Exchange Rate Mechanism

Exchange Rate MechanismJignesh Chandra MishraSenior Manager(Forex Dealer)Bank Of India, Treasury BranchExchange Rate Exchange rate is the rate at which one currency is converted into another currency.The price of one currency in the system , is quoted in terms of another currency.In exchange rate system , the currencies are just like commodities having varying prices.Various currency RatesFixed RateFloating RateFlexible RateSelling Rate and Buying RateInter-bank RatesBid and Offer RateCard Rate

FIXED RATESThe rates fixed by central banking authority i.e. RBI in India.It is a system under the gold standard where the rate of exchange tends to stablise around the mint par value.Now a days , the gold standard does not exist and due to this the fixed rates refer to maintenance of external value at a predetermined level.It prevents speculation.Floating ratesIt is a system where the exchange rates are determined by the conditions of demand and supply of the foreign exchange in the market.The rates fluctuates freely in the line with the demand and supply without any restrictions on buying and selling.

Flexible rateIn this case , the exchange rate is fixed rate but is adjusted in the line with the market conditions.Fixed by central banking authority changed by time to time according to market.Selling rates and buying ratesWhen bank aquires foreign currency it uses buying rate and when it parts with foreign currency , it makes use to selling rate.

The bank quote two different rates i.e. selling rate( at which bank sells foreign currency) and buying rate ( at which foreign currency is purchased).Interbank ratesIn the inter-bank market , the rates are quoted both for buying and selling like this, USD/INR = 62.20/22The quoting bank indicates that it is ready to buy USD at Rs 62.20, and sell at Rs 62.22.This indicates the said bank would pay lesser amount of rupees when USD are purchased and takes more rupees, while sell USD.Bid and offer ratesThe quoting bank in the previous example is ready to buy one USD at Rs 62.20 , which is called bidding for USD.

The bank is ready to sell a USD for Rs 62.22, which is called the offered rate.Card ratesCard rates are calculated at the beginning of each day, based on the current inter-bank rates and cross rates in the international market.The bank calculate the card rates after deducting exchange margin and conveyed to their branches for various types of transactions( buying and selling rates).CROSS RATESIf the price of one currency is not available against the other currency, the rate between them is obtained by using an intermediary currency.The rate thus obtained is called cross rate and the principle applied for obtaining the cross rate is called the chain rule.Ex. 1 USD/INR= 62.20 and 1 EUR/USD= 1.3610 Then EUR/INR(Cross Rate)= 62.20x1.3610 =Rs 84.6542

Types of interbank quotationDIRECT QUOTATIONIn a direct quotation there is a variable unit of home currency and fixed unit of foreign currency.Ex. 1USD= Rs 62.20In India direct quotes are used wef 1 August 1993.INDIRECTQUOTATIONIn an indirect quote there is fixed unit of home currency and a variable unit of foreign currency.Example 100 INR= USD 1.61Value date transactionsWhile quoting the rates, the banks take into account the time factor i.e. how much time is going to take the purchased or sold currency to credited or debited to the NOSTRO account abroad. The settlement date is known as value date.13Types of value date transactionsCash value (same day settlement)

Tom value ( value tomorrow settlement)

Spot value ( value next to tom settlement)

Forward rate (settled after spot value)Types of exchange rateBuying RatesTT Buying RateBill Buying RateCurrency/TC Buying Rate

Selling RatesTT Selling RateBill Selling RateCurrency/TC Selling Rates

Tt buying ratesWhen no delay is involved in realisation of the foreign exchange by the bank or Nostro account is already credited.TTB rate is applied for,Clean Inward remittances(TT,DD,MT).Conversion of proceeds of instruments that are sent for collection( collection of cheques, Export Bills etc.) where cover already received abroad.Cancellation of outward TT,MT etc.Cancellation of forward sale contract.BILL BUYING RATEWhen some delay in realisation of foreign exchange by the bank is involved, bill buying rate is applied. Such rates are calculated by adding the forward premium/discount for transit and usance period .

Bill buying rate is applied for purchase, discount and negotiation of export bills.TT SELLING RATEWhen handling of documents by the bank is not involved (issue of demand drafts, mail transfer etc.) TT selling rate is applied which is calculated on the basis of inter-bank selling rate by adding the exchange margin.TTS is applied for,All clean outward remittancesCancellation of export bill purchased i.e. crystallization of export bills.Cancellation of forward purchase contract.

BILL SELLING RATEWhen transactions involve handling of documents, such as payment for import documents, bill selling rate is applied, it is calculated by adding exchange margin to the TT selling rate.BLS is applied for,Retirement of import bills.Crystallisation of import documentary billsRate calculationsInterbank RatesSpot 1 USD/INR = 61.40/42Cash/Spot = 4/6 paisaCash/Tom = 2/3 paisaTom/Spot = 2/3 paisaExchange margin = 2 PaisaTo Calculate rate for inward remittance of USD 100000 (val cash, val tom, val spot)To Calculate rate for outward remittance of USD 200000 (val cash, val tom, val spot)Factors influencing exchAnage ratesExchange control regulationsBalance of paymentRelative Price(Inflation)Interest rates Other factors