1

CONTENT
Evaluation Certificate

Declaration by the Student

II

Acknowledgement

III

INDEX
Sr. No.
1
2

Particular
Introduction
History- Exchange Rate Regimes

Page No.
6
7

2.1
2.2
2.3
3

Gold Standard
Bretton Woods
Snake In The Tunnel
Foreign Exchange Market-Meaning

8
9
10
11

4
4.1
4.2
4.3
4.4
4.5
5

Definition
Various Exchange Rate Systems
Floating
Fixed
Pegged Float
Managed Float
Dollarization
Various Participants Of Forex Market

12
12
14
17
18
20
22

6
7
6.2

Characteristics Of Foreign Exchange Market

Foreign Exchange Market In India
Financial Instruments Of Foreign Exchange

25
26
28

6.3

Market
Advantages And Disadvantages Of Foreign

30

6.4

Exchange Market.
Conclusion

31

INTRODUCTION
Being the main force driving the global economic market, currency is no doubt an essential
element for a country. However, in order for all the countries with different currencies to
trade with one another, a system of exchange rate between their currencies is needed; this
system is formally known as foreign exchange or currency exchange.

In the early days, the system of currency exchange is supported solely by the gold amount
held in the vault of a country. However, this system is no longer appropriate now due to
inflation and hence, the value of ones currency nowadays is determined through the market
forces alone.
In order to determine the value of a currencys exchange rate, two main types of system is
used which is floating currency and pegged currency.
However, most of the countries do not fully practice the floating exchange rate or the pegged
exchange rate method in reality. Instead, they use a hybrid system known as floating peg.
Floating peg is the combination of the two main systems where one country will normally
fixed their exchange rate to the US Dollars and after that; they will constantly review their
peg rate in order to stay in line with the actual market value.
The Foreign exchange market, or commonly known as FOREX, is the largest and most
prolific financial market because each day, more than 1 trillion worth of currency exchange
takes place between investors, speculators and countries. From this, we can deduce that the
actual mechanism behind the world of foreign exchange is far more complicated than what
we may already know, and that, the information mentioned earlier is just the tip of an iceberg.

HISTORY:
The foreign exchange market (fx or forex) as we know it today originated in 1973. However,
money has been around in one form or another since the time of Pharaohs. The Babylonians
are credited with the first use of paper bills and receipts, but Middle Eastern moneychangers
were the first currency traders who exchanged coins from one culture to another. During the

middle ages, the need for another form of currency besides coins emerged as the method of
choice. These paper bills represented transferable third-party payments of funds, making
foreign currency exchange trading much easier for merchants and traders and causing these
regional economies to flourish.
From the infantile stages of forex during the Middle Ages to WWI, the forex markets were
relatively stable and without much speculative activity. After WWI, the forex markets became
very volatile and speculative activity increased tenfold. Speculation in the forex market was
not looked on as favorable by most institutions and the public in general. The Great
Depression and the removal of the gold standard in 1931 created a serious lull in forex market
activity. From 1931 until 1973, the forex market went through a series of changes. These
changes greatly affected the global economies at the time and speculation in the forex
markets during these times was little, if any.
1944 Bretton Woods Accord is established to help stabilize the global economy after World
War II.
1971 Smithsonian Agreement established to allow for greater fluctuation band for currencies.
1972 European Joint Float established as the European community tried to move away from
its dependency on the U.S. dollar.
1973 Smithsonian Agreement and European Joint Float failed and signified the official switch
to a free-floating system.
1978 The European Monetary System was introduced so other countries could try to gain
independence from the U.S. dollar.
1978 Free-floating system officially mandated by the IMF. 1993 European Monetary System
fails making way for a world-wide free-floating system.

