FOREIGN EXCHANGE MARKET (FOREX)

• International trade and investment would not be possible without the arrangement or mechanism for buying and selling foreign currencies because Rupee is not the medium of international means of exchange.

• The FEM is therefore necessary for making international transactions in an open economy.

What Is a Foreign Exchange Market ?

• A foreign exchange market is a place in which foreign exchange transactions take place. In other words it is a market where foreign money are bought and sold. It is a part of money market in the financial center.

• The basic and primary function of a foreign exchange market is to transfer purchasing power between countries. The transfer function is performed through T.T, M.T, Draft, Bill of exchange, Letters of credit, etc

The bill of exchange is the most important and effective method of transferring purchasing power between two parties located in different countries.

An open economy introduced two kinds of monetary units instead of one:

oDomestic Monetary Unito Foreign Monetary Unit.

Global FEM

• The oldest, biggest, most extensive, most active and fastest growing and most liquid market in the world.

• It is an electronically linked network of big banks, foreign exchange brokers and dealers whose function is to bring buyers and sellers together.

Leading Centers:

• London• New York• Paris• Zurich• Tokyo• Milan • Frankfurt

• Trading is done 24hrs a day by telephone, display monitors, fax machines and a satellite network called Society for Worldwide International Financial Telecommunications (SWIFT) which is a computer based communication system.

Players in FEM in India

Authorised Dealers.Foreign exchange brokers who acts as

intermediaries.Customers-individuals, corporate, who

need foreign exchange for their transactions.

The foreign exchange market is unique because of

• its huge trading volume, leading to high liquidity.

• its geographical dispersion;• its continuous operation: 24 hours a day

except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday;

• the variety of factors that affect exchange rates;

• the low margins of relative profit compared with other markets of fixed income.

Central Bank Intervention

• The RBI has the authority to enter into foreign exchange transactions both on its own account and on behalf of the government.

• It does not deal in foreign exchange directly with the public, it does through ADs.

Functions of the FOREX Market

• The FOREX market is the mechanism by which participants–Transfer purchasing power between

countries • This is necessary as international trade

and capital transactions normally involve parties living in countries with different national currencies

–Obtain or provides credit for international trade transactions• Inventories in transit must be financed

–Minimize exposure to exchange rate risk• FOREX markets provide instruments

utilized in “hedging” or transferring risk to more willing parties

Central Banks and Treasuries

• Central banks and treasuries use the market to acquire or spend their country’s currency reserves as well as to influence the price at which their own currency trades.

• They may act to support the value of their currency because of their government’s policies or obligations or because of commitments entered through joint float agreements such as the European Monetary System (EMS)

• Consequently their motive is not to profit but rather influence the foreign exchange value of their currency in a manner that will benefit their interests

Points to Remember

• The three functions of the foreign exchange market (FOREX) are to transfer purchasing power, provide credit, and minimize foreign exchange rate risk

• A foreign exchange rate is the price of one currency expressed in terms of another currency

• A foreign exchange quotation is a statement of willingness to buy or sell currency at an announced price

• Transactions within the FOREX market are executed either on a spot basis requiring delivery two days after the transaction or on a forward basis requiring settlement at some designated future date.

• European terms quotations are the foreign currency price of one US dollar. American terms are the dollar price of a foreign currency.

• Quotations can also be direct or indirect. A direct quote is the home currency price of a unit of foreign currency, while an indirect quote is the foreign currency price of a unit of the home currency

• A cross rate is an exchange rate between two currencies, calculated from their common relationships with a third currency .

• Participants in forward market:• Hedgers• Speculators• Arbitrageurs

• Hedgers are those who enter the forward exchange market to protect themselves against exchange rate risk.

• Speculators are those who wants to make profit by accepting exchange rate risk

• Arbitrageurs are those who want to make a riskless profit because of the discrepancies IR differential and forward premium.

• General Features of FEM Development Pg-849..