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Global investors choose to diversify their funds across the financial markets to reduce the portfolio risk on the assumption that the returns in various financial markets may not be highly correlated. Another related issue is how far the return in one market will enable to predict the return in the other financial market. From the informational efficiency criteria, any past information even if that information may be pertaining to the return in one financial market, it should not enable to predict the future changes in the return in the other financial market. But at the same time, from the rational expectation point of view, all the informations including the returns from any other financial markets should be factored into the return of the financial markets. For example, how far the return in the stock market influences the return in the foreign exchange market and vice versa. In finance, financial markets facilitate:
The raising of capital (in the capital markets) The transfer of risk (in the derivatives markets) The transfer of liquidity (in the money markets) International trade (in the currency markets)
The origin of the foreign exchange market in India could be traced to the year 1978 when banks in India were permitted to undertake intra-day trade in foreign exchange. However, it was in the 1990s that the Indian foreign exchange market witnessed far reaching changes along with the shifts in the currency regime in India. The exchange rate of the rupee, that was pegged earlier was floated partially in March 1992 and fully in March 1993 following the recommendations of the Report of the High Level Committee on Balance of Payments (Chairman: Dr.C.Rangarajan). The unification of the exchange rate was instrumental in developing a market-determined exchange rate of the rupee and an important step in the progress towards current account convertibility, which was achieved in August 1994. Foreign exchange market is a market in which national currency are bought and sold againsts one another. It is the largest market in world with its daily trading volume exceeding almost 200 billions. The foreign exchange market (forex, FX, or currency market) is a global, worldwidedecentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies. The foreign exchange market assists international trade and investment, by enabling currency conversion. For example, it permits a business in the United States to import goods from the United Kingdom and pay pound sterling, even though its income is in United States dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation on the change in interest rates in two currencies. The modern foreign exchange market began forming during the 1970s after three decades of government restrictions on foreign exchange transactions (the Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states after World War II), when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.
MARKET PARTICIPANTS
The participants in foreign exchange market work in the pyramid shaped structure as below:
Commercial Banks
Banks Commercial companies Central banks Foreign exchange fixing Hedge funds as speculators Investment management firms Non-bank foreign exchange companies
parity, Domestic Fisher effect, International Fisher effect. Though to some extent the above theories provide logical explanation for the fluctuations in exchange rates, yet these theories falter as they are based on challengeable assumptions [e.g., free flow of goods, services and capital] which seldom hold true in the real world. 2. Balance of payments model: This model, however, focuses largely on tradable goods and services, ignoring the increasing role of global capital flows. It failed to provide any explanation for continuous appreciation of dollar during 1980s and most part of 1990s in face of soaring US current account deficit. 3. Asset market model: views currencies as an important asset class for constructing investment portfolios. Assets prices are influenced mostly by people's willingness to hold the existing quantities of assets, which in turn depends on their expectations on the future worth of these assets. The asset market model of exchange rate determination states that the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies.
CONCLUSION:Thus we can conclude that foreign exchange market is termed as the international exchange and it is mainly regulated by the central bank of the country. The foreign exchange market is highly volatile as it depends on many factors and different news and policies of different countries. The various factors can be wars, any financial decision made by superpower country like America, or may be due to any tie ups between two countries, etc. As world has become a village and each and every country depends on one another for one or the other things, foreign exchange markets are now very much into news. Indiviuals also trade on foreign currencies and earn a lot nowadays. But this type of trading is highly risky as even a single paise here and there can take an individual towards profit or loss. Moreover trading in foreign exchange needs more capital. But still it is an upcoming and earning field.