Gold standard:
In a Gold/commodity standard system, countries fix the value of their respective currencies
relative to a certain commodity or group of commodities. With each currencys value fixed in
terms of the commodity, currencies are fixed relative to one another. The gold standard was a
self-regulating system

For centuries, the values of many currencies were fixed relative to gold. Suppose, for
example, that the price of gold were fixed at $20 per ounce in the United States. This would
mean that the government of the United States was committed to exchanging 1 ounce of gold
to anyone who handed over $20. (That was the case in the United Statesand $20 was
roughly the priceup to 1933.) Now suppose that the exchange rate between the British
pound and gold was 5 per ounce of gold. With 5 and $20 both trading for 1 ounce of gold,
1 would exchange for $4. No one would pay more than $4 for 1, because $4 could always
be exchanged for 1/5 ounce of gold, and that gold could be exchanged for 1. And no one
would sell 1 for less than $4, because the owner of 1 could always exchange it for 1/5
ounce of gold, which could be exchanged for $4. In practice, actual currency values could
vary slightly from the levels implied by their commodity values because of the costs involved
in exchanging currencies for gold, but these variations are slight.
Under the gold standard, the quantity of money was regulated by the quantity of gold in a
country. If, for example, the United States guaranteed to exchange dollars for gold at the rate
of $20 per ounce, it could not issue more money than it could back up with the gold it owned.
Because of this tendency for imbalances in a countrys balance of payments to be corrected
only through changes in the entire economy, nations began abandoning the gold standard in
the 1930s.

The Bretton Woods System

Following the Second World War, the Bretton Woods system (19441973) replaced gold with
the U.S. dollar as the official reserve asset. The regime intended to combine binding legal
obligations with multilateral decision-making through the International Monetary Fund
(IMF). The rules of this system were set forth in the articles of agreement of the IMF and the
International Bank for Reconstruction and Development. The system was a monetary order
intended to govern currency relations among sovereign states, with the 44 member countries
required to establish a parity of their national currencies in terms of the U.S. dollar and to
maintain exchange rates within 1% of parity (a "band") by intervening in their foreign
exchange markets (that is, buying or selling foreign money). The U.S. dollar was the only
currency strong enough to meet the rising demands for international currency transactions,
and so the United States agreed both to link the dollar to gold at the rate of $35 per ounce of
gold and to convert dollars into gold at that price.
Due to concerns about America's rapidly deteriorating payments situation and massive flight
of liquid capital from the U.S., President Richard Nixon suspended the convertibility of the
dollar into gold on 15 August 1971. In December 1971, the Smithsonian Agreement paved
the way for the increase in the value of the dollar price of gold from US$35.50 to US$38 an
ounce. Speculation against the dollar in March 1973 led to the birth of the independent float,
thus effectively terminating the Bretton Woods system.
The Bottom Line
Far from being a period of international cooperation and global order, the years of the Bretton
Woods agreement revealed the inherent difficulties of trying to create and maintain an
international order that pursued both free and unfettered trade while also allowing nations to
pursue autonomous policy goals. The discipline of a gold standard and fixed exchange rates
proved to be too much for rapidly-growing economies at varying levels of competitiveness.
With the demonetization of gold and the move to floating currencies, the Bretton Woods era
should be regarded as a transitional stage from a more disciplinary international monetary
order to one with significantly more flexibility.

Snake In The Tunnel

The snake in the tunnel was the first attempt at European monetary cooperation in the
1970s, aiming at limiting fluctuations between different European currencies. It was an
attempt at creating a single currency band for the European Economic Community (EEC),
essentially pegging all the EEC currencies to one another.
Pierre Werner presented a report on economic and monetary union to the EEC on 8 October
1970. The first of three recommended steps involved the coordination of economic policies
and a reduction in fluctuations between European currencies.
With the failure of the Bretton Woods system with the Nixon shock in 1971, the Smithsonian
agreement set bands of 2.25% for currencies to move relative to their central rate against the
US dollar. This provided a tunnel within which European currencies could trade. However, it
implied much larger bands in which they could move against each other: for example if
currency A started at the bottom of its band it could appreciate by 4.5% against the dollar,
while if currency B started at the top of its band it could depreciate by 4.5% against the
dollar.
If both happened simultaneously, then currency A would appreciate by 9% against currency
B. This was seen as excessive, and the Basel agreement in 1972 between the six existing EEC
members and three about to join established a snake in the tunnel with bilateral margins
between their currencies limited to 2.25%, implying a maximum change between any two
currencies of 4.5%, and with all the currencies tending to move together against the dollar.
This agreement also led to the formal end of the Sterling Area.
The tunnel collapsed in 1973 when the US dollar floated freely. The snake proved
unsustainable, with several currencies leaving and in some cases rejoining. By 1977, it had
become a Deutsche Mark zone with just the Belgian and Luxembourg franc, the Dutch
guilder and the Danish krone tracking it. The Werner plan was abandoned.
The European Monetary System followed the "snake" as a system for monetary coordination
in the EEC.

