Table Of ContentC D
ASH AND ERIVATIVES
M F E
ARKETS IN OREIGN XCHANGE
C D
ASH AND ERIVATIVES
M F E
ARKETS IN OREIGN XCHANGE
A.V. Rajwade
Senior Partner
A.V. Rajwade & Co.
Mumbai
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To
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century of a very pleasant association
Praise for Cash and Derivatives
Markets in Foreign Exchange
“I started reading the book, intending to go over only the captions, but ended
up devouring the whole of it in one sitting! The book provides great entry-
level coverage of all topics relevant to the users of the Indian FX and deriva-
tives market.”
Sudhir Joshi
Formerly Head, Treasury, HDFC Bank
“To be able to explain complex ideas in simple words, to be of relevance to the
policy-makers, professionals and neophytes alike, and to continue to hold the
reader’s interest, be it in weekly articles or a book—are extremely rare skills.
Mr. Rajwade possesses these skills and deserves all the accolades for writing
this book… . His vast theoretical knowledge and rich practical experience are
once again on display! All readers will find something useful from the wide
range of topics that he has covered with consummate ease’’.
Partho Datta
Former Finance Director, Murugappa Group
“The complex subject of foreign currency risk management and derivatives
has been dealt with so lucidly and brilliantly by Mr. Rajwade. His books
come as a savior to all financial controllers and regulators who have been
perplexed, cheated or badly hit recently. These books are a must read for all
Board members, Audit Committee members and advisors who have to deal
with Risk and Volatility.”
Shailesh V Haribhakti
Chairman, BDO Haribhakti Consulting Pvt. Ltd.
Foreword
I have the pleasure of writing a foreword to the two companion volumes,
“Cash and Derivatives Markets in Foreign Exchange” and “Currency Exposures
and Derivatives: Risk, Hedging, Speculation and Accounting—A Corporate
Treasurer’s Handbook”, by Mr. A V Rajwade. The manuscripts gave me an
opportunity to partly refresh my memory and partly to know some new
aspects, and above all also provoked me to ponder over some of the issues
discussed, in relation to the recent developments, consequent upon the global
crisis.
The volume on Foreign Exchange and Derivative Markets is of particular
interest for getting an overview of the complex subject. Chapter 1 on foreign
exchange rates is very informative and presents the topic in a simple as well
as objective fashion. It is in the nature of an introduction to the lay person
and a guide to the practitioner. The often ill-informed debate on exchange
rate management in India would do well to note two statements in the book:
“Broadly speaking, the exchange rate of any currency can be determined in
two ways: either administered by the central bank, or by demand and supply
in the exchange market. Various combinations of the two extremes are not
only possible but are more the rule”.
“To be sure, the dividing line between ‘independently floating’ (the dollar,
the euro and the yen for example) and ‘managed floating’ often gets blurred
in practice. To the extent a central bank intervenes in the exchange market in
pursuance of international economic co-operation or domestic macro-eco-
nomic objectives, the exchange rate of the independently floating currencies
is also managed”.
Similarly, those who tend to extensively use the word ‘devaluation’ or ‘up-
valuation’ are well advised to refer to the section on exchange rate indices,
which opens with a clear statement: “Since the dawn of the floating exchange
rate era, the terms ‘devaluation’ or ‘up valuation’ of a currency have lost much
of their significance or meaning: a currency may depreciate against some while
simultaneously appreciating against others, that too by varying percentages.
It is, therefore, necessary to devise some measure, or index, to determine the
appreciation or depreciation of a currency from a base date, against foreign
x Foreword
currencies as a whole, i.e., the effective exchange rate of the currency in ques-
tion. Various indices are in use for the purpose. Some of the more important
ones are described in subsequent paragraphs”.
The author refers to the Multilateral Exchange Rate Model (MERM),
developed by IMF, which has not been used so far in India. Perhaps, empirical
work should begin on this area. I am happy to note a reference in the book to
the fact that Reserve Bank of India had provided details of the methodology
used for its indices (NEER, REER) in the RBI Bulletin of December 2005.
The chapter on Foreign Exchange Markets is an excellent primer on the
subject, and is characterized by clarity and comprehensiveness. It explains
why the forex markets are often described as the most primitive among mod-
ern financial markets and how there are multiple rates in foreign exchange,
particularly to the disadvantage of non-financial and retail customers. The
words used by the participants in foreign exchange markets are often mislead-
ing: “spot transaction” means one in which cash settlement takes place within
two business days and not on the trade data as lay persons may believe.
Detailed references in the books to the surveys of the Bank for International
Settlements help not only in a review of the past and an understanding of
the current status but also act as a guide to updating the reader. Similarly,
the regulatory framework of RBI in regard to foreign exchange markets is
presented in a very simple and easily understandable form. Chapters 3 and
4, “Exchange Arithmetic” and “Global Financial Markets: An Overview” are
interesting practical guides to the participants, both the knowledgeable and
the lay people.
Chapter 5, “Exchange Rate Movements and Managing Currency Risks”
contains two passages which I cannot resist reproducing here:
“In Chapter 2, we have discussed the functioning, size and practices in
the global and domestic foreign exchange markets. In this chapter, we take an
overview of exchange rate movements, in the global and domestic markets;
their predictability or otherwise; and the need for and elements of a corpo-
rate exchange risk management policy. It is not the intention to discuss these
issues at any great length here: the interested reader may like to refer to the
companion volume on the subject (“Currency Exposures and Derivatives: Risk,
Hedging, Speculation and Accounting—A Corporate Treasurer’s Handbook”).
“Media reports and commentary often give an impression that there are
stable and consistent relationships between fundamentals and market move-
ments: too often these are rationalizations after the event, and one should be
cautions in putting faith in one’s own (or others’) ability to predict. Academic
research strongly suggests that markets are too ‘efficient’ to be predicted”.
The interesting fact is that no one really knows what appears to be the
right foreign exchange rate, but then central banks may have to intervene,
with varying degrees of frequency and intensity. This is a problem for central
banks, and understandably Mr. Rajwade does not deal with such dilemmas.
