Unit 4: Exchange Dealings

Dealing Position

It refers to the current position of a forex dealer (bank or trader) after conducting buying and selling activities of foreign currencies.

Purpose: To track how much foreign currency a dealer owes or holds, i.e., their net position.

Types

• Long Position: When a dealer has bought more foreign currency than sold. (Expecting the value to rise.)
• Short Position: When a dealer has sold more foreign currency than bought. (Expecting the value to fall.)

Goal: Dealers aim to balance their position daily to avoid large exposures due to currency fluctuations.

Exchange Position

The net balance of foreign currencies held by a bank or dealer at a given point.

Formula

Exchange Position=Purchases (Receivables)−Sales (Payables)

Types

• Overbought Position: Purchases > Sales (Excess foreign currency).
• Oversold Position: Sales > Purchases (Deficit in foreign currency).

Management: Banks maintain this position within limits set by central banks to control foreign exchange risk.

Cash Position

The actual availability of foreign currency in cash or demand accounts at a particular time.

Focus: This tracks the liquidity — whether the dealer has enough cash to settle transactions.

Example: If a customer comes to withdraw foreign currency, the cash position ensures the bank can fulfill this need immediately.

Difference from Exchange Position: Exchange position includes forward contracts and deals yet to settle, while cash position is about available funds now.

Comparison Table

Summary

• Dealing Position = How much the dealer is exposed to market changes.
• Exchange Position = Net buying/selling position.
• Cash Position = Available foreign currency for immediate use.

Mirror Account

A control account maintained by one branch of a bank to mirror or reflect the foreign exchange transactions recorded by its correspondent branch or head office in another country.

Purpose

• To ensure accuracy and reconciliation between two accounts (home and foreign branch).
• Helps track foreign currency inflows and outflows.

Example: Branch A (India) and Branch B (USA) maintain mirror accounts in each other’s books to record reciprocal entries.

Value Date

The actual date on which a transaction is settled (funds are credited/debited) and becomes effective for interest or accounting purposes.

Importance

• Ensures proper interest calculation.
• Prevents disputes over payment timing.

Example: A foreign exchange deal done on July 20 might have a value date of July 22 due to settlement time.

Exchange Profit and Loss

The gain or loss incurred due to fluctuations in foreign exchange rates during buying/selling or currency conversion.

When It Happens

• Buying at one rate, selling at another.
• Revaluation of foreign currency holdings.

Types

• Realized Profit/Loss: From actual completed transactions.
• Unrealized Profit/Loss: From revaluation of open positions (not yet settled).

Example: Bought $1000 at ₹83, sold at ₹84 → ₹1000 profit.

R Returns (RBI Returns in India)

Periodic statutory reports submitted to the Reserve Bank of India (RBI) by banks dealing in foreign exchange.

Purpose

• To monitor and regulate foreign exchange transactions.
• Ensure compliance with RBI guidelines.

Types

• R-Return (Daily/Monthly): Summary of forex deals, positions, and exposures.
• Other Returns: Like XOS, BEF, ENC, for tracking exports, import payments, etc.

Contents

• Bank’s foreign currency assets and liabilities.
• Exchange position and profit/loss data.

Summary Table

Risk in Forex Dealing

Forex (Foreign Exchange) dealing involves buying/selling foreign currencies, which exposes dealers to various types of risks

Measure of Value at Risk (VaR)

Value at Risk (VaR) is a statistical technique used to measure the maximum potential loss in value of a portfolio (or currency position) over a specified time period at a given confidence level.

Key Components

Example: A 1-day VaR of ₹10 lakh at 99% confidence means: There’s a 1% chance that the loss will exceed ₹10 lakh in one day.

Methods to Calculate VaR

Foreign Exchange Markets

The Foreign Exchange Market (Forex/FX) is a global decentralized market for the trading of currencies.

Key Features

Summary Table

SWIFT (Society for Worldwide Interbank Financial Telecommunication)

CHIPS (Clearing House Interbank Payments System) – USA

 CHAPS (Clearing House Automated Payment System) – UK

Fedwire (Federal Reserve Wire Network) – USA

Comparison Table

Summary

• SWIFT: Secure message system → no funds move.
• CHIPS: Large USD payments → settled in net.
• CHAPS: Instant GBP payments → real-time gross.
• Fedwire: Instant USD payments → real-time gross.