Foreign Exchange Market

MEANING:
Foreign exchange market is the market in which foreign currencies are bought and sold. The
buyers and sellers include individuals, firms, foreign exchange brokers, commercial banks
and the central bank.
Like any other market, foreign exchange market is a system, not a place. The transactions in
this market are not confined to only one or few foreign currencies. In fact, there are a large
number of foreign currencies which are traded, converted and exchanged in the foreign
exchange market.
DEFINITION OF 'FOREIGN EXCHANGE MARKET'
The market in which participants are able to buy, sell, exchange and speculate on currencies.
Foreign exchange markets are made up of banks, commercial companies, central banks,
investment management firms, hedge funds, and retail forex brokers and investors. The forex
market is considered to be the largest financial market in the world.
INVESTOPEDIA EXPLAINS 'FOREIGN EXCHANGE'
Foreign exchange transactions encompass everything from the conversion of currencies by a
traveler at an airport kiosk to billion-dollar payments made by corporate giants and
governments for goods and services purchased overseas. Increasing globalization has led to a
massive increase in the number of foreign exchange transactions in recent decades. The
global foreign exchange market is by far the largest financial market, with average daily
volumes in the trillions of dollars.

Various Exchange Rate Systems:

1. The Floating Exchange Rate
A floating exchange rate, or fluctuating exchange rate, is a type of exchange rate regime
wherein a currency's value is allowed to fluctuate according to the foreign exchange market.
A currency that uses a floating exchange rate is known as a floating currency. The dollar is an
example of a floating currency.
In a free-floating exchange rate system, governments and central banks do not participate in
the market for foreign exchange. The relationship between governments and central banks on
the one hand and currency markets on the other is much the same as the typical relationship
between these institutions and stock markets. Governments may regulate stock markets to
prevent fraud, but stock values themselves are left to float in the market.
Many economists believe floating exchange rates are the best possible exchange rate regime
because these regimes automatically adjust to economic circumstances. These regimes enable
a country to dampen the impact of shocks and foreign business cycles, and to pre-empt the
possibility of having a balance of payments crisis. However, they also engender
unpredictability as the result of their dynamism.
Advantages:

A free-floating system has the advantage of being self-regulating. There is no need for
government intervention if the exchange rate is left to the market. Market forces also

restrain large swings in demand or supply.

For example, that a dramatic shift in world preferences led to a sharply increased
demand for goods and services produced in Canada. This would increase the demand
for Canadian dollars, raise Canadas exchange rate, and make Canadian goods and

services more expensive for foreigners to buy.

Some of the impact of the swing in foreign demand would thus be absorbed in a rising

exchange rate.
In effect, a free-floating exchange rate acts as a buffer to insulate an economy from
the impact of international events.

Disadvantage:

It is a theoretical concept. In practice, all governments or central banks intervene in

currency markets in an effort to influence exchange rates.

Free-floating exchange rates are unpredictable. Contracts between buyers and sellers
in different countries must not only reckon with possible changes in prices and other
factors during the lives of those contracts, they must also consider the possibility of

exchange rate changes.

For eg., an agreement by a U.S. distributor to purchase a certain quantity of Canadian
lumber each year, will be affected by the possibility that the exchange rate between

the Canadian dollar and the U.S. dollar will change while the contract is in effect.
Fluctuating exchange rates make international transactions riskier and thus increase
the cost of doing business with other countries.

