The foreign exchange market allows currencies to be bought and sold and includes individuals, firms, brokers, banks, and central banks. It is a system rather than a physical place. Many currencies are traded, with the main functions being transferring purchasing power between countries, providing credit for international trade, and hedging against currency fluctuations. Foreign exchange markets are split into spot markets, where transactions are settled immediately, and forward markets, where the exchange rate is agreed now but the transaction occurs at a future date. The Foreign Exchange Management Act regulates foreign exchange transactions and restricts activities between residents and non-residents.

1. FOREIGN EXCHANGE

2. Meaning:
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. Functions of Foreign Exchange Market:
Foreign exchange market performs the following three
functions:
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.

4. 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.

5. Kinds of Foreign Exchange Markets:
Foreign exchange markets are classified on the basis
of whether the foreign exchange transactions are spot
or forward accordingly, there are two kinds of
foreign exchange markets:
(i) Spot Market,
(ii) Forward Market.

6. (i) Spot Market:
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.

7. (ii) Forward Market:
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).

8. FEMA
The Foreign Exchange Management Act (1999) or in short
FEMA has been introduced as a replacement for earlier
Foreign Exchange Regulation Act (FERA). FEMA came into
act on the 1st day of June, 2000.
The main objective behind the Foreign Exchange
Management Act (1999) is to consolidate and amend the law
relating to foreign exchange with objective of facilitating
external trade and payments and for promoting the orderly
development and maintenance of foreign exchange market in
India.

10. Main Features
#Activities such as payments made to any person outside India or
receipts from them, along with the deals in foreign exchange and foreign
security is restricted. It is FEMA that gives the central government the
power to impose the restrictions.
#Restrictions are imposed on residents of India who carry out
transactions in foreign exchange, foreign security or who own or hold
immovable property abroad.
#Without general or specific permission of the MA restricts the
transactions involving foreign exchange or foreign security and
payments from outside the country to India – the transactions should be
made only through an authorised person.
#Deals in foreign exchange under the current account by an authorised
person can be restricted by the Central Government, based on public
interest generally.

11. #Although selling or drawing of foreign exchange is done through
an authorized person, the RBI is empowered by this Act to subject
the capital account transactions to a number of restrictions.
#Residents of India will be permitted to carry out transactions in
foreign exchange, foreign security or to own or hold immovable
property abroad if the currency, security or property was owned or
acquired when he/she was living outside India, or when it was
inherited by him/her from someone living outside India.
#Exporters are needed to furnish their export details to RBI. To
ensure that the transactions are carried out properly, RBI may ask
the exporters to comply to its necessary requirements