Definition of Foreign Exchange Market

Foreign exchange market is the market in which money denominated in one currency is bought and sold with money denominated in another currency. It is an over-the counter market, because there is no single physical or electronic market place or an organized exchange with a central trade clearing mechanism where traders meet and exchange currencies. It spans the globe, with prices moving and currencies trading somewhere every hour of every business day. World major trading starts each morning in Sydney and Tokyo, and ends up in the San Francisco and Los Angeles.

The foreign exchange market consists of two tiers: the inter bank market or wholesale market, and retail market or client market. The participants in the wholesale market are commercial banks, investment banks, corporations and central banks, and brokers who trade on their own account. On the other hand, the retail market comprises of travelers, and tourists who exchange one currency for another in the form of currency notes or traveler cheques.

Currency Convertibility

Foreign exchange market assumes that currencies of various countries are freely convertible into other currencies. But this assumption is not true, because many countries restrict the residents and non-residents to convert the local currency into foreign currency, which makes international business more difficult. Many international business firms use “counter trade” practices to overcome the problem that arises due to currency convertibility restrictions.

International Monetary System

Any country needs to have its own monetary system and an authority to maintain order in the system, and facilitate trade and investment. India has its own monetary policy, and the Reserve Bank of India (RBI) administers it. The same is the case with world, its needs a monetary system to promote trade and investment across the countries. International monetary system exists since 1944. The International Monetary Fund (IMF) and the World Bank have been maintaining order in the international monetary system and general economic development respectively.

International Financial Markets

International financial market born in mid-fifties and gradually grown in size and scope. International financial markets comprises of international banks, Eurocurrency market, Eurobond market, and international stock market. International banks play a crucial role in financing international business by acting as both commercial banks and investment banks. Most international banking is undertaken through reciprocal correspondent relationships between banks located in different countries. But now days large bank have internationalized their operations they have their own overseas operations so as to improve their ability to compete internationally. Eurocurrency market originally called as Eurodollar market, which helps to deposit surplus cash efficiently and conveniently, and it helps to raise short-term bank loans to finance corporate working capital needs, including imports and exports.