10

2. The Fixed Exchange Rate

A fixed exchange rate system, or pegged exchange rate system, is a currency system in
which governments try to maintain a currency value that is constant against a specific
currency or good. In a fixed exchange-rate system, a country's government decides the worth
of its currency in terms of either a fixed weight of an asset, another currency, or a basket of
other currencies. The central bank of a country remains committed at all times to buy and sell
its currency at a fixed price.
To ensure that a currency will maintain its "pegged" value, the country's central bank
maintains reserves of foreign currencies and gold. They can sell these reserves in order to
intervene in the foreign exchange market to make up excess demand or take up excess supply
of the country's currency.
The most famous fixed rate system is the gold standard, where a unit of currency is pegged to
a specific measure of gold. Regimes also peg to other currencies. These countries can either
choose a single currency to peg to, or a "basket" consisting of the currencies of the country's
major trading partners.

Adjustable Peg

An exchange rate policy adopted by some countries wherein the national currency is largely
pegged or fixed to a major currency such as the U.S. dollar or euro, but can be readjusted
from time to time within a narrow interval. The periodic adjustments can are usually intended
to improve the country's competitive position in the export market.

Basket-of-currencies

Countries often have several important trading partners or are apprehensive of a particular
currency being too volatile over an extended period of time. They can thus choose to peg
their currency to a weighted average of several currencies (also known as a currency basket).
For example, a composite currency may be created consisting of hundred rupees, 100
Japanese yen and one U.S. dollar the country creating this composite would then need to
maintain reserves in one or more of these currencies to satisfy excess demand or supply of its
currency in the foreign exchange market.

11

A popular and widely used composite currency is the SDR, which is a composite currency
created by the International Monetary Fund (IMF), consisting of a fixed quantity of U.S.
dollars, euros, Japanese yen, and British pounds.

Currency boards

A currency board (also known as 'linked exchange rate system") effectively replaces the
central bank through a legislation to fix the currency to that of another country. The domestic
currency remains perpetually exchangeable for the reserve currency at the fixed exchange
rate. As the anchor currency is now the basis for movements of the domestic currency, the
interest rates and inflation in the domestic economy would be greatly influenced by those of
the foreign economy to which the domestic currency is tied. The currency board needs to
ensure the maintenance of adequate reserves of the anchor currency. It is a step away from
officially adopting the anchor currency (termed as dollarization or euroization).
Advantages:

Price stability: Price stability implies that changes in prices are small, gradual, and

expected
Economic stability and prosperity: diminish the short-run fluctuations in a countrys
output, which are also called business cycles. The reason for decreasing volatility in

output may lie in price stability.

The reduction of uncertainty in international trade and portfolio flows: Exchange
rate risk is a barrier to international business. Under the fixed exchange rate regime,
nobody has to use scarce resources to guess the next periods exchange rate.

Disadvantages:

The announced exchange rate may not coincide with the market equilibrium exchange

rate, thus leading to excess demand or excess supply

The central bank needs to hold stocks of both foreign and domestic currencies at all
times in order to adjust and maintain exchange rates and absorb the excess demand or

supply
Fixed exchange rate does not allow for automatic correction of imbalances in the
nation's balance of payments since the currency cannot appreciate/depreciate as

dictated by the market

It fails to identify the degree of comparative advantage or disadvantage of the nation
and may lead to inefficient allocation of resources throughout the world

12

There exists the possibility of policy delays and mistakes in achieving external

balance
The cost of government intervention is imposed upon the foreign exchange market

13

3. The Pegged Float Exchange Rate

Pegged floating currencies are pegged to some band or value, which is either fixed or
periodically adjusted. These are a hybrid of fixed and floating regimes. There are three types
of pegged float regimes:

Crawling bands: The market value of a national currency is permitted to fluctuate

within a range specified by a band of fluctuation. This band is determined by
international agreements or by unilateral decision by a central bank. The bands are
adjusted periodically by the country's central bank. Generally the bands are adjusted
in response to economic circumstances and indicators.

Crawling pegs: A crawling peg is an exchange rate regime, usually seen as a part of
fixed exchange rate regimes that allows gradual depreciation or appreciation in an
exchange rate. The system is a method to fully utilize the peg under the fixed
exchange regimes, as well as the flexibility under the floating exchange rate regime.
The system is designed to peg at a certain value but, at the same time, to "glide" in
response to external market uncertainties. In dealing with external pressure to
appreciate or depreciate the exchange rate (such as interest rate differentials or
changes in foreign exchange reserves), the system can meet frequent but moderate
exchange rate changes to ensure that the economic dislocation is minimized.

