FOREIGN EXCHANGE MARKET And DETERMINATION OF EXCHANGE RATE

By:Rahul Yadav

Introduction
According to Kindlebereger

The foreign exchange market is place where foreign moneys are bought and sold. Foreign exchange market is an institutional arrangement for buying and selling of foreign currencies. Exporters sell the foreign currencies. Importers buy them. The foreign exchange market is merely a part of the money Market in the financial centres. It is a place where foreign moneys are bought and sold. The buyers and sellers of claim on foreign money and the intermediaries together constitute a foreign exchange market.

Functions of Foreign Exchange Market

1. Transfer Function 2. Credit Function 3. Hedging Function

Participants In Foreign Exchange Market

1. Central Banks
2. Commercial Companies 3. Investment Management Firms 4. Retail Foreign Exchange Brokers

Types of Transactions
Settlement of a transaction takes place by transfer to deposits between the two parties. The day on which these transfers are affected is called the settlement date or the value date. Obviously, to affect the transfers, bank in the countries of two currencies involved, must be open for business. The relevant countries are called settlement locations, which need not be the same as settlement locations. Thus a London bank can sell Swiss franc against US dollar to a Paris bank. Settlement location may be New York and Geneva, while dealing location are London and Paris. The transaction can be settled only on a day on which both the US and Swiss banks are open. Depending upon the time elapsed between the transaction date and the settlement date, foreign exchange transactions can be categorized into spot and forward transaction. A third category called swaps is a combination of a spot and forward transaction.

Rate of Exchange
Rate of Exchange between any two currencies is the rate at which they are exchanged or sold against each other. Transactions in the exchange market are carried out at what are termed at exchange rates. An exchange rate is the price of currency. It i the number of units of one currency that buys one unit of another currency, and this number can change daily. The rate at which the currencies of two nations are exchanged for each other is called the rate of exchange. For example, if 1 US dollar is exchanged for Rs. 10 then foreign exchange rate is 1 U.S. $ = Rs. 10. In other words the rate of exchange is nothing but the value or price of a countrys currency expressed in terms of a foreign currency.

Exchange Rate Quotations and Arbitrage

The foreign exchange market includes both the spot and forward exchange rates. The spot rate is the rate paid for delivery within two business days after the day the transaction takes place. If the rate is quoted for delivery of foreign currency at some future date, it is called the forward rate. In the forward rate, the exchange rate is established at the time of the contract, though payment and delivery are not required until maturity. Forward rates are usually quoted for fixed periods of 30, 66, 90 or 180 days from the day of the contract.

Major Foreign Exchange Instruments

I. Spot market II. Forward market III. Currency Options IV. Currency Futures