3.1.The essence of the exchange rate

International economic transactions involve the exchange of national currencies, the exchange takes place on a certain ratio. The relationship between monetary units of different countries is the price currency of one country expressed in the currency of another country, called the exchange rate. “The main theme of economic life can be indirectly measured in money”[21].

Currency (exchange) rate (exchange rate) – price per unit of national currency, expressed in units of foreign currency[22].

Exchange rate – this is not a technical conversion factor, and the “price” of the currency of the country, expressed in foreign currency or international currency units.

The exchange rate is necessary for the international foreign exchange, settlement, credit and financial transactions. For example, exporters exchanging foreign currency proceeds to the national as well as in normal circumstances, the currencies of other countries are not treated as cash funds within the State. Importer acquires foreign currency to pay for purchased goods abroad.

3.2.The basis of the exchange rate

Cost basis of the exchange rate is purchasing power parity (PPP etc.), that is, the ratio of rates for their purchasing power. Purchasing power is the national average price levels for goods, services and investments. In the free exchange of the notes for gold and gold free circulation between the two countries exchange rate slightly deviates from PPP because of the mechanism of gold dots. The mechanism of gold dots – the limits of deviation from the monetary exchange rate parity (usually less than 1%) lower (at which begins the outflow of gold from the country) and upper (starts its flow). Monetary parity – the ratio of weight of gold in monetary units (coins) in various countries.

In the paper money circulation exchange rates may significantly deviate from the PPP[23]. In many developing countries and countries with economies in transition, the exchange rate in 2 – 4 times lower parity. Deviation from the PPP exchange rate is influenced by supply and demand for the currency, which in turn depends on various factors.

Exchange rates are published in the press. Typically, in the current information contained in the previous two quotes of the day and short-term forecasts.

3.3.Factors affecting the exchange rate

Should distinguish between circumstantial and structural (long term) changes affecting the exchange rate.

Conjuncture factors affecting the exchange rate:

– The state of the economy (inflation rate, interest rates, currency markets, speculation, monetary policy, balance of payments, the extent of the use of national currencies in international payments, the acceleration or delay of International Settlements);

– The political situation in the country (political factor);

– The degree of confidence in the national currency at the national and international markets (psychological factor).

Circumstantial factors associated with fluctuations in enterprise activity, political and military-political situation, guesses and predictions. The exchange rate depends on how pessimistic or optimistic about the company with respect to public policy.

The higher inflation in the country compared with other states, the lower the rate of its currency, if not counteract other factors. Inflationary depreciation of money in the country causes a decrease in their purchasing power and a tendency to decline in their exchange rate[24].

The exchange rate affects the degree of currency on world markets. In particular, the preferential use of the U.S. dollar in international transactions and international capital markets is a constant demand for it and maintains its course even in the fall of its purchasing power or passive balance of payments.

Rising interest rates on deposits and (or) the profitability of securities in any currency will increase the demand for that currency and will lead to higher prices. Relatively high interest rates and yields of securities in the country (in the absence of restrictions on capital flows) will lead in the first place, the influx into this country of foreign capital and thus – to increase the supply of foreign currency, it’s cheaper and more expensive currency. Second, bring a higher return deposit and securities in national currency promote national cash outflow from the currency market, reducing demand for foreign currency, and a decline in the foreign and local currency appreciations.

With an active balance of payments is growing demand for its currency from foreign debtors, its rate can be increased.

Economic importance of the exchange rate determines the need for its regulation.

Along with the market conditions, which include the effect is difficult to supply and demand for currency, is the dynamics of its course, affect, and relatively long-term trends that determine the position of a national currency in the currency of the hierarchy (structural factors).

Structural factors:

– The competitiveness of goods on world markets and its changes. They are caused, ultimately, technological determinants. A forced export stimulates the flow of foreign currency;

– The growth of national income causes an increased demand for foreign products, while imports of goods may increase the outflow of foreign currency;

– A consistent increase in domestic prices compared to prices in the markets of partners increases the desire to buy cheaper foreign goods, while the tendency of foreigners to purchase goods or services that become increasingly expensive, disappears. As a result of reduced supply of foreign currency and depreciation is domestic;

– Other things being equal, higher interest rates is a factor in attracting foreign capital and, consequently, foreign currency, and can also lead to higher prices of domestic. But the rise in interest rates is well known, and the shadow side: it increases the cost of credit and a depressing effect on investment activity in the country;

– The development of securities market (bonds, bills of credit, stocks, etc.) that make up a healthy competition the foreign exchange market. The stock market may attract foreign currency directly, but also attract national funds which would otherwise be used for buying foreign currency[25].