Pegged with horizontal bands: This system is similar to crawling bands, but the
currency is allowed to fluctuate within a larger band of greater than one percent of the
currency's value.

14

4. Managed float
Managed float regimes, otherwise known as dirty floats, are where exchange rates fluctuate
from day to day and central banks attempt to influence their countries' exchange rates by
buying and selling currencies. Almost all currencies are managed since central banks or
governments intervene to influence the value of their currencies. So when a country claims to
have a floating currency, it most likely exists as a managed float.
How a Managed Float Exchange Rate Works
Generally, the central bank will set a range which its currency's value may freely float
between. If the currency drops below the range's floor or grows beyond the range's ceiling,
the central bank takes action to bring the currency's value back within range.
Management by the central bank generally takes the form of buying or selling large lots of its
currency in order to provide price support or resistance. For example, if a currency is valued
above its range, the central bank will sell some of its currency it has in reserve. By putting
more of its currency in circulation, the central bank will decrease the currency's value.
Why Do Countries Choose a Managed Float?
Some economists believe that in most circumstances floating exchange rates are preferable to
fixed exchange rates. Floating exchange rates automatically adjust to economic
circumstances and allow a country to dampen the impact of shocks and foreign business
cycles. This ultimately preempts the possibility of having a balance of payments crisis. A
floating exchange rate also allows the country's monetary policy to be freed up to pursue
other goals, such as stabilizing the country's employment or prices.
However, pure floating exchange rates pose some threats. A floating exchange rate is not as
stable as a fixed exchange rate. If a currency floats, there could be rapid appreciation or
depreciation of value. This could harm the country's imports and exports. If the currency's
value increases too drastically, the country's exports could become too costly which would
harm the country's employment rates. If the currency's value decreases too drastically, the
country may not be able to afford crucial imports.
This is why a managed float is so appealing. A country can obtain the benefits of a free
floating system but still has the option to intervene and minimize the risks associated with a
free floating currency. If a currency's value increases or decreases too rapidly, the central

15

bank can intervene and minimize any harmful effects that might result from the radical
fluctuation.

16

5. Dollarization
As an alternative to maintaining a floating currency or a peg, a country may decide to
implement full dollarization. The main reason a country would do this is to reduce its country
risk, thereby providing a stable and secure economic and investment climate. Countries
seeking full dollarization tend to be developing or transitional economies, particularly those
with high inflation.
Many of the economies opting for dollarization already informally use foreign tender in
private and public transactions, contracts, and bank accounts; however, this use is not yet
official policy, and the local currency is still considered the primary legal tender. By deciding
to use the foreign tender, individuals and institutions are protecting against possible
devaluation of the local exchange rate. Full dollarization, however, is an almost permanent
resolution: the country's economic climate becomes more credible as the possibility of
speculative attacks on the local currency and capital market virtually disappears.
The diminished risk encourages both local and foreign investors to invest money into the
country and the capital market. And the fact that an exchange rate differential is no longer an
issue helps reduce interest rates on foreign borrowing.
Disadvantages of Dollarization
There are some substantial drawbacks to adopting a foreign currency. When a country gives
up the option to print its own money, it loses its ability to directly influence its economy,
including its right to administer monetary policy and any form of exchange rate regime.
The central bank loses its ability to collect 'seigniorage', the profit gained from issuing
coinage (the minting of monies costs less than the actual value of the coinage). Instead, the
U.S. Federal Reserve collects the seigniorage, and the local government and gross domestic
product (GDP) as a whole thus suffer a loss of income.
In a fully dollarized economy, the central bank also loses its role as the lender of last resort
for its banking system. While it may still be able to provide short-term emergency funds from
held reserves to banks in distress, it would not necessarily be able to provide enough funds to
cover the withdrawals in the case of a run on deposits.
Another disadvantage for a country that opts for full dollarization is that its securities must be
bought back in U.S. dollars. If the country does not have a sufficient amount of reserves, it

