Basics Of Stock Market - Intermediate

What is Foreign Exchange?

Foreign Exchange

Forex, also known as foreign exchange, refers to the exchange of currency from one country into another. We will explain what Forex trading is, the functions of foreign currency market and many other details. FX traders seek to profit from fluctuations in prices and speculate on the direction foreign exchange rates will move in the future.

Forex trading markets are open 24 hours a day, five times a week, with Saturday and Sunday off. Because one currency can be bought and the other sold, forex transactions are usually quoted in pairs. The 'base currency' is the currency that you use, while the quote currency' is the currency that you use.

How are currency prices calculated?

A host of economic and political factors influence currency prices, including interest rates, international trade and inflation. Sometimes, the government may participate in the foreign currency market to affect the currency's value. They can either flood the market with their national currency to lower its price or buy to increase the price. This is called central bank intervention.

If the currency of our nation appreciates in proportion to other countries' prices, then the price of goods from our country goes up and foreign goods prices go down.

Foreign Exchange Rate Policies in India

The Indian Foreign Exchange market has seen a tremendous increase in its liquidity since the liberalization. India converted the Rupee in February 1992. In March 1993, the Forex market was opened in India with a single floating rate.

Indian Foreign Exchange Market is made up of buyers and sellers as well as market mediators. Mumbai is the main centre for Foreign Exchange in India. There are also centres in Kolkata, New Delhi and Chennai.

Foreign Exchange Dealers Association, a voluntary association, acts as a regulator. Forex trading is open to all residents, HUFs, and corporations who meet the FEMA criteria.

Forex Markets Operation

Foreign exchange market operates in the same way as commodity market.

  • Spot Market is a spot/current market that only handles current transactions. The exchange rate is the one in effect at the time of the transaction.
  • Forward Markets for Forex are the markets that trade foreign currency for delivery in the future. A currency derivative is a contract to buy/sell a currency rate at a future price. Currency derivatives, like all derivative trading instruments, are an efficient risk management tool and can provide the benefits of hedging and speculation as well as leverage.
  • Commercial companies (corporates) trade in smaller quantities than banks and speculators. Their trades have a short-term effect on the market rate.

Commonly traded currencies

Three letter symbols are used to indicate currencies. These are the standard symbols used to identify some of the most popular currencies:

  • EUR - Euros
  • USD - United States Dollar
  • CAD - Canadian Dollar
  • GBP - British Pound
  • JPY - Japanese Yen
  • AUD - Australian Dollar
  • CHF -Swiss Franc

Majors holding 75 percent of all Forex market operations are the EUR/USD (75%) GBP/USD USD, USD/CHF, USD/JPY and USD/CHF (75%) Because the USD is represented in all currency pairs, it is considered a major currency. Cross currency pairs, or cross rates, are pairs that do not include USD.

These are the cross rates currently traded:

  • EUR/CHF= Euro-Swissfranc
  • EUR/GBP= Euro–Sterling
  • EUR/JPY= Euro Yen
  • GBP/JPY = Sterling-Yen /JPY
  • AUD/JPY= Aussie-Yen
  • NZD/JPY= Kiwi-Yen

The foreign exchange markets are governed by central banks like the RBI. They are involved in the foreign currency market to regulate currencies according to their economic requirements. The money supply, inflation, and/or interest rate are all controlled by central banks.

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