3.4.The main methods of regulating the exchange rate

The main body of the foreign exchange regulations of the Russian Federation is the Central Bank of Russia. It defines the scope and procedure of appeal to the Russian Federation, foreign currency and securities in foreign currency, sets the rules for the residents and Russia operations with foreign currency and securities in foreign currency, as well as rules for non-residents operations with rubles and securities in rubles; establishes the procedure for compulsory transfer, import and transfer to Russia of foreign currency and securities in foreign currency belonging to residents, as well as events and conditions of opening resident foreign currency accounts with banks outside of Russia, sets out general rules for licensing credit institutions to carry out foreign exchange transactions and issues such licenses, establishes uniform forms of accounting, reporting, documentation and statistics of currency transactions.

The main methods of monetary control are:

– Currency intervention (buying and selling foreign currency to national);

– Central bank operations in the open market (buying and selling of securities);

– Change in central bank interest rates and (or) reserve requirements.

Exchange controls exercised by exchange controls and their agents. Currency control bodies are the Central Bank and the Government of the Russian Federation. Currency control agents are organizations that are in accordance with legislative acts may perform the functions of currency control.

The main directions of monetary control are:

– Determination of compliance of foreign exchange transactions with current legislation and the availability of necessary licenses and permits;

– To verify that the residents of foreign currency liabilities to the state, the validity of payments in foreign currency, completeness and objectivity of accounting and reporting of currency transactions and for transactions with nonresidents in rubles.

The object of national and transnational regulation is currency restrictions and currency convertibility regime.

As rightly pointed out Frederic Bastiat “you cannot give money to some members of the community but by taking it from others”[26]. Cash is in fact equivalent to existing facilities, money is their “mirror image”, and, therefore, imperative redistribution of opportunity or simply move the cost of changing the terms without affecting the sum.

Foreign exchange restrictions – is introduced in legislation or regulation, restriction of operations with national and foreign currency, gold and other currency values.

Distinguish restrictions of payments and transfers for current transactions balance of payments and financial transactions (is transactions involving the movement of capital and credit), the operations of residents and nonresidents.

The number and type practiced in the country depends on foreign exchange restrictions convertibility regime. Currency convertibility (reversibility) – is the ability to convert (exchange) currency of the country for the currencies of other nations. Distinguish between free or fully convertible (reversible) exchange, partially convertible and nonconvertible (irreversible).

Fully convertible (“freely usable” in the terminology of the IMF) are the currencies of the countries in which virtually no foreign exchange restrictions on all types of operations to all holders of currencies (residents and nonresidents). In partial convertibility of the country remain restrictions on certain types of operations and / or to individual holders of the currency. If the limited possibilities for conversion of non-residents, the convertible is called outer if non-residents – domestic. What matters most is convertibility on current account of balance of payments, it is possible without restrictions to the import and export goods. Most industrialized countries have switched to this type of partial convertibility of the mid-60s of the twentieth century.

Currency is not convertible, if the country has almost all kinds of restrictions and, above all, a ban on the purchase – sale of foreign currency, its storage, export and import. Inconvertible currency is typical of many developing countries.

3.5.Exchange rate regime

Exchange rate regime characterizes the order setting exchange ratios between currencies[27].

Distinguish between fixed and “floating” exchange rates and options, which combine in various combinations of the individual elements of a fixed and “floating” rate. Such a classification of exchange rate regimes generally conformed to the IMF currency division into three groups:

– Currency-bound (to a single currency, “currency basket” or the international monetary unit);

– Currencies with great flexibility;

– Currencies with limited flexibility.

Fixed exchange rate regime

Under the regime of fixed exchange rate the Central Bank sets the exchange rate at a certain level against the currency of any country to which the “tied” the currency of the country, the currency basket (usually it consists of currencies of major trading partners) or to the international monetary one.

Feature a fixed rate is that it remains unchanged for a longer or shorter time (several years or several months), that is not dependent on changes in supply and demand for the currency. Change the fixed rate is a result of its formal review (depreciation – decrease or revaluation – increase).

With a fixed rate the central bank often sets the various courses on individual transactions – treatment of multiple exchange rates. Fixed exchange rate regime is usually installed in countries with rigid exchange restrictions and non-convertible currency.

Mode of the “floating” or floating its currency

This mode is typical for countries where currency restrictions are absent or insignificant. Under such a regime exchange rate changes with relative ease under the influence of supply and demand for the currency. Mode “floating” exchange rate does not preclude holding the Central Bank of various measures aimed at regulating the exchange rate. In March 1973 the country switched to floating exchange rates. However, the dominant state-controlled swimming rates.