17

will either have to borrow the money by running a current account deficit or find a means to
accumulate a current account surplus.
Finally, because a local currency is a symbol of a sovereign state, the use of foreign currency
instead of the local one may damage a nation's sense of pride.
Advantages of Dollarization
Besides reducing risk and protecting against inflation and devaluation, there are some
compelling reasons for a country to decide to give up so much control over its economy.
As we mentioned above, full dollarization creates positive investor sentiment, almost
extinguishing speculative attacks on the local currency and the exchange rate. The result is a
more stable capital market, the end of sudden capital outflows, and a balance of payments
that is less prone to crises.
Last but not least, full dollarization can improve the global economy by allowing for easier
integration of economies into the world's market.
Conclusion
Many emerging economies already use dollarization to some extent or another. However,
many have shied away from it because economies that would consider full dollarization are
those that are still developing. For many countries, having an autonomous economic policy
and the sense of individual statehood that comes with it is too much to give up for full
dollarization, an extreme option that is for the most part irreversible.

18

VARIOUS PARTICIPANTS OF FOREIGN EXCHANGE MARKET:

1. Governments
Governments have requirements for foreign currency, such as paying staff salaries and local
bills for embassies abroad, or for arraigning a foreign currency credit line, most often in
dollars, for industrial or agricultural development in the third world, interest on which, as
well as the capital sum, must periodically be paid. Foreign exchange rates concern
governments because changes affect the value of product and financial instruments, which
affects the health of a nations markets and financial systems.
2. Banks
There are different types of banks, all of which engage in the foreign exchange market to
greater or lesser extent. Some work to signal desired movement in the market without causing
overt change, while some aggressively manage their reserves by making speculative risks.
The vast majority, however, use their knowledge and expertise is assessing market trends for
speculative gain for their clients
3. Central Bank
External value of the domestic currency is controlled and assigned by central bank of every
county. Each country has a central or apex bank. For example In India Reserve Bank of India
is the central Bank
4. Brokering Houses
These exist primarily to bring buyer and seller together at a mutually agreed price. The broker
is not allowed to take a position and must act purely as a liaison. Brokers receive a
commission from both sides of the transaction, which varies according to currency handled.
The use of human brokers has decreased due mostly to the rise of the interbank electronic
brokerage systems
5. International Monetary Market
The International Monetary Market (IMM) in Chicago trades currencies for relatively small
contract amounts for only four specific maturities a year. Originally designed for the small
investor, the IMM has grown since the early 1970s, and the major banks, who once dismissed

19

the IMM, have found that it pays to keep in touch with its developments, as it is often a
market leader.
6. Money Managers
These tend to be large New York commission houses that are often very aggressive players in
the foreign exchange market. While they act on behalf of their clients, they also deal on their
own account and are not limited to one time zone, but deal around the world through their
agents.6. Corporations: Corporations are the actual end-users of the foreign exchange market.
With the exception only of the central banks, corporate players are the ones who affect supply
and demand. Since the corporations come to the market to offset currency exposure they
permanently change the liquidity of the currencies being dealt with.
7. Retail Clients
This includes smaller companies, hedge funds, companies specializing in investment services
linked by foreign currency funds or equities, fixed income brokers, the financing of aid
programs by registered worldwide charities and private individuals. Retail investors trade
foreign exchange using highly leveraged margin accounts. The amount of their trading in
total volume and in individual trade amounts is dwarfed by the corporations anointer bank
markets.
8. Commercial Bank
Commercial banks are the one which has the most number of branches. With its wide branch
network the Commercial banks buy the foreign exchange and sell it to the importers. These
banks are the most active among the market players and also provide services like converting
currency from one to another.
9. Exchange Brokers
Services of brokers are used to some extent, Forex market has some practices and tradition
depending on this the residing in other countries are utilised. Local brokers can conduct
Forex transactions as per the rules and regulations of the Forex governing body of their
respective country.

