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Role of Foreign Exchange Market in India

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  • Last Updated : 24 Nov, 2021

The foreign exchange market is a financial institution that facilitates the exchange of one country’s currency for that of another. Foreign exchange markets are the oldest and most traditional financial marketplaces. It is a worldwide over-the-counter (OTC) marketplace that decides currency exchange rates all around the world. Banks, dealers, commercial companies, investment management firms, and hedge funds make up the foreign exchange markets. In all major financial centers, all major currencies are exchanged. The currency market is open five days a week, 24 hours a day. In the forex market, currency trading entails the simultaneous buying and selling of two currencies. In this method, the value of one currency (base currency) is determined by comparing it to another currency (counter currency). The foreign exchange rate is the price at which one currency may be exchanged for another currency. The forex market has no physical address. It is an electronically linked network. In a simple definition, the exchange rate is the value at which one currency is exchanged for another or the worth of one currency in terms of another economic zone or currency.

In financial centers, the foreign exchange market is just a subset of the money market. It is a location where foreign currencies are purchased and traded. A foreign exchange market is made up of buyers and sellers of foreign currency claims, as well as middlemen. In the foreign exchange market, there are many different types of traders. Banks are the most significant among them. Banks that deal in foreign exchange have branches in several countries with significant balances. The services of such institutions commonly referred to as “Exchange Banks,” are available all over the world through their branches and correspondents. These financial institutions discount and sell foreign bills of exchange, issue bank draughts, conduct telegraphic transfers and other credit transactions, and discount and collect payments based on such papers.

Foreign Exchange Dealers Association of India (FEDAI) was established in 1958 and incorporated under Section 25 of The Companies Act of 1956, it is an association of Banks that deal with Indian foreign exchange markets.

The Main Functions of Foreign Exchange Market:

1. The function of Transfer:

The primary purpose of the foreign exchange market is to make it easier to convert one currency into another or to make buying power transfers between nations. A number of credit instruments, such as telegraphic transfers, bank draughts, and foreign bills, are used to transmit purchasing power. The foreign exchange market performs the transfer function by making international payments by clearing debts in both directions at the same time, similar to domestic clearings. 

For example, if an Indian exporter imports products from the United States and the payment is to be paid in dollars, FOREX will simplify the conversion of the rupee to the dollar. Credit instruments such as bank draughts, foreign exchange bills, and telephone transfers are used to carry out the transfer function.

2. The function of Credit:

Another important role of the foreign exchange market is to facilitate international trade by providing credit, both domestic and international. When foreign bills of exchange are used in overseas payments, a credit of around three months is necessary before they mature. The FOREX provides importers with short-term loans in order to promote the flow of goods and services between countries. The importer can fund international imports with his own credit.

3. Hedging Function:

Hedging foreign exchange risks is a third function of the foreign exchange market. Hedging is the process of avoiding foreign currency risk. When the exchange rate, or the price of one currency in terms of another currency, changes in a free exchange market, the party involved may earn or lose money. If there are large amounts of net claims or net liabilities that must be satisfied in foreign currency, a person or a company takes on a significant exchange risk. 

As a whole, exchange risk should be avoided or minimized. For this, the exchange market offers forward contracts in exchange as a means of hedging potential or present claims or liabilities. A three-month forward contract is a contract to purchase or sell foreign exchange against another currency at a price agreed upon today for a defined period in the future. At the moment of the deal, no money is exchanged. However, the contract allows you to ignore any potential changes in the currency rate. As a result of the presence of a forward market, an exchange position can be hedged.

Some of the benefits of the Foreign Exchange Market:

  • Flexibility: The forex market offers traders a great deal of freedom. This is due to the fact that the quantity of money that may be traded is unlimited. Moreover, market regulation is essentially non-existent.
  • Transparency: The Forex market is enormous in size and spans many time zones. Despite this, information about the Forex market is freely available. Additionally, neither government nor the central bank has the authority to corner the market or set prices for an extended period of time. Because of the Temporal lag in transferring information, some entities may get short-term benefits. The magnitude of the Forex market makes it fair and efficient!
  • Options Trading: Traders can choose from a wide range of trading alternatives on the forex markets. Traders have lots of different currency pairs to select from. Investors can also choose between spot trading and signing a long-term contract. As a consequence, the Forex market has a remedy for any budgetary and investor’s risk appetite.

Conclusion:

There are various dealers in the foreign currency markets, with banks being the most dominant. Foreign exchange is facilitated by Exchange Banks, which have branches in a variety of nations. The foreign exchange market is a worldwide market where different countries’ currencies are exchanged. It is decentralized in the sense that it is not under the jurisdiction of a single authority, such as an international agency or a government. Governments (typically through their central banks) and commercial banks are the main players in this market. The act of transferring one currency into another is known as foreign exchange. The exchange rate is the rate agreed upon by the two parties in the transaction, which might fluctuate substantially, resulting in foreign currency risk.

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