Foreign Exchange Market is an inter-bank market that took shape in 1971.

This is a set of transactions among forex market agents involving exchange of currency. The exchange rate of one currency to another currency is determined simply: by supply and demand.

As in the rest of the world, in India too, foreign exchange constitutes the largest financial market by far.
Another essential feature of the FOREX market, is its STABILITY.

BANKS: Inter banks market is at the top in forex trading. Inter-bank market accounts 53% of total transaction of the forex. COMMERCIAL COMPANIES Commercial companies play an important role in the forex market. They do participate in forex trading. CENTRAL BANK The central bank RBI (India) plays an important role in the forex market.

HEDGERS SPECULATORS

Another class of market participants involved with foreign exchange-related transactions is speculators .

IMPORTERS Who may need to purchase their suppliers domestic currency to pay for the goods he has supplied. EXPORTERS Who may be paid a foreign currency by an overseas purchaser, and who need to convert it into his or her own currency. TOURISTS Who often purchase foreign currency, travelers cheques and bank notes, prior to visiting an overseas country.

Liquidity: The market operates the enormous money supply and gives absolute freedom in opening or closing a position in the current market quotation. .
Promptness: With a 24-hour work schedule, participants in the FOREX market need not wait to respond to any given event, as is the case in many markets. Availability: A possibility to trade round-the-clock; a market participant need not wait to respond to any given event.

Value: The Forex market has traditionally incurred no service charges, except for the natural bid/ask market spread.

Foreign exchange risk is the risk that the exchange rate will change unfavorably before the currency is exchanged. Foreign exchange risk is linked to unexpected fluctuations in the value of currencies.
Exposure is defined as a contracted, projected or contingent cash flow whose magnitude is not certain at the moment and depends on the value of the foreign exchange rates. There are mainly three types of foreign exchange exposures: Translation exposure Transaction exposure Economic Exposure

 Translation

Exposure

It is the degree to which a firms foreign currency denominated financial statements is affected by exchange rate changes. If a firm has subsidiaries in many countries, the fluctuations in exchange rate will make the assets valuation different in different periods The changes in asset valuation due to fluctuations in exchange rate will affect the groups asset, capital structure ratios, profitability ratios, solvency ratios. Translation exposure = (Exposed assets - Exposed liabilities)*(change in the exchange rate)

Transaction

exposure

This exposure refers to the extent to which the future value of firms domestic cash flow is affected by exchange rate fluctuations. The degree of transaction exposure depends on the extent to which a firms transactions are in foreign currency

 Economic

Exposure

Economic exposure refers to the degree to which a firms present value of future cash flows can be influenced by exchange rate fluctuations. Economic exposure to an exchange rate is the risk that a variation in the rate will affect the companys competitive position in the market and hence its profits. OTHER RISKS : Country Risk Exposure to potential loss or adverse effects on company operations and profitability caused by developments in a countrys political or legal environments.

Cross Cultural Risk

A situation or event where cultural miscommunication puts some human value at stake.

Commercial Risks

Exposure to market preferences and sentiments. This relates to establishing credibility and taking much more trouble to settle down than the home- grown company Currency Risk Change in foreign exchange rates may result in huge amount of losses for an MNC. Thus this is again a risk, which needs to be tackled

Once a firm recognizes its exposure then it has to deploy resources in managing it.
Forecasts: After determining its exposure, the first step for a firm is to develop a forecast on the market trends the main direction/trend is going to be on the foreign exchange rate typically for 6 months. Risk Estimation: Based on the forecast, a measure of the Value at Risk and the probability of this risk should be ascertained. Benchmarking: Given the exposures and the risk estimates, the firm has to set its limits for handling foreign exchange exposure on a cost centre or profit centre basis. Hedging: Based on the limits a firm set for itself to manage exposure, the firms then decides an appropriate hedging strategy.

Stop Loss: The firms risk management decisions are based on forecasts of reasonably unpredictable trends. It is imperative to have stop loss arrangements in order to rescue the firm if the forecasts turn out wrong Reporting and Review: Risk management policies are typically subjected to review based on periodic reporting.

A derivative is a financial contract whose value is derived from the value of some other financial asset, such as a stock price, a commodity price, an exchange rate, an interest rate, or even an index of prices. The instrumrents used are : Forwards Futures Options Swaps Foreign Debt

 Foreign

exchange market plays a vital role in integrating the global economy. It is a 24 hour in over the counter market made up of many different types of players. With the LPG initiated in India, Indian Forex Market have been reasonably liberated to play there efficiently. Derivative instrument are very useful in managing these risks.