20

10. Overseas Forex market

The Forex market operates all around the clock and the market day initiates with Tokyo and
followed by Bahrain Singapore, India, Frankfurt, Paris, London, New York, and Sydney
before things is back with Tokyo the next day.
11. Speculators
In order to make profit on the account of favorable exchange rate, speculators buy foreign
currency if it is expected to appreciate and sell foreign currency if it is expected to depreciate.
They follow the practice of delaying covering exposures and not offering a cover till the time
cash flow is materialized.
12. Other financial institutions involved in the foreign exchange market include:

Stock brokers Commodity

Firms Insurance

Companies Charities

Private Institutions

Private Individuals

21

CHARACTERISTICS OF FOREIGN EXCHANGE MARKET

1. Changing Wealth:
The ratios between the currencies of two countries are exchange rates in forex. If one
currency loss its value in the market and at the same time the value of the currency increases
this causes the fluctuations in the exchange rate in foreign exchange market. For Example,
over 20 years ago a single US dollar bought 360 Japanese Yen, whereas at present1 US dollar
buys 110 Japanese Yen; this explains that the Japanese Yen has risen in value, and the US
dollar has decreased in value (relative to the Yen). This is said to be a shift in wealth, as a
fixed amount of Japanese Yen can now purchase many more goods than two decades ago.
2. No Centralized Market
The foreign exchange market does not have a centralized market like a stock exchange.
Brokers in the foreign exchange market are not approved by a governing agency. Business
network and operation market of foreign exchange takes place without any unification in
transaction. Foreign exchange currency trading has been reformed into a non-formal and
global network organization it consists of advanced information system. Trader of forex
should not be a member of any organization.
3. Circulation work
Foreign exchange market has member from all the countries, each country has different geo
graphical positions so forex operates all around the clock on working days (i.e.) Monday to
Friday every week. Because the time in Australia is different than in European countries, this
kind of 24 hours operation, free from any time is an ideal environment for investors. For
instance, a trader may buy the Japanese Yen in the morning at the New York market, and in
the night if the Japanese Yen rises in the Hong Kong market, the trader can sell in the Hong
Kong market. More number of opportunities is available for the forex traders. In FOREX
market most trading takes place in only a few currencies; the U.S. Dollar ($), European
Currency Unit (), Japanese Yen (), British Pound Sterling (), Swiss Franc

22

FOREIGN EXCHANGE MARKET IN INDIA

The foreign exchange market India is growing very rapidly. The annual turnover of the
market is more than $400 billion. This transaction does not include the inter-bank
transactions. According to the record of transactions released by RBI, the average monthly
turnover in the merchant segment was $40.5 billion in 2003-04 and the inter-bank transaction
was $134.2 for the same period.
The average total monthly turnover was about $174.7 billion for the same period. The
transactions are made on spot and also on forward basis, which include currency swaps and
interest rate swaps.
The Indian foreign exchange market consists of the buyers, sellers, market intermediaries and
the monetary authority of India. The main centre of foreign exchange transactions in India is
Mumbai, the commercial capital of the country. There are several other centres for foreign
exchange transactions in the country including Kolkata, New Delhi, Chennai, Bangalore,
Pondicherry and Cochin.
The foreign exchange market India is regulated by the reserve bank of India through the
Exchange Control Department. At the same time, Foreign Exchange Dealers Association
(voluntary association) also provides some help in regulating the market. The Authorized
Dealers (Authorized by the RBI) and the accredited brokers are eligible to participate in the
foreign Exchange market in India. When the foreign exchange trade is going on between
Authorized Dealers and RBI or between the Authorized Dealers and the overseas banks, the
brokers have no role to play.
Apart from the Authorized Dealers and brokers, there are some others who are provided with
their stricter rights to accept the foreign currency or travellers cheque. Among these, there
are the authorized money changers, travel agents, certain hotels and government shops. The
IDBI and Exim bank are also permitted conditionally to hold foreign currency.
The whole foreign exchange market in India is regulated by the Foreign Exchange
Management Act, 1999 or FEMA. Before this act was introduced, the market was regulated
by the FERA or Foreign Exchange Regulation Act, 1947. After independence, FERA was
introduced as a temporary measure to regulate the inflow of the foreign capital. But with the
economic and industrial development, the need for conservation of foreign currency was felt

