foreign exchange

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DEFINITIONS Foreign Exchange The system of converting one national currency into another, and of transferring money from one country to another.

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Foreign Exchange Market Forex market is a place in which foreign exchange transactions take place. A market in which National currencies are bought and sold against one another The foreign exchange market is one of the largest markets in the world. By some estimates, about 3.2 trillion USD worth of currency changes hands every day.

Features of Foreign Exchange Market:

Features of Foreign Exchange Market The foreign exchange market is unique because of trading volume results in market liquidity geographical dispersion continuous operation: 24 hours a day except weekends the variety of factors that affect exchange rates the use of leverage to enhance profit margins with respect to account size


Participants Individuals: tourists, migrants Firms: importers and exporters Banks: commercial & central banks Governments / monetary authorities International agencies


Example As India import rises the demand for foreign currency increases which in result changes the exchange rate as the value of foreign currency increases with compared to domestic currency.

Functions of Forex Market:

Functions of Forex Market Transfer of Purchasing power Provision of credit Provision of hedging facilities

Determinants of Foreign Exchange Market:

Determinants of Foreign Exchange Market Long – term Factors Short-term Factors

Long-term Factors:

Long-term Factors Balance of Payments

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Strength of economy The relative strength of an economy has effect on demand and supply of foreign currencies. If an economy is growing at a faster rate, in the long-run, it is generally expected to have a better performance on Balance of Trade .

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Interest rate The capital is attracted towards currencies yielding higher interest rates, provided there is full currency convertibility in capital account.

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Inflation A higher rate of inflation will make a country’s currency less attractive because of the loss of real value with inflation. ◦ Hence, that currency would depreciate against major currencies.

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Money Supply An increase in money supply will affect the exchange rate through causing inflation in the country. It can also affect the exchange rate directly in the short run.

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National Income An increase in the national income will lead to an increase in investment or in consumption and accordingly, its effect on the exchange rate will change.

Short term factors:

Short term factors Central bank intervention Buying and selling of foreign currency in the market by the Central Bank with a view to increasing the supply or demand, there by affecting the exchange rate, is known as intervention.

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Export receipts and import payments The difference between the total receipts from export bill realizations and import payments on a given day in a country determines the exchange rate to some extent.

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Foreign investment flows Both foreign direct and portfolio investment inflows and outflows affect the exchange rates.

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Political factors Factors like war. Announcement of election results, oil price increase etc will cause exchange rate fluctuations.

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Speculation If a few big speculators start buying a currency in an aggressive manner, others may follow suit. Thus, the demand of the currency may increase.

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Capital Movements Movement will be caused by external borrowings and assistance. Large-scale external borrowing will have favorable effect on the exchange rate of the country’s currency.


FEMA The Foreign Exchange Management Act or in short FEMA has been introduced as a replacement for earlier Foreign Exchange Regulation Act (FERA). FEMA came into act on the 1st day of June, 2000. The main objective behind the Foreign Exchange Management Act (1999) is to consolidate and amend the law relating to foreign exchange with objective of facilitating external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India. FEMA is applicable to the all parts of India. The act is also applicable to all branches, offices and agencies outside India owned or controlled by a person who is resident of India. FEMA head-office also known as Enforcement Directorate is situated in New Delhi and is headed by a Director. The Directorate is further divided into 5 zonal offices at Delhi, Bombay, Calcutta, Madras and Jalandhar and each office is headed by a Deputy Directors. Each zone is further divided into 7 sub-zonal offices headed by the Assistant Directors and 5 field units headed by the Chief Enforcement Officers


Conclusion Liquid Investment- foreign exchange market has the advantage of being extremely liquid. What this means is that investors would be able to withdraw from their investments at any point in time relatively easily. This is due to the fact that the foreign exchange market has a global market, which means searching for a buyer to purchase a particular currency which you are interested to sell is usually not a big problem. Convenience -foreign currency exchange trading is extremely convenient. Organized as an over-the-counter market, foreign exchange traders from all over the world are brought into contact each day via the internet. This means that traders would be able to trade with one another 24 hours a day, five days a week. FACILITATES TRADE AND DEVELOPMENT

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