International Economics >> The Foreign Exchange Market and Its Functions
Foreign Exchange Market
The foreign exchange market is the market in which 'foreign currencies are bought and sold by the individuals, firms, banks and foreign exchange brokers. It is constituted of the central banks, brokers, commercial banks, exporters and importers, investors, tourists and immigrants. These main players of the market make the structure of the foreign exchange market as shown in Fig. 15.1. As the figure shows, at the bottom of the foreign exchange market are the actual buyers and sellers of the foreign currencies-exporters, importers, tourists, investors and immigrants. They are the actual users of the foreign exchange. Those who need a foreign currency approach the commercial banks to buy the currency.
Commercial banks make the second and the important organ of the foreign exchange market. Banks dealing in foreign exchange play the role 'of 'market makers' in the sense that they quote the daily exchange rates for buying and selling. They work also as the clearing houses. They help in wiping out the difference Between the demand for and supply of a currency. They buy foreign currency from the brokers and sell to the buyers.
Foreign exchange brokers make the third layer of the market. Brokers work as link between the central bank and the commercial banks and also between the banks. They are the major source of market information and they work as a link between the actual buyers and the banks. They themselves do not buy or sell the foreign currency-they only strike the deal between the buyers and sellers on commission basis.
The central banks are apex body in the organization of the foreign exchange market. They work as the 'custodian of the foreign exchange of the country' and 'lender of the last resort'. They have the power to control and regulate the foreign exchange market with a view to make sure that the foreign exchange market works in an orderly fashion. One of their main functions is to prevent the violent fluctuations in the exchange rate by direct intervention. The main form of their intervention is to sell a foreign currency when it gets overvalued and buy it when it tends to be overvalued.
Foreign exchange market is the biggest market in the world today, daily transaction exceeding $ 100 billion. Most major countries have foreign exchange market centres. London, New York, Paris, Tokyo, Zurich, Frankfurt, Singapore are some famous foreign exchange market centres for US dollar. The foreign exchange market centres are very well connected with each other by telecommunication system and they work 24 hours.
Functions of the Foreign Exchange Market
The foreign exchange markets perform the following functions. The functions of the foreign exchange markets are, in fact, the outcome of their working. (i) In the process of their working, they transfer funds (foreign currency) from one country to another where they are needed in the settlement of payments; (ii) They provide short-term credit to the importers and, thereby, facilitate the smooth flow of goods and services from one country to another; and (iii) The spot and forward markets work in such a way that helps often in stabilizing the foreign exchange rate.
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