1 Foreign Exchange Banking in PK Guide

1 Foreign Exchange Banking in PK Guide

CHAPTER - I

Definitions

Exchange control

The restrictions imposed by the government of a country on conversion of its currency for another, with the purpose to improve its balance of payments position is called exchange control.

Exchange position

Foreign exchange position is the balances of bank foreign exchange assets and liabilities that generate the risk of obtaining additional revenues or expenditures upon the modification of exchange rates.

Foreign Exchange

Any currency other than the local currency which is used in settling international transactions can be termed as foreign exchange. This includes, instruments, such as, draft, cheques etc. and paper currency, used to make payments between countries.

Foreign exchange contract

It is a commitment to buy or sell a specified amount of foreign currency on a fixed date and rate of exchange. Such contracts are used by the importers as a hedge against exchange rate fluctuations.

Foreign exchange earning

It includes, proceeds from the export of goods and services of a country, and the returns from foreign investments, denominated in convertible currencies.

Foreign Exchange Market

The foreign exchange market deals in trading currencies. The purpose of the foreign exchange market is to help international trade and investment. It helps businesses convert one currency to another. For example, it permits a Pakistani businessman to import European goods and pay Euros, even though the businesss income is in Pak rupees. 

The foreign exchange market is the largest and most liquid financial market in the world. Traders include large banks, central banks, currency speculators, corporations, governments, and other financial institutions. The average daily volume in the global foreign exchange and related markets is continuously growing. Daily turnover is over US$3.00 trillion. Central banks 

play an important role in the foreign exchange markets.

Foreign exchange rate

This is the conversion rate of one currency into another. This rate depends on the local demand for foreign currencies and their local supply, countrys trade balance, strength of its economy, and other such factors. Exchange rates can be fixed or floating.

Fixed rates is the system in which the value of a countrys currency, in relation to the value of other currencies, is maintained at a fixed conversion rate through government intervention.

Floating rate is a system in which a currencys value is determined by the interchange of the market forces of demand and supply, instead of by government intervention. However, all central banks  try to control these rates within a certain range by buying or selling their countrys currency as the situation warrants.

Terms used in money market

Annualized

Extrapolates the behavior of an element (such as volatility) from a certain time period to a full year.

Ask

The price at which sellers offer currencies to buyers.

Base currency

Usually the currency of the home market in which a trader or investor is buying or selling.

Bid

The price at which buyer offers to buy currencies from sellers.

Currency pair

Exchange rate relationship between two currencies, where one currency is expressed in terms of the other. For example, USD-EUR (US dollar against Euro) is a currency pair.

Dollar rate

The exchange rate of a foreign currency as quoted against the US dollar (USD). Some currencies are typically only quoted against the US dollar, such as the Arab Emirates Dirham (AED) Pak Rupees (PKR). The exchange rate of the Arab Emirates dirham and PKR will be thus computed from AED-USD and PKR-USD.

Exchange rate

The number of one currency needed to buy another.

Exchange rate risk

The potential loss that could be incurred from a movement in bid/ask prices, or exchange rates. For traders, risk is measured by the open currency position.

Exposure

The risk which an investor accepts when buying and selling in foreign currency-hedged financial instruments.

Filtering data

Some data may be "bad," stemming from such causes as a market maker incorrectly typing a price, or entering the correct price but in the wrong format. All data used by OANDA is filtered using its own sophisticated algorithms.

Financial institution

An organization primarily established to offer and perform financial services. 

Examples of financial institutions include brokerages and banks.

Forecast

A statistical analysis of the markets whereby a percentage chance is assigned to a given price movement occurring. A forecast of the foreign exchange markets is similar to a weather report in that both assign a 

probability to the occurrence of an identified market or climatic change. 

FX or Forex

An abbreviation for foreign exchange.

Hedging

A transaction strategy used by traders and investors in foreign exchange to protect an investment or portfolio against currency price fluctuations. A current sale or purchase is offset by contracting to purchase or sell at a specified future date in order to defer a profit or loss on the current sale 

or purchase. In this way risk is offset due to currency price fluction.

Interbank prices

Currency prices that reflect market rates among financial institutions for transactions typically over US $1 million. Interbank prices are different from retail prices.

ISO

The International Standards Organization, a worldwide standard-setting 

body. We use ISO 4217 currency codes in all of our services.

Long position

A market position where a trader has bought a currency he previously did not own. A long position is normally expressed in terms of the base currency.

Market maker

A financial institution or individual making consistent buy and sell quotations

in selected currencies. A market maker must hold or have ready access to the amounts quoted, that is carry an inventory.

Overbought

Situation where price movement has risen 150% faster or stronger than normal, rising too far in response to net buying. A price movement that becomes overbought is expected to soon make a corrective move. In other 

words, the price of the currency pair is expected to fall soon.

Oversold

Situation where price movement has fallen 150% faster or stronger than normal, declining too far in response to net selling. A price movement that becomes oversold is expected to soon make a corrective move. In other 

words, the price of the currency pair is expected to soon rise.

Portfolio

A selection of securities held by an investor or financial institution. Portfolios are designed primarily to spread investment risk.

Price / basis point, or pip

One basis point = one paisa (0.01)

Price movement

The change in the price of a currency over a specified time period.

Retail prices

Currency prices which reflect commissions and special charges that a bank or exchange agency demands to convert currencies for no corporate customers. These commissions and special charges vary among countries, banks, and exchange agencies. 

Risk

The potential loss that an investor accepts when he makes an investment. Risk can also be defined statistically as the annualized standard deviation of returns. See exchange rate risk.

Short position

A market position where a trader has sold a currency he does not previously own. A short position is normally expressed in terms of the base currency.

Spread

The difference between the bid and the asking price of a currency.

Stop-buy

A buy order for a currency price that is above the current "market," or current price, that becomes a market order when the specified price is reached. Stop-buys are used by traders to establish positions in markets which they perceive to be rising in value.

Stop-loss

A price specified by a trader at which he closes his position ,buys or sells currencies to exit the market, to ensure that in case of a loss he is able to keep his loss in line with his risk profile.

Time horizon 

The period of time over which a forecast of the foreign exchange markets is made. Traders generally look at forecasts over several time horizons before making a trading decision. Typical time horizons presently used in financial services are:

� one day (24 hours) 

� five days 

� three weeks 

� three months 

Vendor or supplier

An financial organization which collects, packages, and distributes up-to-

the-minute price quotes from banks and other financial institutions.

Volatility

A measure by which an exchange rate is expected to fluctuate or has fluctuated over a given period. Volatility figures are often expressed as a percentage per annum.