The Significance of Foreign Exchange Market

Narendra Kumar

06 Apr, 2021

The Significance of Foreign Exchange Market

The main significance of foreign exchange market is to get the best market value of a business.

Foreign Exchange Market is a type of financial institution which performs following functions:

• Liquidation of international currencies;
• For certain currency determines exchange rates;
• For international trades and reserves, sets auctions.

For the purpose of monitoring the stock market in India, usually, corporate hire brokers. Where financial brokers assist companies to maintain the market status of their investment.

What is Foreign Exchange Market?

Foreign exchange determines the value of foreign investment. Foreign exchange markets is mainly concerned with buying and selling of different currencies. Under this market, the currency of one country is exchanged with the currency of another country. Foreign exchange is also done in the market with a view to managing risk (hedging), arbitrage and speculative gain. This type of market provides international liquidity with relative stability.

Foreign Exchange Markets helps in determining the value of foreign savings. It is a marketplace where the foreign money is bought and sold and we can also say it is a type of institutional arrangement where the foreign currencies are bought and sold. Under this, importers buy the foreign currency which is sold by the exporters.

In financial centers, this type of market merely forms a part of money market where the foreign money is bought and sold. Foreign exchange market is not restricted to any geographical area. It is a market for foreign currencies.

In foreign exchange markets, there are a wide variety of dealers such as banks. Banks which deal in foreign exchange have their branches in different countries. These are also called as “Exchange Banks” from where the services are available in all over the world.

Here are the following duties which are performed by such banks:

• Discount and sell foreign bills of exchange;
• Issuance of bank drafts;
• Effect of telegraphic transfers and credit instruments;
• Collection of the amount on the basis of such documents.

In foreign exchange, there are bill brokers in the foreign bill which assist buyers and sellers. Banks are not the direct dealers as there are intermediaries.

In foreign exchange, there are acceptance house dealers who help in foreign remittances by accepting bills on the behalf of the customers. In foreign exchange, central bank and treasury of a country are also dealers who may intervene in the market. Exchange rates are managed by these authorities. In various ways, exchange controls are implemented by these authorities. In India, there is no such exchange market. Strict exchange control system exists in India.

What are the Important Instruments in Foreign Exchange Market?

• Foreign bills of exchange;
• Telegraphic transfer;
• Letter of Credit;
• Bank Draft.

What are the Important functions of Foreign Exchange Market?

Here are some other important functions of foreign exchange market:

1. Transfer Function

This function is to transfer finance and purchasing power from one country to another country. Through foreign bills^[1] or remittances which were made through telegraphic transfer, such type of transfer gets affected.

Mainly below-mentioned functions are performed by foreign exchange market:

• For the purpose of accomplishing transfers of purchasing power between two countries, facilitate the conversion of one currency into another;
• Through various credit instruments transfer purchasing power gets affected such as telegraphic transfers, bank draft, and foreign bills.
• For clearing debts, foreign exchange markets carries out international payments.

2. Credit Function

This function is to issue credit for the purpose of international trade.

• To promote foreign trade, the foreign exchange provides credit both nationally and internationally.

3. Hedging Function

This function is for hedging facilities such as; facilitate buying and selling spot or forward foreign exchange. Hedging refers to the “foreign exchange risk avoidance” as in foreign exchange market there might be gain or loss to the party because of change in the price of one currency in terms of another currency. In case of huge amount of net claims or net liabilities in foreign exchange then a person or a firm as the case may undertake a high exchange risk.

Such exchange risk should be reduced. In exchange, through forwarding contracts, foreign exchange market provides such facilities for anticipated hedging. A forward contract is a type of contract related to buying or selling foreign exchange against another currency in future at the fixed date on the agreed price. This type of contract makes it possible to avoid changes in exchange rate. This forward market helps in hedging exchange position.

For more information about foreign exchange regulations visit us at Enterslice.