FOREIGN EXCHANGE MARKET OVERVIEW

In todays world, no economy is self-sufficient, so there is need for exchange of goods and services amongst the different countries. So in this global village, unlike in the primitive age the exchange of goods and services is no longer carried out on barter basis. Every sovereign country in the world has a currency that is legal tender in its territory and this currency does not act as money outside its boundaries. So whenever a country buys or sells goods and services from or to another country, the residents of two countries have to exchange currencies. So we can imagine that if all countries have the same currency then there is no need for foreign exchange.

Need for Foreign Exchange

Let us consider a case where Indian company exports cotton fabrics to USA and invoices the goods in US dollar. The American importer will pay the amount in US dollar, as the same is his home currency. However the Indian exporter requires rupees means his home currency for procuring raw materials and for payment to the labor charges etc. Thus he would need exchanging US dollar for rupee. If the Indian exporters invoice their goods in rupees, then importer in USA will get his dollar converted in rupee and pay the exporter. From the above example we can infer that in case goods are bought or sold outside the country, exchange of currency is necessary. Sometimes it also happens that the transactions between two countries will be settled in the currency of third country. In that case both the countries that are transacting will require converting the irrespective currencies in the currency of third country. For that also the foreign exchange is required.

About foreign exchange market

Particularly for foreign exchange market there is no market place called the foreign exchange market. It is mechanism through which one countrys currency can be exchange i.e. bought or sold for the currency of another country. The foreign exchange market does not have any geographic location. Foreign exchange market is described as an OTC (over the counter) market as there is no physical place where the participant meets to execute the deals, as we see in the case of stock exchange. The largest foreign exchange market is in London, followed by the New York, Tokyo, Zurich and Frankfurt. The markets are situated throughout the different time zone of the globe in such a way that one market is closing the other is beginning its operation. Therefore it is stated that foreign exchange market is functioning throughout 24 hours a day. In most market US dollar is the vehicle currency, viz., the currency sued to dominate international transaction. In India, foreign exchange has been given a statutory definition. Section 2 (b) of Foreign Exchange Regulation ACT,1973 states: Foreign exchange means foreign currency and includes : All deposits, credits and balance payable in any foreign currency and any draft, travelers cheques, letter of credit and bills of exchange. Expressed or drawn in India currency but payable in any foreign currency. Any instrument payable, at the option of drawee or holder thereof or any other party thereto, either in Indian currency or in foreign currency or partly in one andpartlyintheother. In order to provide facilities to members of the public and foreigners visiting India, for exchange of foreign currency into Indian currency and vice-versa. RBI has granted to various firms and individuals, license to undertake money-changing business at seas/airport and tourism place of tourist interest in India. Besides certain authorized dealers in foreign exchange (banks) have also been permitted to open exchange bureaus.

Following are the major bifurcations:

 Full fledge moneychangers they are the firms and individuals who have been authorized to take both, purchase and sale transaction with the public. Restricted moneychanger they are shops, emporia and hotels etc. that have been authorized only to purchase foreign currency towards cost of goods supplied or services rendered by them or for conversion into rupees. Authorized dealers they are one who can undertake all types of foreign exchange transaction. Banks are only the authorized dealers. The only exceptions are Thomas cook, western union, UAE exchange which though, and not a bank is an AD. Even among the banks RBI has categorized them as follows: Branch A They are the branches that have nostro and vostro account. Branch B The branch that can deal in all other transaction but do not maintain nostro and vostro a/cs fall under this category. For Indian we can conclude that foreign exchange refers to foreign money, which includes notes, cheques, bills of exchange, bank balance and deposits in foreign currencies.

The main players in foreign exchange market are as follow:1 . C U S T O M E R S : - The customers who are engaged in foreign trade participate
in foreign exchange market by availing of the services of banks. Exporters require converting the dollars in to rupee and importers require converting rupee in to the dollars, as they have to pay in dollars for the goods/services they have imported.

2.COMMERCIAL BANKS:
They are most active players in the forex market. Commercial bank dealing with international transaction offer services for conversion of one currency in to another. They have wide network of branches. Typically banks buy foreign exchange from exporters and sells foreign exchange to the importers of goods. As every time the foreign exchange bought or oversold position. The balance amount is sold or bought from the market.

3. CENTRAL BANK:
In all countries Central bank have been charged with the responsibility of maintaining the external value of the domestic currency. Generally this is achieved by the intervention of the bank.

