What is forex trading and how does it work in india

October 27, ; Accepted Date: October 27, ; Published Date: J Stock Forex Trad 3: This is an open-access article distributed under the terms of the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original author and source are credited. For this study, we have collected primary information from the market practitioners with the help of a structured mailed questionnaire.

It is observed that forward contracts play an important role in addressing the exchange rate risk. It is observed that qualitative attributes like market sentiments, expectations, political stability and financial news play a vital role in determination of forward premia apart from quantitative factors viz. What is forex trading and how does it work in india is also found that forwards and futures would continue to have their respective market shares in the Indian foreign exchange market since both of them have unique features in minimizing the exchange rate risk.

Forwards and futures would continue to have their respective market shares in the Indian foreign exchange market since both of them have unique features in minimizing the exchange rate risk. Further, the survey results reveal that multi-currency regime and forward market would co-exist in future.

There is a unanimous view that RBI played a proactive role in bringing down volatility in the Indian markets during the financial crises in the past. Forward markets are very significant in determining foreign currency prices through the interaction of fundamentals viz. Interest rate differential, other things being equal will be the main factor in determination of forward premia especially when two countries have free market economies.

In the international finance, Parity theory has many variants viz. These parity theories integrate the relationship of forward premia, exchange rates, inflation and interest rates in the international financial markets. As one would expect findings of the research are of a mixed nature, some studies validated these theories, while others rejected them. However, research findings of Sharma et al. George and Mallik [ 7 ], Shah and Patnaik [ 8 ], and Varma [ 9 ] concluded that CIP conditions were non-existent in the foreign exchange markets.

Whereas, some authors viz. As exchange rate is an output derived out of market behaviour, merely concluding that exchange rate follows a random walk would mean that the market forces behind this rate are erratic.

This is a conclusion to be contested and to be answered both at theoretical and at empirical level. On the other hand, over dependence on macro theories that it can explain and forecast exchange rates near-accurately at all-time horizons is also not completely acceptable. Meese and Rogoff [ 11 ] it was found that forecasts based on the monetary approach to exchange rate determination could not Out-perform the random walk forecasts; the macro models lost their allure subsequently.

In the short-run, the recent studies, particularly after the introduction of online trading systems that made the tick-by-tick high frequency data available, have shown that macroeconomic fundamentals are barely useful in predicting the rate movement Sarno and Taylor,for the survey. The current study is divided into five sections.

The second section presents an overview on the foreign exchange forward market in India. The third section explains nature of data. The fourth section discusses the findings from survey on forward market.

What is forex trading and how does it work in india fifth section concludes the study. India was ranked at 15 in the world in terms of foreign exchange turnover; and stood at 16th position in terms of turnover in derivatives segment. As per the Survey, the maturity profile of outright forward contracts in India as well as in the world is shown in Table 1. It is noticed that the per cent of outright forwards with a tenor of more than one year in India is higher than that of world figures because of growing share of capital flows viz.

The what is forex trading and how does it work in india and level of operations of the Indian foreign exchange market during the last decade are shown in Table 2 [ 13 ].

It is clear from Table 2 that there was a spectacular growth in the total annual turnover of the Indian foreign exchange market i. Daily average turnover also witnessed similar kind of growth increased to almost 10 times during the period under review indicating deep, liquid and efficient market conditions in the market.

Table 3 portrays the foreign exchange market scenario in terms of indicated parameters between and As already indicated, total annual turnover in Indian foreign exchange market exhibited phenomenal growth by increasing almost 10 times during the period from to However, the shares of inter-bank turnover and merchant turnover in the total turnover remained flat during the period, albeit their proportions changed during the course of the period.

Further, it is noticed that the total market turnover in terms of foreign currency assets item 8 in Table 3 and the BoP item 7 in Table 3 also rose sharply during the period displaying vibrant market conditions. The questionnaire is constructed by using Likert Scale. We could collect information from market practitioners. Random sampling technique was used to select the respondents.

Primary data on Indian foreign exchange forward market have been interpreted in the following paragraphs. Participants in the market book forward contracts mainly to cover exchange rate risk that stems from exports, imports, overseas borrowings and investments. Hence, it can be stated that forward contracts come very handy to mitigate the exchange rate risk in foreign currency transactions.

The most widely used derivative instruments are the forwards and swaps in the Indian foreign exchange market [ 14 ]. Indian foreign exchange market has the following characteristics. Indian foreign exchange market has matured in terms of depth, liquidity and efficiency especially after introduction of market determined exchange rate regime in March and gradual liberalization of inflows and outflows in foreign currency.

This is evident from its higher turnover and lower what is forex trading and how does it work in india spreads. Low bid-ask spreads on exchange rates reflect higher liquidity and efficiency, lower volatility and less of information asymmetry in the market. Bid-ask spreads will decrease gradually as the number and size of transactions increase in the market. Efficiency in the foreign exchange markets can be established when forward premium acts as an unbiased predictor of future spot rates, reflecting informational efficiency [ 416 - 20 ].

