Foreign Exchange Market

The term market has been interpreted in Economics as the place where both the buyers as

well as the sellers meet and they buy and or sell goods. The foreign exchange market is a place

where the transactions in foreign exchange are conducted. In practical world the external

transaction requires the use of foreign purchasing power i.e. foreign currency. The foreign

exchange market facilitates such transactions by performing number of functions.

Definitions of Foreign Exchange Market

According to Paul Einzig, "The foreign exchange market is the system in which the conversion

of one national currency in to another takes place with transferring money from one country to

another."

According to Kindleberger, "It is place where foreign moneys are bought and sold."

In simple words, the foreign exchange market is a market in which national currencies

are bought and sold against one another. There are large numbers of foreign transactions such as

buying goods abroad, visiting foreign country for any purpose. Corresponding nation in whose

currency the transaction is to be fulfilled. The foreign exchange market provides the foreign

currency against any national currency. However, it is to be understood that unlike other

markets, this market is not restricted to any particular country or any geographic area. There are

large numbers of dealers' instruments such as exchange bills, bank drafts, telegraphic transfers

(TT), etc. There are certain other dealers such as brokers, acceptance houses as well as the

central bank and treasury of the nation.

The foreign exchange market is unique because of the following characteristics:

Foreign Exchange market is not restricted to single place its continuous operation: 24 hours a day except weekends, i.e., trading from

22:00 GMT on Sunday (Sydney) until 22:00 GMT Friday (New York); its huge trading volume representing the largest asset class in the world leading to

high liquidity; its geographical dispersion;

the low margins of relative profit compared with other markets of fixed income; and

its huge trading volume representing the largest asset class in the world leading to

high liquidity;

the variety of factors that affect exchange rates;

Functions of Foreign Exchange Market

(A) Transfer Function : As mentioned above, the foreign exchange markets are exchange

markets engaged in transferring the purchasing power between two nations and two currencies. It

is prime function of this market. In simple terms, it is conversion of one currency into another

such as converting Indian Rs. into U.S. $ and vice versa at some rate. Various instruments like

bank drafts, exchange bills, are used for transferring the purchasing power. In this regard

international clearing to both the direction is important to because it simplifies the conduct of

international trade as well as capital movements from one country to another.

(B) Credit Function : Under this function the foreign exchange market provides credit to the

traders such as exporters and importers. Exporters can get credit such as reshipment and post-

shipment credit. Recently started Euro-Dollar market is a leading credit market at international

level. This function of making credit available plays a crucial role in growth and expansion of

the international trade.

(C) Hedging : Hedging is a specific function. Under this function the foreign exchange market

tries to protect the interest of the persons dealing in the market from any unforeseen changes in

the exchange rate. The exchange rates (price of one currency expressed in another currency)

under free market situation can go up and down. This can either bring gains or losses to the

concerned parties. Foreign exchange market guards the interest of both exports as well as

importers, against any changes in the exchange rate.

Thus, these are various functions performed by the foreign exchange market. To perform above

functions it uses the following instruments.

Instruments of Foreign Exchange Market

The instruments, with the help of which the international payments are effected. They

are,

1) Cheques and Bank Drafts : Persons dealing with foreign exchanges can use bank cheques

as well as bank drafts in order to make payments. The cheque is drawn on particular bank

instead of a person.

2) Bills of Exchange : It is also called as foreign bill of exchange which is an unconditional

order in writing addressed by one person to another. It mentions the person to whom a

certain sum is to be paid either on demand or on specific date.

3) Mail Transfer (MT) : Under this, funds are transferred from one account of a destination

to the another destination in the nation by mail. For international payments air-mail is

used.

4) Telegraphic Transfers (TT) : By this method a sum can be transferred from one place to

another place in the world by cable or telex. This is the quickest method of transferring

fund from one place to another.