Foreign Exchange Market

Each nation has its own official currency, which is normally issued by the central bank of that country.  The official currency is used for denominating trade transactions that happen within each country’s domestic geographical area.  In today’s global village, however, firms operating in different countries often conduct trade with each other.  When goods are traded across boundaries, the selling and buying firms prefer to receive pay consideration in a currency of their choice.  Further, firms as well as governments borrow both domestically and internationally.  When they trade or borrow internationally, multiple currencies come into play.  Thus, there has to be a market that enables participants to buy or sell currency in such a way that they can convert the inflows or outflows into the currency of their choice.  The market that facilitates such exchange of currencies is the Foreign Exchange Market.  The Foreign Exchange Market is largely an Over-The-Counter (OTC) market. While foreign exchange deals frequently take place between residents of different countries, the money being traded never actually leaves the country of the currency. Thus, when a US company exports to a foreign country of India, for example, foreign exchange is required. The people manufacturing and performing services in the United States must be paid in local currency, US dollars. The people consuming the goods and services in India have only their local currency, Rupees with which to pay. There are now two possibilities for settling the account between the United States and India. The US exporter bills the Indian importer either in US dollars or in Rupees. Commercial Banks are the main participants in the Foreign Exchange Market. Indeed, one say that it is the commercial banks that “make a market” in foreign exchange. Next in importance are the large Corporations with foreign trade activities. Finally, central banks are present in the foreign exchange market.