Question

Explain the functions of the Foreign Exchange Market and its purpose.

Answer 1

Foreign Exchange Market is a market place where the buyers & sellers participate in the transaction of foreign currencies.The Foreign Exchange Market also known as FOREX, is a global market place where foreign currencies are traded.

Functions of FOREX:

1) Transfer Function: One of the most important functions of FOREX market is the transfer of foreign currency from one country to another. Or, in other way, it can be said that conversion of one currency to another,wherein FOREX plays a great role in transferring the purchasing power from one country to another. For exa, Suppose India import goods from USA and has to make payment in dollars, in that case the role of FOREX comes, i.e., to convert rupee to dollar. The transfer function is carried out by the use of a number of credit instruments, like, bank drafts,bills of foreign exchange and telegraphic transfers.

2) Credit Function : Another function of FOREX market is, it provides a short-term credit to the importers to promote foreign trade. For exa, If an Indian company wants to purchase goods from the USA, it can pay by issuing a bill of exchange in the foreign exchange market, with a period of three months maturity.

3) Hedging Function : The third function of the FOREX market is to provide a means of protection against foreign exchange risks. In a free exchange market, when exchange rates change, the outcome may be a loss or gain to the concerned party. And because of this the FOREX provides a defence against the anticipated or actual claims or liabilities in exchange for the forward contracts. As we know a forward contract is a three month contract for foreign exchanges at a fixed date in the future at a price agreed upon today, so no need to pay money at the time of the contract. As such the risk can be avoided or reduced.

The main prupose of FOREX market is to trade foreign currencies in order to make financial market strong. It also develops a cordial relationship between countries. It is the FOREX market which determines the relative values of different currencies. FOREX combines worldwide financial institutions and organizations into one market place. When an Indian company buys goods from a foreign company, say USA it needs to pay in dollars. In this case the FOREX plays an important role in converting rupee to dollar. FOREX market promotes foreign trade by providing short-term credit to importers. The importers can purchase goods on credit from a FOREX market and pay later, i.e., within three months period.