Foreign Exchange Market

 The Foreign Exchange Market is a market where the

buyers and sellers are involved in the sale and
purchase of foreign currencies. In other words, a
market where the currencies of different countries are
bought and sold is called a foreign exchange market.
 The structure of the foreign exchange market
constitutes central banks, commercial banks, brokers,
exporters and importers, immigrants, investors,
tourists.

By Annu Kumari, Assistant Professor, LPU

Structure of Foreign Exchange
Market

By Annu Kumari, Assistant Professor, LPU

Structure of Foreign Exchange
Market
 At the bottom of a pyramid are the actual buyers and
sellers of the foreign currencies- exporters, importers,
tourist, investors, and immigrants. They are actual users of
the currencies and approach commercial banks to buy it.
 The commercial banks play a role of “market makers”, as
they quote on a daily basis the foreign exchange rates for
buying and selling of the foreign currencies. Also, they
function as clearing houses, thereby helping in wiping out
the difference between the demand for and the supply of
currencies. These banks buy the currencies from
the brokers and sell it to the buyers.

By Annu Kumari, Assistant Professor, LPU

Structure of Foreign Exchange
Market
 Foreign exchange brokers function as a link between the
central bank and the commercial banks and also between
the actual buyers and commercial banks. These are the
persons who do not themselves buy the foreign currency,
but rather strike a deal between the buyer and the seller on
a commission basis.
 The central bank has the power to regulate and control the
foreign exchange market so as to assure that it works in the
orderly fashion. One of the major functions of the central
bank is to prevent the aggressive fluctuations in the foreign
exchange market, if necessary, by direct intervention.
Intervention in the form of selling the currency when it is
overvalued and buying it when it tends to be undervalued.

By Annu Kumari, Assistant Professor, LPU

Types of Forex Market

By Annu Kumari, Assistant Professor, LPU

Types of Forex Market
 Spot Market: A spot market is the immediate delivery
market, representing that segment of the foreign
exchange market wherein the transactions (sale and
purchase) of currency are settled within two days of
the deal. That is, when the seller and buyer close their
deal for currency within two days of the deal, is called
as Spot Transaction.
 Thus, a spot market constitutes the spot sale and
purchase of foreign exchange. The rate at which the
transaction is settled is called a Spot Exchange Rate.
It is the prevailing exchange rate in the market.

By Annu Kumari, Assistant Professor, LPU

Types of Forex Market
 Forward Market: The forward exchange market refers to the
transactions – sale and purchase of foreign exchange at some
specified date in the future, usually after 90 days of the deal.
That is, when the buyer and seller enter into a contract for the
sale and purchase of foreign currency after 90 days of the deal at
a fixed exchange rate agreed upon now, is called a Forward
Transaction.
 Thus, the forward market constitutes the forward transactions in
foreign exchange. The exchange rate at which the buyers or
sellers settle the transactions in the forward market is called
a Forward Exchange Rate.
 Thus, the spot and forward markets are the important kinds of
foreign exchange market that often helps in stabilizing the
foreign exchange rate.

By Annu Kumari, Assistant Professor, LPU

Functions of Forex Market

By Annu Kumari, Assistant Professor, LPU

Functions of Forex Market
 Transfer Function: It basically includes
the conversion of one currency to
another, wherein the role of FOREX is to transfer
the purchasing power from one country to another.
 For example, If the exporter of India import
goods from the USA and the payment is to be
made in dollars, then the conversion of the rupee
to the dollar will be facilitated by FOREX. The
transfer function is performed through a use of
credit instruments, such as bank drafts, bills of
foreign exchange, and telephone transfers.
By Annu Kumari, Assistant Professor, LPU
Functions of Forex Market
 Credit Function: FOREX provides a short-term
credit to the importers so as to facilitate the smooth
flow of goods and services from country to country. An
importer can use credit to finance the foreign
purchases.
 Such as an Indian company wants to purchase the
machinery from the USA, can pay for the purchase by
issuing a bill of exchange in the foreign exchange
market, essentially with a three-month maturity.

