Question

Distinguish between the spot and forward markets, for foreign currencies. Why is it necessary to have two markets rather than one?-

What are the principal factors affecting the value of any particular foreign currency in the international exchange markets?-

Exactly what is meant by the phrase INTEREST RATE PARITY?

Who are the market participants in the foreign exchange markets?-

Answer 1

Answer 1)

Spot Market	Forward Market
handle only current or spot transactions. Affected transactions at prevailing rate only	Currency bought and sold to deliver at some future date Transactions take place at forward rate Froward rate may different from spot rate.

It is very important to have both spot and forward market for foreign currency at time rather than one because,

• The transaction in spot market and forward market based on the demand and supply between two countries
• These market maintain the balance in global economy by change in exchange rate , as differential from spot and forward rate.

Answer 2) The major determinants of exchange rate in international markets are,

• Interest rate in country
• Purchasing power ( rate of inflation )
• Balance of trade levels and trend
• Cash flow between two countries
• Dissemination in economy policy

Answer 3)

The simple meaning of Interest rate parity is difference in interest rate between two countries, which is based on no-arbitrage condition in interest rate to get an equilibrium state.

The forward exchange is reflection of interest rate differential between two countries as ,

where, F = forward exchange rate , S= Spot rate , i_a and i_b = interest rate in two countries.

Answer 4) The major market participants in the foreign exchange markets are,

• commercial banks of different countries
• International banks
• Dealers in Foreign exchange market,
• Central banks of different countries
• Big multinational companies
• Small business houses.
• Some time Individuals investors.