Forex Cargo
Forex Trading involves trading between the currency of our country (say, US $) and the currency of any other country, as well as trading between the currencies of other countries (e.g., between Euro and Pound Sterling). Such trading becomes necessary for payments in current account transactions (such as supply/purchase of goods and services) as well as payments in capital account transactions (such as borrowing/lending including purchase or sale of Securities of a Government/Company, payment of interest on debt instruments or dividend on company shares).
Current Account Transactions: When goods are imported from another country, say Pound Sterling, the British exporter would, generally, prefer to get his payment in the currency of his country as he would have incurred his expenses like those on salaries/wages, raw material, transport etc for his export in his countrys currency. The American importer has to buy Pound Sterling against delivery of US $ for making payment to the British exporter. The market in which the American importer buys Pound Sterling is called the Forex market. Contrari-wise, an American exporter of goods may get Pound Sterling against his exports to a British importer. As he needs to get US$ to meet his expenses and encash his profit, he has to convert the Pound Sterling into US $ which he does in Forex market.
Similarly, an American importer may buy insurance from a B ritish Insurance company in connection with his import. This service has to be paid for in Pound Sterling and to make such payment the importer has to buy pound sterling against his American Dollars in the Forex Market. On the other hand, a British exporter may obtain insurance from USA for which he has to pay in US$ and, for making payment of premium in US $ he has to acquire US $ in exchange for his British Pounds.
Capital a/c transactions: A Britisher may keep a deposit with an American Bank in US $. When the Deposit is to be repaid with interest, the US Bank has to purchase British pounds in exchange for US $ in the Forex market. On the other hand an American may wish to invest his funds in Indian Share Market. For the purpose he has to buy Indian Rupees in exchange for his US $.
Operators in Forex Market: Banks are the institutions which are the main dealers in various currencies from exporters/importers of goods and services. In the process of purchase and sale of currencies Banks make profit for themselves by buying low and selling high.
The Bank Branch which deals in foreign exchange maintains what is called a Nostro account with a Bank in the country whose currency it deals in. For example, a British Banks buying and selling US $ maintains a Nostro Bank with an American Bank into which US $ gets credited when the former Bank buys US $ against any other currency or from which US $ is paid out when it sells US $ against any other currency. A Bank dealing in currencies of various countries also opens for other countries Banks, Accounts called Vostro Bank a/cs which are accounts in which local currency equivalent is credited against foreign currency received and from which local currency is paid out under instructions of the Bank holding the Vostro account.
Most of a Forex-dealing Bank Branchs transactions of purchase and sale of foreign currencies are passed through Nostro and Vostro accounts. Such a Bank Branch may also at the request of a party accept foreign currency cash and deliver in exchange cash in other foreign currency (or even local currency) or, contrary-wise, deliver foreign currency in exchange for local currency. There are also dealers in foreign currencies other than Banks which exchange foreign currency cash against cash in any other currency including local currency. Both such Bank Branches and non-Bankdealers in currencies also sell/buy Travellers Cheques in foreign currencies against local currency.
Banks dealing in foreign currencies are in competition with each other and hence the margin they make for themselves in sale/purchase of foreign currencies is very meager, not exceeding a few cents per Dollar or equivalent thereof.
When Banks buy foreign currencies they sell off the same in the Forex market on the same day and when they sell they buy foreign currencies the Banks buy on the same day whatever they sell. The amount remaining outstanding unsold against a Banks purchases of a day in a particular foreign currency minus the amount outstanding unpurchased against its sales of the same day in the same currency is referred to as the Banks position in Banking terminology. Banks generally try to maintain at the end of a day either nil or near nil position (square or near-square position). If they maintain substantial position at the end of a day the same has to be in consonance with the policy and guidelines laid down by the Bank and by the Banks Supervising Authority. A position maintained carries exchange risk for the Bank as the currency in which position is held may move in favour of or adverse to the Bank.
Forward purchases & sales: Anyone (e.g. exporter, importer) who has agreed to make or receive payment in future runs exchange risk as the exchange rate in respect of that currency keeps constantly fluctuating and may move in his favour or adverse to him compared to the presently prevailing exchange rate. For example, an exporter agrees to supply three months hence or receive payment three months hence against supply already made. He needs and wishes to have the amount he may receive in his countrys currency (in which he has incurred his expenditure and needs his profit). Such a party may like to fix the amount receivable/payable in his countrys currency . Such a party may enter into a forward contract to purchase/sell the approximate amount of the foreign currency receivable/payable at a rate to be fixed in advance.. The exchange rate fixed in such forward contract depends on whether the exchange rate is expected to move up or down based on demand/supply of the currency and interest at the rate prevailing in that currency. Banks generally call for some margin against such contracts to cover the risk arising from movement of the currency favourable to the party when the party would have no incentive to buy/sell in accordance with the forward exchange contract entered into by him.
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