Foreign exchange market

The foreign exchange market where the currency of one country is exchanged for the currency of another country. Most currency transactions are channelled through the world wide. Interbank market is the whole sale market in which major banks trade with each other.

Forex market is a world wide market of an informed network of telephone, taler,satellite facsimile and computer, communication as between the forex market participants.

Which include banks, foreign exchange, dealers , arbitrageurs and speculators. The foreign market operates are guided by different motives when they deal in the foreign exchange market.

Understanding of forex market

The foreign exchange markets in view of their critical role in overall growth and development of the economy. Particular in the transmission mechanism of  monetary policy.

The pace of reforms was contingent upon putting in place appropriate system and procedures, technologies and market practice. Initiatives taken by the Reserve bank have brought about a significant transformation of various segment of the financial markets. These developments by improving the depth and liquidity in domestic financial markets. Its contributed to better price discovery of interest rates and exchange rates.

The increase in size and depth and liquidity and freedom to market participants have also strengthened the integration of various segments of the financial market.

Increased integration not only leads to more efficient dispersal of risks across the spectrum but also increases the efficacy of monetary policy impulses.

Financial market reforms in India have enabled a greater integration of various segments of the financial market, reducing arbitrage opportunities, achieving higher level of efficiency of monetary policy in the economy.

Integration of the foreign exchange market

The degree of integration of the foreign exchange market with other markets is largely determined the degree of openness.

In the Indian context the forward price of the rupee is not essentially determined by the interest rate differentials but is also significantly influence by

a) Supply and demand of forward US dollars

b)Interest differentials and expectation of future interest rates.

C) Expectations of future us-dollar rupee exchange rate.

Participants of foreign exchange market

1)Arbitrageurs- Arbitrageurs seek to earn risk less profit by taking advantage of differences in exchange rates among countries.

2)Traders- Traders engage in the export or import of goods to a number of countries. They operate in the foreign exchange market because exporters receive foreign currencies which they have to convert into local currencies .They purchase by exchanging the local currency. They also operate in the foreign exchange market to hedge their risk.

3)Hedgers- Multinational firms have their operation in a number of countries and their assets and liabilities are designed in foreign currencies. The foreign exchange rates fluctuations can cause diminution in the home currency value of their assets and liabilities.

They operate in the foreign exchange market as hedges to protect themselves against the risk of fluctuation in the foreign exchange rates.

4)Speculators- Speculators are guided purely by the profit motive.They trade in foreign currencies to benefit from the exchange rate fluctuations. They take risks in the hope of making profits.

Foreign exchange rates

A foreign exchange rate of two currencies ,we can find the exchange rate for the third currency.

1) Cross rate -Cross rate is an exchange rate between the currencies of two countries that not quoted against each other.

Currencies of many countries are not truly traded in the forex market. Therefore all currencies are not quoted against each other . Most currencies are quoted against the US dollar. The cross rates of currencies that are not quoted against each other can be quoted in terms of the US dollar.

2) Spot exchange rate- The spot exchange rate is the rate at which a currency can be bought a sold for immediately delivery. Delivery can be within two business days after the day of the trade. In the spot market, currencies are traded for immediate delivery within two days. Financial news papers generally provide information an exchange rates.

3) Bid-ask spread- The foreign exchange dealers are always ready to buy or sell foreign currencies.  The quotations are given as a bid-ask price.

The difference between the buying(bid) and selling(ask) rates is the forex operator’s,(say,bank) spread.

Bid ask spread is the difference between the bid and ask rates of a currency.It is based on the breadth and depth of the market for that currency and its volatility. This spread is a cost transaction in the foreign exchange market.It is computed as a given below.

Spread =\frac{Ask price-Bid price}{Ask price}

4)Forward exchange rates- The forward exchange rate is the rate that is currency paid for the directory of a currency some future. In the forward market currencies are traded for the future delivery. In terms of the volume of currency transaction. The spot exchange market is much larger than the forward exchange market.

Forward rates (30 day,90 day or 180 day forward rates) for a few currencies are quoted in forex market. Most banks will however,quote currency forward rates to the traders.

 

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