Srinivas Mallya, an Engineer with a Masters Degree in Business Administration, has indepth knowledge of the Foreign Exchange markets. He has been working in the Forex Exchange Broking industry for the last 15 years and has expertise on the Dollar Rupee Forwards Derivative Market.
In today’s world where we import oil from gulf countries and export products to the deepest of Africa, ever wondered how would the payments would be made?? What use would rupee be to a gulf country and an exotic African currency to an Indian economy unless there was an opposite trade of an equal value, but that would be very rare. Foreign exchange markets have made trade simpler by making payments/ receivables in a universally accepted currencies like US$ or euro. A brief walk through the world foreign exchange markets, today’s foreign exchange market is a very liquid & biggest market with a daily turnover of 5 trillion with 90% of trade speculative and rest genuine trade based. The markets are open 24hours across the 3 major continents, Asian markets opens when US closes, and Europe opens when Asia closes and US market opens when Europe closes so the cycle continues. So the prices of all major currencies are available at any time. Indian is so placed that it opens when the south east Asian markets are open, noon time Europe opens and during closing hours US markets open, so when there is any major movement in these markets it immediately impacts Indian markets.
Now let us try understanding how prices are quoted in the markets:
Prices of currencies are of two types, direct quotes and indirect quotes. When US dollar is the base currency i.e. the price is quoted per US dollar it is called as direct quotes, e.g 1 US dollar = 55 INR here USD is the base currency and INR is called the quoting currency. When US dollar is not the base currency it is called indirect quotes e.g 1 euro =1.22 US dollar and 1 stg = 1.58 US dollar. Among the major currencies GBP, EURO, AUD, NZD are example of indirect quotes.
The Indian rupee is quoted directly and is linked to the US dollar and to find value against any other currency one needs to cross multiple.
Consider the following two way quote for a US$ / INR currency
55.5000 // 55.5200
What is quoted is the price of the base currency i.e US in this case. The dealer quoting this price is buying 1 USD at 55.5000 INR also called as bid side and selling 1 USD at 55.5200 INR is called offer side. The dealer quoting this price will always bid (buy) the base currency at a lower rate and offer (sell) at the higher rate. The difference is called the spread, and is always in favor of the dealer who quotes, as he runs the risk. Any party who wants to buy US$ will have to buy at the offer side (sell side) at the quote 55.5200 and if he want to sell he has to sell on the bid side of the quote 55.5000. Both cannot be buyers and sellers at the same price for the same currency. A forex trade is an exchange of two currencies, what is a buy in a base currency (US$) for a party is also a sell in the quoting currency (INR) for the same party.
The market convention is to make two way quote in ascending order, the buy/bid/lower side first followed by the sell/offer/higher side. In the FX market , the action may be specified in either base or quoting currency. In the US$/ INR quote , buying USD is the same as selling INR for any party. When the action is stated in the base currency (US$) it is easy to follow because it is a price quotation.
Indian markets are still in the developing stage with newer instruments and players being introduced in the markets. In the next write up I will be talking about forward markets, the next big instrument after spot in the Indian markets.