What is Foreign Exchange Market
Foreign exchange market is a market for buying and selling of foreign currencies. It is a global online network where currencies of different countries sell and buy. Foreign exchange market determines the exchange rate for currencies around the world. This market is also termed as Currency, FX or forex market. Its structure comprises of individuals, firms, commercial banks, central bank, importers and exporters, investors, broker, immigrants, tourists.
Foreign exchange market is a system and do not have any physical location. This market operates 24 hours a day from 5 p.m. EST on Sunday to 4 p.m. EST on Friday. It is the world’s most liquid financial market. Trading of currencies in foreign exchange market always take place in pairs so that value of one of currencies in that pair is relative to value of other.
This global market has two tiers. First one is known as interbank market and second one is known as over-the-counter market. Interbank market is the one where bigger banks trade and exchange currencies with each other. On the other hand over the counter market is the one where individuals and companies trade and has become very popular market as now there are several companies that provides online trading platforms.
Types of Foreign Exchange Market
Different types of Foreign exchange market are as follows:
Spot market is a market in which quick transactions regarding currency exchange takes place. Here buying and selling of currencies is done for immediate delivery. Immediate payment at the current exchange rate is provided to buyers and sellers in spot market. Trade in spot market takes one or two days for settlement of transactions and allows traders open to the volatility of currency market. This can increase or decrease price, between agreement and trade. Spot market almost accounts for one third of currency exchange transactions.
It is a market in which transactions are done for doing trade at some future date. Here both payment and delivery are done at future date at agreed exchange rate also termed as forward exchange rate. Contract is made between buyers and sellers for sale and purchase of currency after 90 days. Forward contracts are non-standardized contracts. It means that these contracts can be customized or tailored according to the needs of participants. At the time of entering contract, no security deposit is required as no money exchange takes place.
Future market is also similar to the forward market. In future market, contract are made between buyers and sellers to do trade in future. All payments and delivery in this market are done at decided exchange rate which is also termed as future rate. Whereas future contracts are standardized contracts and cannot be customized. These contracts are standardized in terms of their date, features, size and cannot be negotiated. Trading on future market is centralized on stock exchanges like BSE, NSE and KOSPI.
Swap market is one where transactions for simultaneous lending and borrowing of two different currencies are done between investors. It is a contract between two or more parties for exchanging cash flows on the basis of predetermined notional principal amount. In swap market, there two types of swap transactions done that are currency swap and interest swap. Currency swap is an exchange of fixed currency rate of one country with floating currency rate of another country. Interest swap means exchange of floating interest rate with a fixed rate of interest.
Option market is one where transactions are done for exchanging one currency with at agreed rate and on specified date. Under option contract, it is an option for an investor to convert the currency but not under any obligation to do so. Buyer of option has the right but not an obligation to sell or purchase the underlying currency in contract at future date and at agreed rate. Options are of two types that is call option and put option. Put option gives the right to sell and call option gives the right to buy.