Forward market is driven more by fundamentals viz. Hence, it is less volatile due to time lag effect in accessing information related to some of these macro-economic variables. Data on BoP is published on quarterly basis. This view was supported by the findings of the research study conducted by the authors [ 23 ] that lagged values of forward premia, interest rate differential and turnover in the foreign exchange market had a significant impact in determining forward premia during the period December through March During the last decade, Euro and Chinese Yuan have emerged as strong contenders to USD and getting considerable attention in the markets.

Forward contracts are usually delivered on the due date. This indicates a lower level of participation of speculators in the Indian forward market.

This shows that speculative transactions do exist in the Indian foreign exchange forward market at a considerable level.

As participants in the market have to submit documentary evidence to Authorised Dealers before expiry of each forward contract, this prevents speculative transactions in the market to a great extent.

India achieved full integration in its financial market segments viz. Hence, it is deduced that India is yet to achieve full integration in all of its financial market segments. The research studies undertaken by Jain and Murthy [ 24 ], Bhat and Virmani [ 25 ] and George and Mallik [ 7 ] corroborated this view.

So the policy makers may think of more reform initiatives such as further widening of the base of participants, introduction of new instruments, and development of institutional infrastructure in the Indian financial markets to achieve market integration further. The results of sample survey are mixed. Hence, it may be inferred from the survey results that the existing system i.

It is observed that the Forward Premium acts as a bridge between domestic and foreign interest rates through Covered Interest Arbitrage [ 926 ]. It is noticed that the latter class of NRIs are influenced by yields interest rate differentials and the former by depreciation of INR [ 23 ]. The motivating factors for what is forex trading and how does it work in india inflows seem to be the strong macro-economic scenario in India rather than interest arbitrage alone.

Jalan [ 27 ] endorses this view and states that there has been no evidence that capital moves from the US to the Europe or elsewhere merely on account of interest rate differential. The frequency of buy—sell operations of foreign investors in equity, money and Govt. It is observed that portfolio flows, with sudden and huge volumes, from foreign investors have an impact on foreign exchange market in general and forward premia in particular [ 28 ]. It is noticed that portfolio flows are invested in Indian financial markets for a short period with a view to maximising returns.

Volatility in exchange rates including in forward premia is of high policy relevance because it is often seen as what is forex trading and how does it work in india impediment to trade and welfare [ 29 ]. Since portfolio investments, in general, are not deployed for a longer tenor, hot money flows from FIIs may be monitored closely.

Forward premia are influenced by a large no of forces, both quantitative and qualitative. The following table portrays some of the qualitative attributes. It is evident from Table 14 that most of the respondents agreed that qualitative attributes like market sentiments, expectations, political stability and financial news play a major role in determination of forward premia. The research studies conducted by Sharma and Mitra [ 5 ], Kumar and Mukherjee [ 15 ] also supported this view.

However, it may be inferred from the survey results that force majure events have a lesser impact on forward premia in comparison with other factors. Ajay Shah and Ila Patnaik [ 8 ] highlighted that forward market in India consists of exporters and importers who are free to hegde or not to hedge depending on their expectations about currency movements, which affects forward premia.

Exchange rate volatility is determined by strong seasonal patterns, by arrival of the news and the revelation of private information [ 30 ]. Currency Futures were introduced in the Indian foreign exchange market in August As they have what is forex trading and how does it work in india counter party risk and higher ease in execution, they are likely to overtake forward contracts in the next 5 years. Volumes in Futures and Options segment in India increased from Rs.

Further, it is observed that the turnover in the forward market outright forwards and swaps stood at USD Hence, it is inferred that both forwards and futures may continue to retain their respective market shares in future. So the policy makers may devise guidelines to deepen the forward and futures markets further. As India mainly depends on oil imports, majority of Indian oil companies book forward contracts to mitigate their exchange rate risks; and the same will affect forward premia.

In case of extreme volatile conditions, the monetary authorities may think of novel solutions in this regard. The world may move what is forex trading and how does it work in india a single currency regime bythereby making forward market irrelevant Table However, the USD is likely to retain its what is forex trading and how does it work in india position in the international financial markets in the near future.

Hence, it is understood that forward market would continue to be an essential segment of financial markets. Indian foreign exchange market—both spot and forward segments— experienced volatility during the East Asian currency crisisPokhran nuclear blastsKargil war and recent global financial meltdown RBI played a proactive role by using its policy instruments like direct intervention during these periods.

Hence, it is inferred from the results that RBI played a proactive role through direct intervention in the market during the times of crises as cited above.

Hence, it is suggested that RBI may continue to adopt these strategic initiatives in future also. It is construed from the questionnaire survey results that forward contracts play an important role in addressing the exchange rate risk.

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