By Annu Kumari, Assistant Professor, LPU

Functions of Forex Market
 Hedging Function: The change in the exchange rate
may result in a gain or loss to the party concerned.
Thus, due to this reason the FOREX provides the
services for hedging the anticipated or actual
claims/liabilities in exchange for the forward
contracts.
 A forward contract is usually a three month contract to
buy or sell the foreign exchange for another currency
at a fixed date in the future at a price agreed upon
today. Thus, no money is exchanged at the time of the
contract.

By Annu Kumari, Assistant Professor, LPU

Types of Forex Transactions

By Annu Kumari, Assistant Professor, LPU

Types of Forex Transactions
 Spot Transaction: The spot transaction is when the buyer
and seller of different currencies settle their payments
within the two days of the deal. It is the fastest way to
exchange the currencies. Here, the currencies are
exchanged over a two-day period, which means no
contract is signed between the countries.
 The exchange rate at which the currencies are exchanged is
called the Spot Exchange Rate. This rate is often the
prevailing exchange rate. The market in which the spot sale
and purchase of currencies is facilitated is called as a Spot
Market.

By Annu Kumari, Assistant Professor, LPU

Types of Forex Transactions
 Forward Transaction: A forward transaction is a
future transaction where the buyer and seller enter
into an agreement of sale and purchase of
currency after 90 days of the deal at a fixed exchange
rate on a definite date in the future.
 The rate at which the currency is exchanged is called
a Forward Exchange Rate. The market in which the
deals for the sale and purchase of currency at some
future date is made is called a Forward Market.

By Annu Kumari, Assistant Professor, LPU

Types of Forex Transactions
 Future Transaction: The future transactions are also the forward
transactions and deals with the contracts in the same manner as
that of normal forward transactions.
 The forward contracts can be customized on the client’s request,
while the future contracts are standardized such as the features,
date, and the size of the contracts is standardized.
 The future contracts can only be traded on the organized
exchanges, while the forward contracts can be traded anywhere
depending on the client’s convenience.
 No margin is required in case of the forward contracts, while
the margins are required of all the participants and an initial
margin is kept as collateral so as to establish the future position.

By Annu Kumari, Assistant Professor, LPU

Types of Forex Transactions
 Swap Transactions: The Swap Transactions involve
a simultaneous borrowing and lending of two
different currencies between two investors.
 Here one investor borrows the currency and lends
another currency to the second investor. The
obligation to repay the currencies is used as collateral,
and the amount is repaid at a forward rate.
 The swap contracts allow the investors to utilize the
funds in the currency held by him/her to pay off the
obligations denominated in a different currency
without suffering a foreign exchange risk.

By Annu Kumari, Assistant Professor, LPU

Types of Forex Transactions
 Option Transactions: The foreign exchange option gives
an investor the right, but not the obligation to exchange
the currency in one denomination to another at an agreed
exchange rate on a pre-defined date.
 An option to buy the currency is called as a Call Option,
while the option to sell the currency is called as a Put
Option.
 Thus, the Foreign exchange transaction involves the
conversion of a currency of one country into the currency
of another country for the settlement of payments.

By Annu Kumari, Assistant Professor, LPU

 Commercial Banks are the ___________ in the foreign
exchange market.
a) Market maker
b) Regulator
c) Speculator
d) None of these

By Annu Kumari, Assistant Professor, LPU

 At the bottom of a pyramid are ______________
tourist, investors, and immigrants.
a) exporters, importers,
b) Commercial banks
c) Central Banks
d) Brokers

By Annu Kumari, Assistant Professor, LPU

 The foreign exchange option gives an investor
the _______, but not the obligation to exchange the
currency.
a) Compulsion
b) Right
c) Imposed
d) None of these

By Annu Kumari, Assistant Professor, LPU

 The forward contracts can be ___________ on the
client’s request, while the future contracts
are_____________.
a) Customized, standardized
b) Standardized, Customized
c) Customized, Marginalized
d) None of these.

By Annu Kumari, Assistant Professor, LPU