23

and on their commendation of the Public Accounts Committee, the Indian government passed
the Foreign Exchange Regulation Act, 1973 and gradually, this act became famous as FEMA

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FINANCIAL INSTRUMENTS OF FOREIGN EXCHANGE MARKET

Spot Market
Spot market involves the quickest transaction in the foreign exchange market. This involves
immediate payment at the current exchange rate is called as spot rate. The spot market
accounts for 1/3rdof all the currency exchange, trades in Federal Reserve that takes place
within two days of the agreement. The traders open to the volatility of the currency market,
which can raise or lower the price between the agreement and the trade.
Futures Market
These kind transactions involve future payment and future delivery at an agreed exchange
rate. Future market contracts are standardized, it is non-negotiable and the elements of the
agreement are set. It also takes the volatility of the currency market, specifically the spot
market, out of the equation. This type of market is popular for Steady return on their
investment that is done on large currency transactions.
Forward Market
The terms are negotiable between the two parties. The terms can be changes according to the
needs of the participants. It allows for more flexibility. Two entities swap currency for an
agreed amount of time, and then return the currency at the end of the contract.
Swap Transactions
In swap two parties are involves where they exchange the currencies for certain time and
agree to reserve the transaction at a later date. Swap is the most commonly used forward
Transaction. In swap transaction it is not traded through the exchange and there is no
standardization. Until the transaction is completed the deposit is required to hold the position.

25

ADVANTAGES AND DISADVANTAGES OF FOREIGN EXCHANGE MARKET.

Advantages
1. The forex market is extremely liquid; hence its rapidly growing popularity.
Currencies may be converted when bought or sold without causing too much
movement in the price and keeping losses to a minimum.
2. As there is no central bank, trading can take place anywhere in the world and operates
on a 24-hour basis apart from weekends.
3. An investor needs only small amounts of capital compared with other investments.
Forex trading is outstanding in this regard.
4. It is an unregulated market, meaning that there is no trade commission overseeing
transactions and there are no restrictions on trade.
5. In common with futures, forex is traded using a good faith deposit rather than a
loan. The interest rate spread is an attractive advantage.
Disadvantages
1. The major risk is that one counterparty fails to deliver the currency involved in a very
large transaction. In theory at least, such a failure could bring ruin to the forex market
as a whole.
2. Investors need a lot of capital to make good profits because the profit margins on
small-scale trades are very low.

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Conclusion
When trading on Forex markets, it is very important to understand different exchange rate
regimes which countries have adopted. The main types are as follows: a floating exchange, a
pegged floating exchange, and a fixed rate exchange.
The floating exchange rate regime is the most popular one and is adopted in many different
countries. The USD, EUR, JPY, GBP are all examples of currencies that are floating freely.
In

these

instances,

market

participants

are

determining

current

rates

through

increasing/decreasing supply or demand. Central banks sometimes intervene in free market

operations in order to minimize excessive volatility in the value of a currency. Some
commentators would use the term managed float in these cases.
A pegged float regime is a system of pegging a countrys currency to a band or value, which
may be fixed or periodically adjusted. A peg helps importers and exporters to minimize their
exchange rate risk allowing them to plan safely enough regarding their future trade
operations. It is also helps to ease the inflationary pressures.
However, the Indian currency markets are well-regulated and there is almost no counter-party
risk. Investors should start small and gradually invest more. Liberalization has transformed
Indias external sector and a direct beneficiary of this has been the foreign exchange market
in India. From a foreign exchange-starved, control- ridden economy, India has moved on to a
position of $150 billion plus in international reserves with a confident rupee and drastically
reduced foreign exchange control. As foreign trade and cross-border capital flows continue to
grow, and the country moves towards capital account convertibility, the foreign exchange
market is poised to play an even greater role in the economy, but is unlikely to be completely
free of RBI interventions any time soon.

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Bibliography/Webliography
Investopedia.com
Wikipediea.com
Academyft.com
Yourarticlelibrary.com
business-standard.com