Characteristics and Functions of the Foreign Exchange Market

Characteristics and Functions of the Foreign Exchange Market

10 Mar 2021 05:00 PM
 

The foreign exchange market is the most liquid financial market in the world with a daily trading volume of over $6 trillion, wherein the buying and selling of foreign currencies are not restricted to any geographical area. The forex market consists of a global network of financial centres and has no physical location or one centralized exchange. It operates for five days a week and 24 hours a day wherein currency is traded electronically, the value of which is dictated by the fluctuating foreign currency exchange rates. The forex market's importance is not just confined to larger corporations with business operations scattered across the globe, but even individuals, without even realizing it find forex significant at some point in their life due to personal or professional reasons. An Indian tourist visiting a museum in America would not be buying the entry tickets using his domestic home currency INR. The tourist would need to get the local currency exchanged to that of the country he is visiting during the international travel, which in this case would be INR to US dollars. Similarly, a company situated in the US that regularly buys cheese from France will be making the payment in Euros and not US dollars, thus requiring converting the equivalent US dollars into Euros based on the foreign exchange rate.

Functions of the Foreign Exchange Market

The foreign exchange market's participants engaged in the trade of foreign currencies include brokers, commercial banks, traders and speculators, the central bank, and the traditional users involving the students studying abroad, patients getting treated abroad, companies with global business operations and foreign tourists, etc. These participants, irrespective of their role, collectively make up the forex market.  The forex market serves a multitude of purposes that can be understood by studying the role of forex in shaping economies and fulfilling individuals' and organizations' currency needs.

  1. Transfer Function
    The most basic and prominent function that the forex market serves is the transfer of funds that involves foreign currencies from one country to another to settle payments arising from international trade. This consists of converting one country's currency into another since the trade happening beyond the domestic boundaries witnesses the utilization of foreign currencies for payment and not home currencies. Bank drafts, transfers, and bills of foreign exchange are the instruments used to facilitate the transfer function. 

    For example, an importer in India having trade associations with a US supplier would be required to convert an equivalent amount of Indian rupee to dollar based on the foreign exchange rates. Suppose the goods being imported by the Indian importer amounted to $ 10,000  with an exchange rate of 1 $= 73.59 INR quoted by the bank for the currency conversion, then the importer would have to pay Rs.7,35,900 for converting the equivalent INR to US dollar necessary for the payment to the supplier. 

  2. Credit Function
    One of the necessary functions facilitated by the forex market is to promote cross-border trade through national and international credit. The import and export industry's trade cycle is relatively long, wherein expedited payments for the shipped goods are absent, creating a challenge of access to required capital. In the case of importers, it allows for the acquisition of larger orders, possession of goods through timely payment against import bills, which would have been delayed or prolonged due to the waiting period associated with selling the goods and obtaining money from the transaction.

  3. Hedging Function

    Utilizing hedging for foreign risk management against forex risks is another crucial function that the forex market serves. Any corporation or individual might encounter forex losses on their forex transactions due to the fluctuating exchange rates with movements that do not favour the parties involved. Thus to protect the bottom line of companies and ensure enhanced safety from forex exposures, the correct hedging strategies involving the right hedging tool are employed. Forward contracts are one popular way of hedging wherein the buying and selling of currencies happen at a predetermined foreign exchange rate at a specific date in the future. Thus, reducing the impact of adverse forex rates movements, especially for longer forex transactions exposed to forex volatility for a prolonged period. 

Characteristics of the Foreign Exchange Market

  1. Transparency

    The Forex market has high price transparency that works in favour of the traders wherein one can directly trade with the market maker. Monitoring the real-time profit/loss on open positions is accessible to traders, where they can even benefit from account tracking capability and real-time portfolio. The traders can get both indicative and executable prices from reputable brokers and access reports generated on-demand, providing all the relevant details.

  2. Dynamic Nature
    The forex market is one of the most dynamic financial markets in the world due to the market transparency, low transactions cost, low barrier to entry and fast execution that it offers. All these features, along with the fact that it is open for 24 hours a day and operative in different time zones, make the forex market highly active, witnessing massive participation from not just traders and investors but also companies and commercial banks.

  3. High liquidity
    The forex market is highly liquid with a massive daily trading volume since the currency is deemed to be one of the most traded financial instruments globally, always enabling a buyer for a seller and vice versa. In the forex market, you can settle at any time and at any price, which is contrary to the case in the options and the stock market. 

  4. Accessibility
    With the advancement in technology for ease of online currency trading and the reduced barrier to entry, the accessibility to the forex market and one's account can be ensured with just a secure internet connection. One can trade from any corner of the world without any difficulty, which is a feature that might be absent in some financial markets that mandate physical presence for trade execution.

  5. Leverage
    One of the forex market's key characteristics is the high leverage that allows the one to trade on margins or borrowed capital. Traders can manifold their returns or profits from forex trading with no need for an upfront payment of the full trade amount but just paying a minimal percentage. However, one cannot neglect the losses that also get magnified due to leverage in the quest of multiplying their profits.

The understanding of the forex market enables more informed forex decisions not just in terms of getting better forex rates to enhance savings on forex transactions but also for employing the right foreign exchange risk management strategies. Even for someone who is just starting out with online currency trading or forex trading would first require the knowledge of the forex market to further bolster their trading strategy. However, with the advancement in the finance and technology space, accessing experts has become easier, which presents a more convenient and cost-effect way to extract the most value out of one's forex transactions. Myforexeye provides a range of forex services that fulfil all the forex needs of individuals and firms, readily accessible to users via our user-friendly platforms. Whether it be for getting better forex rates through our transaction process outsourcing service, implementing correct forex risk management techniques through our services like Dr. Forex (Forex Risk Advisory) and Forex Risk Management, our services make forex simplified and profitable to our clients. Besides this, smooth and quick trade financing, secure money transfer, live forex rate updates, custom alerts, etc., are other benefits that our services extend to our clients. 

Conclusion

Myforexeye is committed to providing a resolution to your Forex and trade finance needs and filling the gap of the unmet demands in terms of credit and financial guidance to MSMEs and larger corporates. Through our team of experienced professionals and consultants well versed in the field of forex and trade finance, we provide streamlined forex solutions for one’s convenience and at their disposal. Corroborating our efforts of providing solutions that are effective to companies for realizing their maximum potential are the latest technology and assistance from the veterans of the forex and trade finance industry. It is our objective to aid our clients in making savings and eliminating the aspect of hidden commission fees payable to the bank. Our user-friendly digital platforms - web portal and mobile app, enables one to access the best quotes for all types of forex conversions as well as avail import and export finance and calculate interest costs to make informed decisions. 

Speak to one of our specialists to acquire a detailed understanding of forex solutions offered by Myforexeye. 

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