Answer:
The foreign exchange market is the place where money denominated in one currency is bought and sold with money denominated in another currency. It is the largest financial market in the world with prices moving and currencies trading somewhere every hour of every business day.
- Market Transparency
- Dollar is extensively traded currency
- Most Dynamic Market
- International Network of Dealers
- Over the Counter Market (OTC)
- High Liquidity
- Twenty -Four Hour Market
- Lower Trading Cost
1. Market Transparency:
Trader in the foreign exchange market has full access to all market data and information. They can easily monitor different countries’ currencies price fluctuations through real-time portfolio and account tracking without the need of a broker. All this information helps in making better trading decisions and control over investments.
2. Dollar is extensively traded currency
The dollar is the most dominant currency in the foreign exchange market. This currency is paired with every country’s currency being traded in the forex market. In a major proportion of transactions every day, the dollar is one of the two currencies
being traded.
3. Most Dynamic Market
The foreign exchange market is a dynamic market. In these markets, currency values change every second and hour. These values change in accordance with changing forces of demand and supply which also helps in determining the exchange rates. Due to its fast-changing character, this market is termed as the perfect market to trade.
4. International Network of Dealers
The market is made up of an international network of dealers. The market consists of a limited number of major dealer institutions that are particularly active in foreign exchange, trading with customers and (more often) with each other. Most, but not all, are commercial banks and investment banks. These dealer institutions are geographically dispersed, located in numerous financial centres around the world. Wherever located, these institutions are linked to, and in close communication with, each other through telephones, computers, and other electronic means.
5. Over the Counter Market:
Until the 1970s, all foreign exchange trading in the United States (and elsewhere) was handled “over-the-counter,” (OTC) by banks in different locations making deals via telephone and telex. In the United States, the OTC market was then, and is now, largely unregulated as a market.
Although the OTC market is not regulated as a market in the way that the organized exchanges are regulated, regulatory authorities examine the foreign exchange market activities of banks and certain other institutions participating in the OTC market.
Examinations deal with such matters as capital adequacy, control systems, disclosure, sound banking practice, legal compliance, and other factors relating to the safety and soundness of the institution.
6. High Liquidity
The foreign exchange market is the most liquid financial market in the world. It involves the trading of various currencies across the globe. All traders in this market are free to buy or sell currencies anytime as per their choice. They are free to exchange currencies without prices of currencies being traded getting affected. Currencies prices remain the same both at the time of order placed and executed thereby enabling to earn the expected prices.
7. Operates 24 Hours
Foreign exchange markets function 24 hours a day. It provides a platform where currencies can be traded anytime by traders. It provides a convenient time to all necessary adjustments when and wherever needed.
8. Lower Trading Cost
The forex market has a very low trading cost. In these markets, there are no commissions like in case of any other investments. Any difference between buying and selling prices of currencies is the only cost of trading in the forex market. As there are low costs then the possibility of incurring losses is also minimum thereby making it possible for small investors to make good profit from trading.
Functions of Foreign Exchange Market:
The following are the important functions of a foreign exchange market:
1. To transfer finance, purchasing power from one nation to another. Such transfer is affected through foreign bills or remittances made through telegraphic transfer. (Transfer Function).
2. To provide credit for international trade. (Credit Function).
3. To make provision for hedging facilities, i.e., to facilitate buying and selling spot or forward foreign exchange. (Hedging Function).
1. Transfer Function:
The basic function of the foreign exchange market is to facilitate the conversion of one currency into another, i.e., to accomplish transfers of purchasing power between two countries. This transfer of purchasing power is effected through a variety of credit instruments, such as telegraphic transfers, bank draft and foreign bills.
In performing the transfer function, the foreign exchange market carries out payments internationally by clearing debts in both directions simultaneously, analogous to domestic clearings.
2. Credit Function:
Another function of the foreign exchange market is to provide credit, both national and international, to promote foreign trade. Obviously, when foreign bills of exchange are used in international payments, a credit for about 3 months, till their maturity, is required.
3. Hedging Function:
A third function of the foreign exchange market is to hedge foreign exchange risks. Hedging means the avoidance of a foreign exchange risk. In a free exchange market when exchange rate, i. e., the price of one currency in terms of another currency, change, there may be a gain or loss to the party concerned. Under this condition, a person or a firm undertakes a great exchange risk if there are huge amounts of net claims or net liabilities which are to be met in foreign money.
Exchange risk as such should be avoided or reduced. For this the exchange market provides facilities for hedging anticipated or actual claims or liabilities through forward contracts in exchange. A forward contract which is normally for three months is a contract to buy or sell foreign exchange against another currency at some fixed date in the future at a price agreed upon now.
No money passes at the time of the contract. But the contract makes it possible to ignore any likely changes in exchange rate. The existence of a forward market thus makes it possible to hedge an exchange position.
Foreign bills of exchange, telegraphic transfer, bank draft, letter of credit, etc., are the important foreign exchange instruments used in the foreign exchange market to carry out its functions.
Structure of Foreign Exchange Market
Foreign Exchange market is a market where foreign currencies are bought and sold. It is simply a virtual place where buyers and sellers meet for purchasing, selling and exchanging currencies of different countries with one another.
This market is also termed as Forex market or currency market. Foreign exchange market is an international decentralized market which does not have any physical existence. This market determines the exchange rate for every currency. Forex market is the largest and highly liquid market in the world where trillions of dollars’ changes hand each day.
The market is open for 24 hours a day and 5 days in a week excluding holidays. It is one of the key financial market that facilitates the international payments system. Forex market has 2 tiers: – Interbank market and over the counter market. Interbank market is one where large banks exchange currencies with each other whereas over the counter market is one where individuals and companies trade. This global market is highly risky in nature as it is not regulated by any central body. Spot market, Future market, Forward market, Option market and Swap market are major types of foreign exchange market.
The structure of foreign exchange market is composed of different participants who are the main players and occupies different positions. These participants are commercial banks, central banks, immigrants, importers, exporters, tourists and investors. Role played by these participants in forex market is discussed in detail below: –
Commercial Bank
Commercial banks are important organs of foreign exchange market which are termed as “market makers”. These banks trade in foreign currencies for themselves and also for their clients. Commercial banks quote the foreign exchange rate on a daily basis for purchasing and selling of foreign currencies. They act as a clearing house by facilitating the carrying off of differences in between the demand and supply of these currencies. Currencies are purchased from broker by commercial banks for selling them to buyers.
Central Bank
Central bank is the apex body in foreign exchange market which has power to regulate operations related to trading of foreign currency. It directly intervenes in the functioning of forex market to avoids aggressive fluctuations. For controlling fluctuations, currency is sell off when it is overvalued and purchased in case it is undervalued. Central bank ensure that an exchange rate is at optimum that fulfills the needs of national economy.
Foreign Exchange Brokers
Broker in foreign exchange market work as an intermediary in between the commercial bank and central bank and also in between the commercial banks and buyers. These persons carry a large source of information about market. Brokers only facilitate the currency trade but do not get themselves involved in market transactions. They work on a commission basis where do the task of striking the deal in-between the seller and buyer.
Buyers And Seller
These are real buyers and sellers, exporters, importers, tourists, investors, immigrants etc. of foreign currencies who trade in foreign exchange market with the help of brokers. They approach commercial banks for purchasing and selling off currencies. Importer, exporters, tourist, immigrants and investors are some of these peoples.
