Question

What are the 6 major segments of the foreign exchange market according to the text? Who are the participants in the foreign exchange market? Give examples.

Answer 1

There are two segments of foreign exchange market, Spot Market and Forward Market.

Spot Market- Currencies are traded in the market directly on the the. This market is used when a company on-the-spot wants to change one currency for another. The procedure is an extremely simple one. A banker may either manage the company's trade, or can have another bank manage it. The company knows exactly how many units of one currency are to be received or paid for a certain number of units of another currency within minutes.

Forward Market- Forward market came into being in order to avoid uncertainties. In the Forward market, a forward contract on which currencies are to be exchanged, when the exchange is to take place, how much of each currency is involved and which side of the contract is agreed between the companies by each party. A firm removes one uncertainty with this deal, the exchange rate risk of not understanding what it will be getting or paying in future. It can be noted, however, that any potential gains in exchange rate changes are also estimated, and the contract may cost more than it turns out worth.

Participants in Foreign Exchange Market:

Commercial Banks- The major foreign exchange market participants are the large commercial banks which provide the core of the market. On the foreign exchange, as many as 100 to 200 banks around the globe actively "make the market." These banks serve their retail customers, the bank customers, conducting foreign trade or investing internationally in financial assets that require foreign exchange.

Foreign Exchange Brokers- Foreign exchange traders also work on the world currency market. They serve as agents that promote inter-dealer trade. Unlike the banks, brokers merely serve as matchmakers and don't risk their own money.

Central banks- The Central Bank of the different countries is another significant player in the international market. Central banks frequently intervene in the market to maintain the exchange rates of their currencies within a desired range and to smooth fluctuations within that range. The extent of intervention by the bank would depend on the exchange rate regime flowed by the central bank of the country in question.

MNCs- As they share cash flows associated with their global activities, MNCs are the largest non-bank participants in the forward market. MNCs also either agree to pay or receive fixed sums in foreign currencies at future dates, thus exposing them to foreign currency risk. This is why such potential cash flows are also hedged through the interbank forward exchange market.