The foreign exchange market allows currencies to be bought and sold between individuals, firms, banks, and central banks. It is a decentralized global market system rather than a physical place. Many currencies are traded and exchanged. The key functions of the foreign exchange market are to transfer purchasing power between countries, provide credit for international trade, and allow hedging against currency fluctuations through future contracts. There are two main types of markets - the spot market where transactions are settled immediately, and the forward market where exchange rates are agreed upon today for future transactions. Common transactions include hedging to mitigate exchange rate risk, arbitrage to profit from price differences, speculation to profit from rate changes, and currency swaps conducted by banks.

1. Foreign Exchange Market

2. 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.
Like any other market, foreign exchange market is a system, not
a place.
The transactions in this market are not confined to only one or
few foreign currencies.
In fact, there are a large number of foreign currencies which are
traded, converted and exchanged in the foreign exchange market.

3. 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.
Functions

4. 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
Functions

5. 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.
Functions

6. Kinds
Spot market refers to the market in which the receipts and payments are made
immediately.
Generally, a time of two business days is permitted to settle the transaction.
Spot market is of daily nature and deals only in spot transactions of foreign
exchange (not in future transactions).
The rate of exchange, which prevails in the spot market, is termed as spot
exchange rate or current rate of exchange.
The term ‘spot transaction’ is a bit misleading. In fact, spot transaction should
mean a transaction, which is carried out ‘on the spot’ (i.e., immediately).
However, a two-day margin is allowed as it takes two days for payments made
through cheques to be cleared.
(i) Spot Market

7. Kinds
 Forward market refers to the market in which sale and purchase of foreign
currency is settled on a specified future date at a rate agreed upon today.
The exchange rate quoted in forward transactions is known as the forward
exchange rate.
 Generally, most of the international transactions are signed on one date and
completed on a later date.
 Forward exchange rate becomes useful for both the parties involved in the
transaction.
Forward Contract is made for two reasons
(a) To minimize the risk of loss due to adverse changes in the exchange rate
(through hedging);
(b) To make profit (through speculation).
(ii) Forward Market

8. Types of transactions
It is a method of covering risk arising from a change in the
exchange rate.
It actually means settling the exchange rate by agreement 90 days
in advance for forward transactions with a view to avoid the loss due
to the exchange rate fluctuations
1. Hedging

9. Types of transactions
It is an act of simultaneous purchase and sale of different
currencies in two or more exchange markets.
The objective is to make profits by taking advantages of
exchange rate differentials in different markets.
2. Arbitrage

10. Types of transactions
It is a deliberate assumption of risk to make profits from
fluctuations in the exchange rates.
The speculative sale and purchase of foreign currency is
based on the speculator’s expectations about the future
exchange rates.
3. Speculation

11. Types of transactions
It is a kind of foreign exchange transaction in which there is a
spot sale of currency and a forward purchase of the same
currency in a single sale-purchase transaction.
These transactions are usually made by the banks
4. Currency swap