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Foreign Exchange Market

The foreign exchange market allows for the exchange of one country's currency for another. It determines exchange rates and facilitates currency transactions. Historically, currencies were backed by gold under the gold standard (1875) and later the US dollar replaced gold under the Bretton Woods system (1944). The top traded currencies today are the US dollar, euro, Japanese yen, and British pound. The FX market performs transfer of funds between countries, provides credit for international trade, and allows hedging against exchange rate risk. It has both a retail market for individuals and a wholesale interbank market where large institutions determine rates. Key participants include central banks, commercial banks, corporations, hedgers and speculators. Transactions occur in the spot

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Carmela Anne Sampiano
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179 views16 pages

Foreign Exchange Market

The foreign exchange market allows for the exchange of one country's currency for another. It determines exchange rates and facilitates currency transactions. Historically, currencies were backed by gold under the gold standard (1875) and later the US dollar replaced gold under the Bretton Woods system (1944). The top traded currencies today are the US dollar, euro, Japanese yen, and British pound. The FX market performs transfer of funds between countries, provides credit for international trade, and allows hedging against exchange rate risk. It has both a retail market for individuals and a wholesale interbank market where large institutions determine rates. Key participants include central banks, commercial banks, corporations, hedgers and speculators. Transactions occur in the spot

Uploaded by

Carmela Anne Sampiano
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Foreign

Exchange
Market
Sampiano, Carmela Anne C.
BSA 2-1

Definition
o foreign exchange market - provides the physical and
institutional structure through which the money of
one country is exchanged for that of another
country,
the rate of exchange between currencies is determined,
and foreign exchange transactions are physically
completed
o foreign exchange transaction - an agreement between a
buyer and a seller that a given amount of one
currency is to be delivered at a specified rate for some
other currency
o foreign exchange rate - the price of a foreign

currency

History
I.Gold Standard System
The creation of the gold standard monetary
system in 1875 is one of the most important
events in the history of the ForEx market. The
basic idea behind the gold standard was that
governments guaranteed the conversion of
currency into a specific amount of gold, and vice
versa. In other words, a currency was backed by
gold. This represented the first official means of
currency exchange in history.

II.
Bretton Woods System
In July 1944, representatives from the Allies met in
Bretton Woods, New Hampshire, to deliberate over what
would be called the Bretton Woods system of international
monetary management. The main feature of Bretton
Woods was that the U.S. dollar replaced gold as the main
standard of convertibility for the world's currencies.
Furthermore, the U.S. dollar became the only currency in
the world that would be backed by gold.

Top 10 Most Traded


Currencies of the
World
New Zealand Dollar; 1.6
Swdish Krona; 2.2 Other currencies; 18.5
Hong Kong Dollar; 2.4
Canadian Dollar; 5.3
Swiss Franc; 6.4
Australian Dollar; 7.6

US Dollar; 85

British Pound; 13
Japanese Yen; 19
Euro; 39

Source: http://www.dummies.com/how-to/content/top-tentraded-currencies-of-the-world.html

Functions of Foreign
Exchange Market
1. Transfer
2. Credit
3. Hedging

1. Transfer Function
It transfers purchasing power
between the countries involved in the
transaction. This function is
performed through credit instruments
like bills of foreign exchange, bank
drafts and telephonic transfers.

2. Credit Function
It provides credit for foreign trade. Bills
of exchange, with maturity period of three
months, are generally used for
international payments. Credit is required
for this period in order to enable the
importer to take possession of goods, sell
them and obtain money to pay off the bill.

3. Hedging Function
When exporters and importers enter
into an agreement to sell and buy goods
on some future date at the current prices
and exchange rate, it is called hedging.
The purpose of hedging is to avoid losses
that might be caused due to exchange rate
variations in the future.

Types of Foreign Exchange


Market
1. Retail
2. Wholesale

1. Retail Market
The retail market is a secondary price maker. Here
travelers, tourists and people who are in need of foreign
exchange for permitted small transactions, exchange one
currency for another.

2. Wholesale Market
The wholesale market is also called interbank market.
The size of transactions in this market is very large. Dealers
are highly professionals and are primary price makers. The
main participants are Commercial banks, Business
corporations and Central banks. Multinational banks are
mainly responsible for determining exchange rate.

Market Participants
1) Governments and Central Banks try to control the money
supply, inflation and/or interest rates
2) Banks and Other Financial Institutions - act as dealers in
the sense that they are willing to buy/sell a currency at the
bid/ask price.
3) Hedgers - to lock in a specific exchange rate for the future
or to remove all sources of exchange-rate risk for that
transaction.
4) Speculators attempt to make money by taking advantage
of fluctuating exchange-rate levels.

Foreign Exchange
Transactions
1. Spot
2. Forward
3. Swap

1. Spot Market (Current Market)


Market which handles only spot transaction or
current transaction
Characteristics:
daily in nature, does not trade in future
deliveries
Spot Exchange Rate happens to prevail at the
time when transactions are incurred.

2. Forward Market
Market which handles such transaction of
foreign exchange as are meant for future delivery
Characteristics:
Caters to forward transaction
Determines forward exchange rate at which
forward transaction are to be honored

3. Swap Market
A swap transaction involves the simultaneous
purchase and sale of a given amount of foreign
exchange for two different value dates.
The most common type of swap is a spot against
forward, where the dealer buys a currency in the
spot market and simultaneously sells the same
amount back to the same back in the forward
market.

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