Sampiano, Carmela Anne C.BSA 2-1

Foreign Exchang

e Market

What is foreign exchange market?

The foreign exchange market provides the physical and institutional structure through which the money of one country is exchanged for that of another country, the rate of exchange between currencies is determined, and foreign exchange transactions are physically completed

History of ForEx Market

Gold Standard System (1875) - currency would be backed by gold

Bretton Woods System - a method fixed exchange rate; U.S. dollar replaced gold as the main standard of convertibility for the world's currencies

Market Participants1) Governments and Central Banks – try to control the

money supply, inflation and/or interest rates

2) Banks and Other Financial Institutions - act as dealers in the sense that they are willing to buy/sell a currency at the bid/ask price.

3) Hedgers - to lock in a specific exchange rate for the future or to remove all sources of exchange-rate risk for that transaction.

4) Speculators – attempt to make money by taking advantage of fluctuating exchange-rate levels.

Functions of Foreign Exchange Market1. Transfer2. Credit3. Hedging

1. Transfer Function

It transfers purchasing power between the countries involved in the transaction. This function is performed through credit instruments like bills of foreign exchange, bank drafts and telephonic transfers.

2. Credit FunctionIt provides credit for foreign trade.

Bills of exchange, with maturity period of three months, are generally used for international payments. Credit is required for this period in order to enable the importer to take possession of goods, sell them and obtain money to pay off the bill.

3. Hedging FunctionWhen exporters and importers enter

into an agreement to sell and buy goods on some future date at the current prices and exchange rate, it is called hedging. The purpose of hedging is to avoid losses that might be caused due to exchange rate variations in the future.

Types of Foreign Exchange Market1. Retail2. Wholesale

1. Retail Market

The retail market is a secondary price maker. Here travelers, tourists and people who are in need of foreign exchange for permitted small transactions, exchange one currency for another.

2. Wholesale Market

The wholesale market is also called interbank market. The size of transactions in this market is very large. Dealers are highly professionals and are primary price makers. The main participants are Commercial banks, Business corporations and Central banks. Multinational banks are mainly responsible for determining exchange rate.

Operations of Foreign Exchange Rate1. Spot2. Forward

1. Spot Market (Current Market)•Market which handles only spot

transaction or current transaction

Characteristics: daily in nature, does not trade in future

deliveriesSpot Exchange Rate happens to prevail at

the time when transactions are incurred.

2. Forward Market

•Market which handles such transaction of foreign exchange as are meant for future delivery

Characteristics:Caters to forward transactionDetermines forward exchange rate at

which forward transaction are to be honored