4. EXCHANGE BROKERS
Forex Brokers play very important role in the foreign exchange market. However the extent to which services of foreign brokers are utilized depends on the tradition and practice prevailing at a particular forex market center. In India as per FEDAI guideline the Ads are free to deal directly among themselves without going through brokers. The brokers are not among to allowed to deal in their own account all over the world and also in India.

5. OVERSEAS FOREX MARKET:

Today the daily global turnover is estimated to be more than US$ 1.5 trillion a day. The international trade however constitutes hardly5 to 7 % of this total turnover. The rest of trading in world forex market is constituted of financial transaction and speculation. As we know that the forex market is 24-hour market, the day begins with Tokyo and thereafter Singapore opens, thereafter India, followed by Bahrain, Frankfurt, Paris, London, New York, Sydney, and back to Tokyo.

6. SPECULATORS :The speculators are the major players in the forex market. Bank dealing are the major speculators in the forex market with a view to make profit on account of favorable movement in exchange rate, take position i.e. if they feel that rate of particular currency is likely to go up in short term. They buy that currency and sell it as soon as they are able to make quick profit.

 Corporations particularly multinational corporation and transnational corporation having business operation beyond their national frontiers and on account of their cash flows being large and in multi currencies get in to foreign exchange exposures. With a view to make advantage of exchange rate movement in their favor they either delay covering exposures or do not cover until cash flow materialize. Individual like share dealing also undertake the activity of buying and selling of foreign exchange for booking short term profits. They also buy foreign currency stocks, bonds and other assets without covering the foreign exchange exposure risk. This also results in speculations.

EXCHANGE RATE SYSTEM

Countries of the world have been exchanging goods and services amongst themselves. This has been going on from time immemorial. The world has come a long way from the days of barter trade. With the invention of money the figures and problems of barter trade have disappeared. The barter trade

has given way ton exchanged of goods and services for currencies instead of goods and services. The rupee was historically linked with pound sterling. India was a founder member of the IMF. During the existence of the fixed exchange rate system, the intervention currency of the Reserve Bank of India (RBI) was the British pound, the RBI ensured maintenance of the exchange rate by selling and buying pound against rupees at fixed rates. The interbank rate therefore ruled the RBI band. During the fixed exchange rate era, there was only one major change in the parity of the rupee- devaluation in June 1966. Different countries have adopted different exchange rate system at different time. The following are some of the exchange rate system followed by various countries.

FACTOR AFFECTING EXCHANGE RATES

In free market, it is the demand and supply of the currency which should determine the exchange rates but demand and supply is the dependent on many factors, which are ultimately the cause of the exchange rate fluctuation, sometimes wild.

The volatility of exchange rates cannot be traced to the single reason and consequently, it becomes difficult to precisely define the factors that affect exchange rates. However, the more important among them are as follows:

STRENGTH OF ECONOMY
Economic factors affecting exchange rates include hedging activities, interest rates, inflationary pressures, tradeimbalance, and euro market activities. Irving fisher, an Americaneconomist, developed a theory relating exchange rates to interestrates. This proposition, known as the fisher effect, states that interestrate differentials tend to reflect exchange rate expectation. On the other hand, the purchasing- power parity theory relatesexchange rates to inflationary pressures. In its absolute version, thistheory states that the equilibrium exchange rate equals the ratio of domestic to foreign prices. The relative version of the theory relateschanges in the exchange rate to changes in price ratios.

POLITICAL FACTOR
The political factor influencing exchange rates include theestablished monetary policy along with government action on itemssuch as the money supply, inflation, taxes, and deficit financing. Activegovernment intervention or manipulation, such as central bank activityin the foreign currency market, also have an impact. Other politicalfactors influencing exchange rates include the political stability of acountry and its relative economic exposure (the perceived need for certain levels and types of imports).

EXPACTATION OF THE FOREIGN EXCHANGE MARKET

Psychological factors also influence exchange rates. These factors include market anticipation, speculative pressures, and future expectations .A few financial experts are of the opinion that in todays environment, the only trustworthy method of predicting exchange rates by gut feel. Bob Eveling, vice president of financial markets at SG, is corporate finances top foreign exchange forecaster for 1999.evelings gut feeling has, defined convention, and his method proved uncannily accurate in foreign exchange forecasting in 1998.SG ended the corporate finance forecasting year with a 2.66% error overall, the most accurate among 19 banks. The secret to evelings intuition on any currency is keeping abreast of world events. Any event, from a declaration of war to a fainting political leader, can take its toll on a currencys value. Today, instead of formal modals, most forecasters rely on an amalgam that is part economic fundamentals, part model and part judgment.

Fiscal policy Interest rates Monetary policy Balance of payment Exchange control

Central bank intervention Speculation Technicalfactors