Question

The foreign exchange market performs THREE (3) important functions. Critically explain.

Answer 1

The foreign exchange market performs THREE (3) important functions:

1.Transfer

2. Credit

3. Hedging

1. Transfer Function:

Transfer function is basically the function of transferring purchasing power . A US company has the purchasing power in dollar in USA. If it wants to import goods from a foreign country , for example Germany, it will need the purchasing power in Euro. It will need to convert US dollar to Euro. The foreign exchange market does the function of providing Euro in exchange of US dollar.

.

2. Credit Function

Credit function is to provide short term credits for promotion of foreign trades.

It performs this function through credit instruments like bills of exchange in foreign currency,

Credit help importers to import goods, sell and repay

3. . Hedging Function

Hedging is mitigation of loss due to fluctuation in foreign exchange rate.

Foreign exchange market provides facilities of hedging through forward contracts for purchase and sell of foreign currency