Download foreign exchange market (forex)

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:
o Domestic Monetary Unit
o 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 .
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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
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