FAQs - Foreign Exchange Basics

What is foreign exchange?

An exchange of one (domestic) currency with other (international) currency is called foreign exchange and the rate at which one currency is exchange with another is called foreign exchange rate.

What is the need for foreign exchange?

With increase in international trade (and even capital) there is a need to measure the value of one country’s currency (or region) with that of the others’.

From where one can buy foreign exchange?

Foreign exchange can be purchased from any authorized dealer (bank). Besides authorized dealers, full-fledged money changers are also permitted to release exchange for business and private visits.

What is the foreign exchange market?

It is a global decentralized market for the trading of currencies. It assists international trade and investments by enabling currency conversion.

What are the basic features of the foreign exchange market?

It is the world largest market with a trading volume of around $ 5.3 trillion per day, operating 24 hours a day. It starts trading at the Sydney open on Sunday at 5 PM EST and trades until 5 PM EST on Friday when the market in New York closes. The London is the biggest centre with market share of 40% and USD is by far the most actively traded currency, comprising 87% of the total trade.

A brief history of the Rupee’s exchange rate.

India was a founding member of the International Monetary Fund (IMF). During the time the fixed exchange rate system was in place, the Reserve Bank of India’s intervention currency was the British Pound. After the collapse of the fixed exchange rate system in 1971, the RBI continued to maintain parity with the Pound. The exchange rates against other currencies were determined using their cross rates against the Pound. However by 1975, it was apparent that India’s trade had diversified substantially in terms of both currencies and destinations and that a peg to the Pound did not hold much merit. Rupee was then pegged to a basket of currencies.

In July 1991, a two-step devaluation of the Rupee was engineered and the intervention currency was changed to the US Dollar. But in March 1992, a dual exchange rate system was introduced under which, one rate was administered and the other was determined by the market. In March 1993, this system was abolished and a single market determined exchange rate has been applicable for all transactions ever since.

How are exchange rates quoted?

There are two standard ways in which exchange rates are quoted:

  • Direct quote – The exchange rate for a foreign currency is expressed in terms of units of local currency equal to one unit of foreign currency. Eg, USD 1= INR 62 would be direct exchange rate for USD in India. This is also called ‘Price quotation’ in the international markets.
  • Indirect quote – The exchange rate is quoted in terms of number of units of foreign currency equal to a unit of local currency. Eg, an indirect quote for the USD in London would be USD 1.6632 = GBP 1. This is also called ‘quantity quotation’. Most commonwealth nations like the UK, New Zealand and Australia use indirect quotations. GBP/USD, AUD/USD etc. Are quoted indirectly.