Intermediate versions of exchange rate regime

For intermediate between a fixed and “floating” exchange rate regime options are:

– Mode “sliding lock”, in which the Central Bank sets the exchange rate daily based on certain factors: inflation, balance of payments, changes in the value of official gold reserves, etc.;

– Mode of “currency corridor” in which the central bank sets the upper and lower limits of the exchange rate variations. Mode “currency corridor” as a mode called “soft commit” (if set narrow limits of variation) and the mode of “managed float” (if the corridor is wide enough). The wider “corridor”, the more the movement of the exchange rate corresponds to the actual ratio of market supply and demand for currency[28];

– The mode of “co” or “collective diving” rates, which rates countries – members of the group supported the currency in relation to each other within the “currency corridor” and “swim together” around the office, outside the group.

The development of the exchange rate regime of the ruble in Russia

After the entry of Russia in 1992, the IMF, the Central Bank refused treatment of multiple exchange rates and imposed a regime of “floating” exchange rate. Since mid-1995 mode of the “floating” exchange rate regime was replaced by “currency corridor”. In 1995-1997 The Bank of Russia established the absolute values of the upper and lower bounds on the exchange rate variations, and later introduced “horizontal trading band” with a central rate of the ruble to the U.S. dollar to possible deviations from it within certain limits. This “corridor” has been extended August 17, 1998, and since September 1998 exchange rate is set to “free float”.

3.6.Currency quotation

Exchange rates – defining the proportions of exchange, that is, the mobile market rates of the day. They depend on the condition of the course yesterday, before closing, and on major international stock exchanges – from Tokyo to New York, what are the views of market conditions, foreign exchange potential of the banks. Full quotation includes the selling rate (usually higher) and buying (lower). The difference (margin) account fees.

Turnover on international stock exchanges, as well as short-term play money capital in order to profit from the difference in interest rates and exchange rates in the hundreds of times higher than world trade[29].

Exchange rates (currency quotation) – To identify and exchange rate chosen on the basis of market mechanisms[30].

In the currency market are two methods of currency quotes: direct and indirect (inverse). In most countries (including Russia) applied direct quotation, in which the rate of one unit of foreign currency expressed in domestic currency. In the indirect quotation exchange rate of national currency units expressed in a certain amount of foreign currency. Indirect quotation applied in the UK and since 1987 in the USA.

There are also quotes an official, interbank, exchange-traded. The official exchange rate quotation by the Central Bank. The official exchange rate used for accounting purposes and customs payments for the balance of payments.

Methods for determining the official exchange rate varies by country depending on the nature of the monetary system and exchange rate regime. In countries where the fixed exchange rate regime, the quotation is determined purely by administrative means. The Central Bank sets (regardless of supply and demand for currency) exchange rate against the currency of any one country to which the “tied” the currency of that country, or in relation to several currencies at once (on the basis of the “currency basket”) or SDRs. At the same time the Central Bank may establish different exchange rates for individual operations (multiplicity of exchange). This method was used in the Russian Federation until July 1992.

Under the regime of “currency corridor” official exchange rate set under the “currency corridor”, or at the level of the exchange (as, for example, in Russia from July 1995 to May 1996) or by daily quotations, the so-called “sliding fixation”.

In some countries with underdeveloped exchange market, where the main circulation of currency transactions pass through the currency market, the official rate set at the level of the exchange.

In countries with a free currency market, where a regime of “floating” rate, depending on the prevailing supply and demand for foreign currency, central banks set the official exchange rate at the interbank level. In some industrialized countries maintained a tradition of setting the official exchange rate at the level of the exchange.

Since the bulk of foreign exchange operations in industrialized countries are carried out on-the-counter interbank market, the main course of the internal market in these countries is the interbank rate. Interbank quotation install large commercial banks – the main operators of the foreign exchange market, supporting one another permanent relationship. They are called market makers (makers of the market).Other banks – market-users (users of the market) to apply for quotation of market makers. Interbank Foreign Exchange quotes are set by market makers by sequential comparison of supply and demand for each currency.

On the interbank rates are guided all the other members of the currency market, it is the basis of establishing rates for each currency. Exchange rate is mostly for reference.

In countries with rigid exchange restrictions and fixed exchange rate, all operations are conducted at the official rate. In some countries with underdeveloped exchange market, where the volume of currency transactions are in foreign currency exchange rate of the main foreign exchange market is the exchange quotation, which is formed on the exchange, based on the consistent comparison of bids for the purchase and sale of foreign currency (exchange fixing). Exchange rate is the basis of establishing rates, both in interbank transactions and for bank customers.

Distinguish quotes:

– The lines are used in most countries (including Russia). When direct quotation cost per unit of foreign currency expressed in national currency unit (for example, U.S. $ 1 = 31.90 RUR):

– Indirect, the unit adopted a national currency, the rate of which is expressed in a certain amount of foreign currency. Indirect quotation is used in the UK, since 1987, and in the U.S. (for example, 1 RUR = 0.031 U.S. dollar).

Between direct and indirect quotations of the inverse relationship exists:

The display of exchange rates of a large bank of any country are induced by the dollar against other currencies, that is, represented by direct quotation.

