Foreign

Exchange
Market

Sampiano, Carmela Anne C.

BSA 2-1

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 Participants
1) 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 Market
1. Transfer
2. Credit
3. 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 Function
It 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 Function
When 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

Market
1. Retail
2. 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 Rate
1. Spot
2. Forward

1. Spot Market (Current Market)

Market which handles only spot transaction or
current transaction
Characteristics:
daily in nature, does not trade in future
deliveries
Spot 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 transaction
Determines forward exchange rate at which
forward transaction are to be honored