MBA (General)IV – Semester, International Business Unit 1
Definition of Determination of Exchange Rate
The most common type of foreign transaction involves the payment and receipt of the foreign exchange within two business days after the day the transaction is agreed upon.
Determination of Exchange Rate
The most common type of foreign
transaction involves the payment and receipt of the foreign exchange within two
business days after the day the transaction is agreed upon. The two-day period
gives adequate time for the parties to send instructions to debit and credit the appropriate bank accounts
at home and abroad and complete requirements
under the forex regulations.
This type of transactions is called a spot transaction, and the exchange rate at which the
transaction takes place is called the spot rate. Besides spot transaction,
there are forward transactions. A forward transaction
involves an agreement today to buy or sell a specified amount of a foreign currency at a specified future date at a
rate agreed upon today (the forward
rate). The typical forward contact is for one month; three months; or six
months, with three months being most
common. Forward contracts for longer periods are not as common because of the great uncertainties involved. However,
forward contract can be renegotiated for one or more periods when they become
due.
The equilibrium forward rate is determined at the intersection of the market demand
and supply forces of foreign exchange for future delivery. The demand for the supply of forward foreign exchange arises in the course of hedging, from
foreign exchange speculation, and from covered interest
arbitrage.