For the British pound has historically maintained an indirect quotation, so the string GBP in this table is read as follows:

– Cross-rate is the ratio between the two currencies in relation to third currencies.

For example, on December 15, 2011 Bank of Russia[31] set for accounting purposes and customs payments the following rates: 1 U.S. dollar = 31.90 RUR.

The most common is separation of currency transactions in cash and term. The first is also called the overnight (overnight). In this case we are talking about the provision of goods (currency) at the time of the transaction or within a few days, in the second – about the time lag between the date of the transaction and its implementation.

4.1.Cash Transactions (transaction “spot”)

Transactions on a “spot” (spot – cash, instant) made at the rate established at the time of the agreement, and the supply of currency no later than the second enterprise day. Delayed pay increases progressively fine-interest.

At the heart of deals “spot” is based on correspondent relationships among banks.

– The spatial arbitrage. This foreign currency transaction had to start spontaneously dealers. Profit arises from differences in the courses on various foreign exchange markets.

Under normal conditions, currency trading is, in its macroeconomic consequences, to a positive phenomenon, because it promotes the equalization of market rates. But inflation in the atmosphere an additional influx of a particular currency may cause the exchange rate distortions.

In a simple arbitrage interact two counterparties. Buyer shall pay from their bank accounts, dealer – acting on the orders of the first (or in conjunction with them) – accrues revenue. Their foreign exchange reserves as a whole does not change.

Complex or the conversion arbitrage involves working with a number of currencies in different markets. The study of the geography of currency rates reveals a point relative to cheaper foreign currency purchase. Broker like climbing the stairs, exchanging currency purchased on the third and fourth. And back to the original currency is not necessary.

Arbitration profit extremely unstable and conversion operations involve a risk to stay in the position outright in any link.

– Cross-operation – this is the equation of one currency to another through a third – the National, the country where the transaction or that the fairly widespread in world currency markets, through a preliminary equalization rates to the dollar.

In Russia, the cross-denominated transactions are carried out mediation when dealing with “soft” currencies.

Cross – the operation used a combination of foreign exchange purchase and sale of securities.

But the use of cross-operation is fraught with the risk of exchange rate changes between the first and second acts of the transaction. Sometimes, to avoid losses, it is necessary to involve a third or fourth transaction currency.

4.2.Forward contracts

Urgent or forward contracts are two-fold objective: profit-in the form of foreign exchange and insurance of participants against currency risks.

Emergency surgery for the sale (purchase) of foreign currency consists of the following conditions:

– The course of the transaction is recorded at the time of its conclusion;

– Transfer of currencies is carried out in 1 – 3 months (sometimes deadline is extended to one year);

– At the time of the transaction no amounts of accounts are generally not performed.

Forward exchange transaction occurred as a form of insurance for foreign trade operations. If the goods are sold on credit, the exporter seeks to preserve the value of its currency now existing rate. The importer, buying goods on credit and insuring themselves against the appreciation of the currency of the country of origin, may act as a buyer of the currency at a fixed time of the transaction rate.

Forward transactions are bank lenders seeking to guarantee itself against a possible depreciation of currency, which provided a loan.

Common in international practice has focus on the rate of “LIBOR” (London: Inter Bank Offered Rate) – the interest on interbank deposits in London.

Calculation of the premium (discount) to the forward rate by the following formula:

RQC – rate quoted currency;

% B – the rate on deposits in foreign currency B;

% A – the rate on deposits in foreign currency A;

PF – period forward.

The enterprise press usually puts the data on exchange rates of CIS countries and the interest rates on deposits. However, in this currency environment plays a significant role time unpredictability, non-economic conditions, foreign exchange rates on forward transactions are contractual in nature.

4.3.Deal with an option

In contrast, forward transactions with exact delivery date, united by the concept of “outright” (outright), option (a choice) does not fix the date of delivery. Distinguish between temporary options, options buyers and sellers. In all cases we are talking about the fact that one party pays the other an additional premium, but instead gets some special right. In the temporary option, for example, the right timing of currency supply. The bank sells foreign currency to the client on the forward rate “+” an extra bonus with the deadline for delivery. But the customer gets the right to demand payment at any time during a fixed period. Such an option could be very advantageous for particular variations in market exchange rates. If the option is received (for a premium) the buyer, then as a matter of choice may be, and the right to refuse to accept the exchange of goods. Here, premium – premium plays the role of compensation. Right out of the deal for the forward period, and may belong to the seller who pays a premium to the buyer.

4.4.Transaction “swap”

Today, the transaction “swap” – is the purchase or sale of currency under a fixed exchange rate, but at the same time the conclusion of the reverse forward transaction, and payment terms are usually not the same (deal “sell-buy” in the jargon of the foreign exchange market). The swap transaction is used to cover the currency risk, as well as a possible gain in the future.