  • USD/SEK = 10.50
  • USD/CHF = 0.92

Then, USDX is computed using the above formula with the exponents.

American Depository Receipt (ADR) and Global Depository Receipt (GDR)

ADR and GDR are financial instruments allowing foreign companies to raise capital in American and other international markets respectively. They represent ownership in the shares of a foreign company.

Example:

If an Indian company issues 1 GDR = 10 shares at $20 per GDR, effective price per share is:

    Price per share = $20 / 10 = $2

This enables international investors to invest in Indian companies without dealing directly with Indian regulations.

Previous Chapter
Fixed Income Markets - Debt / Bond Markets 		Next Chapter
Interconnection of various markets/Market Dynamics

Chapter List: MODULE D: FINANCIAL PRODUCTS AND SERVICES

© 2025 Suman Biswas. All rights reserved.

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