The foreign exchange market or the forex market is the market in which the participants sell, buy, exchange and speculate currencies. The interbanks, central banks, commercial companies, hedge funds, investment management firms, hedge funds, investors and retail forex brokers together make the foreign exchange market. This market is considered as the largest financial market in the world.
The forex market is believed to be the most active and efficient financial market in the world as this currency market is large and highly liquid. The market is not a single exchange; rather it is constructed of a global network of computers, which links the participants from all over the world.
Unlike any other market, the forex market is a system, it has no physical existence. It is an iver the counter market. The transactions are not bound to only one or few foreign currencies. A large number of foreign currencies are exchanged, traded or converted in this market.
Some of the functions of the foreign exchange market are discussed below.
The foreign exchange market mainly operates three functions. They are-
Transfer functions:
Transfer function refers to the function that transfers purchasing ability between the countries who are involved in the currency transaction. Through credit instrument (bank drafts, foreign exchange bills, telephonic transfers etc) transfer function is performed.
Credit function:
Credit functions are generally operated for international trade. In order to do foreign trade, this function provides credit. Credit requires bills of exchange with maturity period of three months. This period of time is required because it allows the importer to take possession of good and sell them in order to obtain money to pay off the bill.
Hedging function:
In order to sell and buy goods in some future date at current prices and exchange rate, an agreement occurs between exporters and the importers. This agreement is known as hedging function. Losses, which can be occurred due to exchange rate fluctuations in the future, can be avoided by hedging.
On the basis of forex transactions, the forex market can be classified into two kinds. They are Spot market and forward market.