INTRODUCTION

Foreign exchange (Forex or FX) refers to the

global marketplace for trading national
currencies against one another. The Forex
market operates 24 hours a day, five days a
week, and involves banks, financial
institutions, corporations, governments, and
individual traders.
It is a decentralized global market where
national currencies are traded. It is essential
for international trade and investments,
allowing businesses and governments to
convert currencies for cross-border
transactions.

Like in the goods market, there are buyer

and sellers in the foreign exchange market
as various individuals, firms or financial
institutions.

Generally, the term foreign exchange points

out two things
 a.Foreign currency – currency of other
countries
b. Rate of exchange – rate at which
one unit of currency of a
country is exchange for the currency of
another country

Exchange Rate

An exchange rate is the price of one

currency in terms of another. It determines
how much of one currency is needed to buy
another. Exchange rates fluctuate based on
factors such as inflation, interest rates, and
geopolitical stability.
For example, if the USD/INR exchange rate
is 83, it means 1 US dollar is equivalent to
83 Indian rupees.
Similarly, if the EUR/USD rate is 1.10, it
means 1 euro equals 1.10 US dollars.
Exchange rates can be fixed (controlled by
central banks) or floating (determined by
market forces).
A rise in the external value or exchange rate
of a currency is called appreciation and fall
in the exchange rate is called depreciation
of that currency
 Fixed and flexible rate of exchange
1. Fixed rate of exchange –
A fixed rate of exchange means that the
rate of exchange is fixed by the
government. All efforts are made Loy the
government to enforce this rate.
A member country could change the par
value of its currency, i.e., devaluation or
overvaluation by 10 per cent after notifying
the IME; and in case of larger variation it
had to seek the approval of the IME. The
fixed exchange rate is not determined by
the market conditions and therefore is not
subject to supply-demand fluctuations.

DETERMINATION –
It is determined by the government who
alone is competent to change it.
2. Flexible rate of exchange –
flexible rate of exchange refers to that
system in which the rate of exchange of a
country's currency undergoes change in
accordance with its demand and supply in
the exchange market. The exchange is
Pegged by the government at a particular
level. Under this system, the rate of
exchange fluctuates according to the
demand for and supply of different
currencies in the international money
market.

According to Shomen, a flexible rate of

exchange is helpful in making the
monetary policy of the country more
effective.

DETERMINATION –
The flexible rate of exchange is not
determined by the government. It is
determined by the market forces, like the
price of any other commodity.
 The market where forces, like the price of
any other commodity.

FACTORS OF FOREIGN EXCHANGE –

 Receipts on account of export of goods

to rest of the world.
 Receipts on account of the sale of factor
as well as non-factor services to the rest
of the world.
 Remittances by the resident companies
in the rest of the world.
 Transfers from the rest of the world
 NRI deposits
 Loans from the rest of the world.


 THEORIES OF RATE OF EXCHANGE –

The main theories determining the rate of exchange

under different Monetary Standards are as follows:

(1) Mint Par Theory

According to this theory when two countries are

on metallic standard, i.e. Gold or Silver Standard
then the rate of exchange of their currencies is
determined based on the weight of gold or silver
contained in their currency units.

Suppose the gold content of one British pound

(£) is 10 grams of gold, while the gold content of
one US dollar ($) is 2 grams of gold. According to
Mint Par Theory, the exchange rate between the
two currencies would be determined by their
gold content ratio:

(2) Purchasing Power Parity Theory

Purchasing power theory is an economic theory

that states that the exchange rate between two
currencies should equal the ratio of their
respective purchasing power. In other words, a
unit of currency should have the same
purchasing power in different countries when
exchange rates are adjusted.
(3) Balance of Payments Theory

Balance of Payment (BOP) Theory explains

exchange rate determination based on a
country's balance of payments—a record of all
economic transactions between residents of a
country and the rest of the world. According to
this theory, a country’s exchange rate fluctuates
depending on its trade balance, capital flows,
and current account status.

 If a country has a BOP surplus (more exports,

foreign investments, and inflows), its currency
appreciates due to higher demand.
 If a country has a BOP deficit (more imports,
capital outflows), its currency depreciates due to
higher supply
 MONETARY POLICY AND EXCHANGE RULE

Monetary policy refers to the actions taken by a

country's central bank to regulate money supply,
interest rates, and inflation. It plays a crucial role
in determining exchange rates by influencing
economic stability and investor confidence.
changes in monetary parameters as a
consequence of changes in monetary policy of
the country have a significant bearing on the
equilibrium exchange rate. Generally, a tight
monetary policy raises the rate of interest in the
domestic economy.
If the domestic rate of interest is higher than in
other countries, there will be an inflow of capital
from the rest of the world. This implies an
increase in the supply of foreign currency an
increase in the demand for domestic currency,
and consequently an appreciation of domestic
currency.
On the other hand, a cheap monetary policy
reduces the interest rate. If the domestic interest
rate is lower than the international interest rate,
there will be an outflow of capital to the rest of
the world. Capital outflow means more demand
for foreign Currencies which would result in
depreciation of the domestic currency.
 NEWS AND EXCHANGE RATE

Like the stock exchange, the foreign

exchange market has a worldwide network
and is influenced by major news worldwide.

Some roles of news on exchange rates -

 Economic Reports: Data such as GDP
growth, unemployment rates, and
inflation figures can influence a
currency’s value.
 Central Bank Decisions: News on
interest rate changes or monetary policy
by central banks (like the U.S. Federal
Reserve or the European Central Bank)
directly impacts exchange rates.
 Political Events: Elections, trade
agreements, and geopolitical tensions
 can cause fluctuations in currency
values.
 Market Sentiment and Speculation:
News stories can drive trader sentiment,
influencing market activity and thus
affecting exchange rates.
 CONCLUSION

In this report, we analysed the dynamics of

the foreign exchange (Forex) market,
focusing on key factors influencing currency
fluctuations, exchange rate policies, and the
impact of economic indicators. The foreign
exchange market plays a critical role in
global trade, investment, and economic
stability, making it essential for businesses,
policymakers, and investors to understand
its complexities.
Our findings highlight that exchange rates
are influenced by a combination of
macroeconomic factors, including interest
rates, inflation, geopolitical events, and
market sentiment. Additionally, central bank
policies and international trade balances
significantly impact currency valuation. The
volatility in Forex markets presents both
risks and opportunities, emphasizing the
importance of strategic risk management for
traders and businesses engaging in cross-
border transactions.