Foreign Exchange Market.

Introduction:
An important distinction between foreign trade and domestic
trade is that under the former settlements entails foreign
currencies or exchange.

For example, when one buys a Japanese product in India,both its price
and payment is in rupees. However, both the manufacturer and
workers in Japan expects payments in yen.

Similarly, Indian software engineers in Gurgoan expect compensation

in rupees for the sale of software to Sweden.

\Clearly,to effect such transactions a mechanism must exist that

converts or exchanges rupees for yen and kronor for rupees. The
mechanism is the foreign exchange market.
 Foreign Exchange Market:
• Foreign Exchange Market is a market where
foreign currencies are exchanged by
governments, exporters, importers, financial
institutions, tourists, currency speculators,
and anybody who wants to engage in
international trade.
• In India, the foreign exchange market is a three-
level structure consisting of (a) RBI at the top, (b)
authorised dealers licensed by the RBI and, (c)
customers ( exporters, importers, companies, and
other foreign exchange earners).
• In addition, to these main market players, there
are foreign money changers who bring buyers
and sellers together, but are not permitted to
deal in foreign exchange on their own account.
• Dealings in foreign exchange market include
transactions between authorised dealers and the
exporters/importers and other customers,
transactions among authorised dealers
themselves, transactions with overseas banks and
transactions between authorised dealers and the
RBI.
• The authorised dealers are governed by the
guidelines framed by the Foreign Exchange
Dealers Association of India(FEDAI).
Functions of Foreign Exchange Market:
Transfer Functions: It implies transfer of purchasing
power in terms of foreign exchange across different
countries of the world.
Credit Functions: It implies provisions of credit in terms of
foreign exchange for the export and import of goods and
services across different countries.
Hedging Functions: It implies protection against the risk
related to variations in foreign exchange rate. Demand for
and supply of foreign exchange at some commonly
agreed rate of exchange even when the commitments are
to be honoured on some future date
 Operations of Foreign Exchange
Market:
• Foex Market operates as either:
• 1) Spot Market(Current Market): It is that market
which handles only spot or current transactions.
• In terms of “period of transaction” , spot market
is of ‘daily nature’. It does not trade in future
deliveries.
• The rate of exchange determined in this market is
known as ‘Spot rate of exchange’ or ‘Current rate
of exchange’.
• This exchange rate prevails at the time when
transactions take place.
• 2) Forward Market: This market handles such
transactions of foreign exchange as are meant for
future delivery.
• Such transactions are signed today but are to
materialised or honoured on some future date.
• It does not deal in spot transactions; only forward
transactions.
• It determines forward exchange rate- the
exchange at which forward transactions are to be
honoured.
 Foreign Exchange Rate:
• Exchange rate is the rate at which one currency
can be exchanged for another-usually expressed
as the value of the one in terms of the other. Or,
• Foreign exchange rate refers to the rate at which
one unit of currency of a country can be
exchanged for the number of units of currency of
another country. In other words, it is the price
paid in domestic currency in order to get one unit
of foreign currency. Example,
• $1=Rs 50 or Re 1=1/50 Dollar= 2 cents.
• Thus, exchange rate expresses the ratio of
exchange between the currencies of two
countries.
• It is the price of a currency expressed in terms of
another currency.
• Some economists refer to it as the external value
of the currency.
• In the words of Crowther, “The exchange rate
measures the number of units of one currency
which is exchanged in the foreign market for one
unit of another.”