Unit-2: Foreign

Exchange Market
DR. ETI KHATRI
Definition :Foreign Exchange Market
Foreign Exchange Market is the market where the buyers
and sellers are involved in the buying and selling of foreign
currencies. Simply, the market in which the currencies of
different countries are bought and sold is called as a foreign
exchange market.
The foreign exchange market is commonly known as FOREX,
a worldwide network, that enables the exchanges around
the globe.
FOREIGN EXCHANGE MARKET
Foreign Exchange Market is the market in which foreign currencies are bought and sold.
The buyers and sellers include individuals, firms, foreign exchange brokers, commercial banks
and the central bank.
 Largest market in the world.
 Market with no central trading location and no set hours of trading.
Prices and other terms of trade are determined by computerized negotiations.
Structure of Forex Market
Functions of Forex Market
Transfer Function:
The basic and the most visible function of foreign
exchange market is the transfer of funds (foreign currency)
from one country to another for the settlement of
payments.
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.
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.
Hedging Function:
The third function of a foreign exchange market is
to hedge foreign exchange risks.
The parties to the foreign exchange are often afraid of the
fluctuations in the exchange rates, i.e., the price of one
currency in terms of another.
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.
Foreign Exchange Market Participants
1. Commercial and Investment Banks
2. Central Banks
3. Businesses and Corporations
4. Fund Managers, Hedge Funds, and Sovereign Wealth Funds
5. Internet-based Trading Platforms
6. Online Retail Broker-Dealers
FOREIGN EXCHANGE
Foreign Exchange refers to the mechanism of the ways and means by which
payment in connection with International Trade are effected.
Foreign exchange refers to all currencies other than the domestic currency of
a given country.
For example- India’s domestic currency is Indian Rupee and all other
currencies like US dollar, British Pound etc are foreign exchange.
The rate of exchange is the price of one currency expressed in terms of
another currency, it is the reflection of the external value of the domestic
currency.
It should also be noted here that exchange rate is not always constant, it goes
on changing from time to time o account of change in demand for and supply
of foreign currency.
FACTORS INFLUENCING EXCHANGE
RATES
1. Differentials in Inflation.
2. Differentials in Interest Rates.
3. Public Debt.
4. Terms Of Trade.
5. Political Stability And Economic Performance.
Exchange Rate Determination in SPOT
Markets
Questions
Exchange Rate Determination in
FORWARD Markets
Society for Worldwide Interbank
Financial Telecommunications (SWIFT)
Society for Worldwide Interbank Financial Telecommunications
(SWIFT) is member-owned cooperative that provides safe and secure
financial transactions for its members.
This payments network allows individuals and businesses to take
electronic or card payments even if the customer or vendor uses a
different bank that the payee.
SWIFT works by assigning each member institution a unique ID code
that identifies not only the bank name but country, city , branch.
Who Uses SWIFT?
Banks
Brokerage Institutes and Trading Houses
Securities Dealers
Asset Management Companies
Clearing Houses
Depositories
Exchanges
Corporate Business Houses
Treasury Market Participants and Service Providers
Foreign Exchange and Money Brokers
Services Offered by SWIFT
Applications
Business Intelligence
Compliance Services
Messaging, Connectivity, and Software Solutions
Mechanism of SWIFT
Assume a customer of a Bank of America branch in New York wants to send money to his friend
who banks at the UniCredit Banca branch in Venice. The New York customer can walk into his
Bank of America branch with his friend’s account number and UnicaCredit Banca’s unique SWIFT
code for its Venice branch. Bank of America will send a payment transfer SWIFT message to the
UniCredit Banca branch over the secure SWIFT network. Once Unicredit Banca receives the
SWIFT message about the incoming payment, it will clear and credit the money to the Italian
friend’s account.

As powerful as SWIFT is, keep in mind that it is only a messaging system – SWIFT does not hold
any funds or securities, nor does it manage client accounts.
The balance of payments (BOP)
The balance of payments (BOP) is the record of all international
financial transactions made by the residents of a country.
There are three main categories of BOP: the current account, the
capital account, and the financial account.
The current account should be balanced versus the combined
capital and financial accounts, leaving the BOP at zero, but this rarely
occurs
The Balance of Payments Divided
The BOP is divided into three main categories:
 the current account
the capital account
the financial account
The Current Account
The current account is used to mark the inflow and outflow of goods and
services into a country. Earnings on investments, both public and private, are
also put into the current account.
Within the current account are credits and debits on the trade of merchandise,
which includes goods such as raw materials and manufactured goods that are
bought, sold, or given away (possibly in the form of aid).
 Services refer to receipts from tourism, transportation (like the levy that must
be paid in Egypt when a ship passes through the Suez Canal), engineering,
business service fees (from lawyers or management consulting, for example),
and royalties from patents and copyrights. When combined, goods and services
together make up a country's balance of trade (BOT).
The Capital Account
The capital account is where all international capital
transfers are recorded.
 This refers to the acquisition or disposal of non-financial
assets (for example, a physical asset such as land) and non-
produced assets, which are needed for production but have
not been produced, like a mine used for the extraction of
diamonds.
The Financial Account
In the financial account, international monetary flows related to investment in business, real
estate, bonds, and stocks are documented.
Also included are government-owned assets such as foreign reserves, gold, special drawing
rights (SDRs) held with the International Monetary Fund (IMF), private assets held abroad, and
direct foreign investment.
 Assets owned by foreigners, private and official, are also recorded in the financial account.
The capital account is broken down into the monetary flows
branching from debt forgiveness, the transfer of goods, and
financial assets by migrants leaving or entering a country,
the transfer of ownership on fixed assets (assets such as
equipment used in the production process to generate
income), the transfer of funds received to the sale or
acquisition of fixed assets, gift and inheritance taxes, death
levies and, finally, uninsured damage to fixed assets.
Thank You