Forex Market

Meaning:
 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 foreign exchange (forex) market is the largest financial market in the world and is made up of banks,
commercial companies, central banks, investment management firms, hedge funds, and retail forex brokers and
investors.
 The foreign exchange market is a global decentralized or over-the-counter (OTC) market for the trading
of currencies. This market determines foreign exchange rates for every currency. It includes all aspects of
buying, selling and exchanging currencies at current or determined prices. In terms of trading volume, it is by far
the largest market in the world, followed by the credit market.
 Need for Foreign Exchange Market
There are immense needs of an FEM as follows:
➢ There are as many national currencies as there are sovereign nations. The multitude of national currencies provides an extra
dimension to every international economic transaction between resident of one country with that of another. Hence, every
international transaction requires a foreign exchange transaction that is conversion of one currency into another. If a single
currency were used throughout the world, there would be no need for an FEM and trade among nations (e.g. the USA and
Japan) would resemble trade among the various states of a country;
➢ International trade would come at a standstill in the absence of FEM. It would become next to impossible for exporters and
importers to seek out one another who are in need of foreign currency. For instance, an Indian exporter might sell goods to a
trader in USA. The trader in USA pays in Dollar. Now, the Indian exporter needs to seek someone in India who is in need of
Dollar, so as to convert the Dollar to Rupee. Let us assume that he finds an importer who is seeking Dollar in exchange of
Rupee. Even if the exporter finds someone who needs Dollar, there is one more hurdle. The amount of Dollar which the
Indian exporter wants to exchange might not match the amount of Dollar which the Indian importer seeks. Thus, in absence
of FEM, global trade would become over-complicated;
➢ Foreign currency is required for other purposes as well. It is required by tourists visiting other countries, foreign investors
willing to buy assets, students going abroad for education, people travelling abroad for health-related issues, etc. All these
activities would be impossible without FEM.
 Functions of Foreign Exchange Market
a. Transfer/Clearing 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.
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.
b. 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
c. 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.
 Features of Foreign Exchange Market
This kind of exchange market does have characteristics of its own, which are required to be identified. The features of the
Foreign Exchange Market are as follows:
a. High Liquidity: The foreign exchange market is the most easily liquefiable financial market in the whole world. This
involves the trading of various currencies worldwide. The traders in this market are free to buy or sell the currencies anytime
as per their own choice.
b. Market Transparency: There is much clarity in this market. The traders in the foreign exchange market have full access to
all market data and information. This will help to monitor different countries’ currency price fluctuations through the real-
time portfolio.
c. Dynamic Market: The foreign exchange market is a dynamic market structure. In these markets, the currency values change
every second and hour.
d. Operates 24 Hours: The Foreign exchange markets function 24 hours a day. This provides the traders the possibility to trade
at any time.
Structure of the Foreign Exchange Market
Operations of Forex Market
 Participants in the forex market
a. Forex Dealers- Forex dealers are amongst the biggest participants in the Forex market. They are also known as
broker dealers. Most Forex dealers in the world are banks. It is for this reason that the market in which dealers
interact with one another is also known as the interbank market. However, there are some notable non-bank
financial institutions also that deal in foreign exchange.
These dealers participate in the Forex markets by providing bid-ask quotes for currency pairs at all times. All
brokers do not participate in all currency pairs. Rather, they may specialize in a specific currency pair. Alternatively,
a lot of dealers also use their own capital to conduct proprietary trading operations. When both these operations are
combined, Forex dealers have a significant participation in the Forex market.

b. Brokers- The Forex market is largely devoid of brokers. This is because a person need not deal with brokers
necessarily. If they have sufficient knowledge, they can directly call the dealer and obtain a favorable rate.
However, there are brokers in the Forex market. These brokers exist because they add value to their clients by
helping them obtain the best quote. For instance, they may help their clients obtain the lowest buying price or
the highest selling price by making available quotes from several dealers. Another major reason for using
brokers is creating anonymity while trading. Many big investors and even Forex dealers use the services of
brokers who act as henchmen for the trading operations of these big players.
c. Hedgers- There are many businesses which end up creating an asset or a liability priced in foreign currency in
the regular course of their business. For instance, importers and exporters engaged in foreign trade may have
open positions in several foreign currencies. They may therefore be impacted if there is a fluctuation in the
value of foreign currency. As a result, to protect themselves against these losses, hedgers take opposite positions
in the market. Therefore if there is an unfavorable movement in their original position, it is offset by an
opposite movement in their hedged positions. Their profits and losses and therefore nullified and they get
stability in the operations of their business.

d. Speculators- Speculators are a class of traders that have no genuine requirement for foreign currency. They
only buy and sell these currencies with the hope of making a profit from it. The number of speculators increases
a lot when the market sentiment is high and everyone seems to be making money in the Forex markets.
Speculators usually do not maintain open positions in any currency for a very long time. Their positions are
transient and are only meant to make a short term profit.

e. Arbitrageurs- Arbitrageurs are traders that take advantage of the price discrepancy in different markets to make
a profit. Arbitrageurs serve an important function in the foreign exchange market. It is their operations that
ensure that a market as large, as decentralized and as diffused as the Forex market functions efficiently and
provides uniform price quotations all over the world. Whenever arbitrageurs find a price discrepancy in the
market, they start buying in one place and selling in another till the discrepancy disappears.
f. Central Banks- Central Banks of all countries participate in the Forex market to some extent. Most of the
times, this participation is official. Although many times Central Banks do participate in the market by covert
means. This is because every Central Bank has a target range within which they would like to see their
currency fluctuate. If the currency falls out of the given range, Central Banks conduct open market operations
to bring it back in range. Also, whenever the currency of a given nation is under speculative attack, Central
Banks participate extensively in the market to defend their currency.

g. Retail Market Participants- Retail market participants include tourists, students and even patients who are
travelling abroad. Then there are also a variety of small businesses that indulge in foreign trade. Most of the
retail participants participate in the spot market whereas people with long term interests operate in the futures
market. This is because these participants only buy/sell currency when they have a personal/professional
requirement and dealing with foreign currencies is not a part of their regular business.

The participants have been listed in descending order. This means that dealers are the most active traders in the
Forex markets, followed by brokers and so on. It would also be fair to say that dealers have the maximum
information about the market, followed by brokers and so on.
Commonly traded currencies in the Forex Market