The foreign exchange dealing of a bank with its customer is known as ‘merchant business’ and
the exchange rate at which the transaction takes place is the ‘merchant rate’. The merchant business in which the contract with the customer to buy or sell foreign exchange is agreed to and executed on the same day is known as ‘ready transaction’ or ‘cash transaction’. As in the case of inter bank transactions, a ‘value next day’ contract is deliverable on the next business day and a ‘spot contract’ is deliverable on the second succeeding business day following the date of the contract. Most of the transactions with customers are on ready basis. In practice, the terms ‘ready’ and ‘spot’ are used synonymously to refer to transactions concluded and executed on the same day. We shall study how ready rates for merchant business are calculated in India.
The exchange rate is interpreted from the perspective of the quoting bank. In the deal between the bank and its customer, the rates are interpreted from the perspective of the bank. An exporter or importer should first learn to see the rates quoted by the bank from its perspective. Therefore while talking of a foreign exchange transaction:
- The transaction is always talked of from the bank’s point of view; and
- The item referred to is the foreign currency.
Therefore, when we say a purchase, we imply that –
- The bank has purchased; and
- It has purchased foreign currency.
Similarly, when we say a sale, we imply that –
- The bank has sold; and
- It has sold foreign currency.
In a purchase transaction, the bank acquires foreign currency and parts with home currency. In a sale transaction the bank parts with foreign currency and acquires home currency.
For example, determine which of the following transactions constitute (i) purchase; and (ii) sale of foreign exchange:
- The bank issues a demand draft on France for GBP 100.
- The customer of the bank purchases a telegraphic transfer on Ireland for GBP 500.
- A traveler encashes at the bank a traveler cheque for GBP 50.
- The bank purchases a demand draft on Italy for GBP 500.
Solution. (1) and (2) are Sales; (3) and (4) Purchases.
Exchange quotation between a bank and its customer is not a two-way quotation. The customer has to obtain a rate specifically providing all the details of the transaction. Therefore merchant rate is a one-way quotation and applicable for a specific transaction only.
Next: Currency Derivatives