Forex Market

FOREX Market A foreign exchange market is a place in which foreign exchange transactions take place. In other words it is a market where foreign money are bought and sold. It is a part of money market in the financial center. The basic and primary function of a foreign exchange market is to transfer purchasing power between countries. The transfer function is performed through T.T, M.T, Draft, Bill of exchange, Letters of credit, etc. the bill of exchange is the most important and effective method of transferring purchasing power between two parties located in different countries. Another important function of foreign exchange market is to provide credit to the importer debtor. The exporters draw the bill of exchange on importers on their bankers. On acceptance of the bills by the importer or their bankers, the exporter will get the money realized on the maturity of the bills. In case the exporters are anxious to receive the payment earlier, the bills can be discounted from their bankers, or foreign exchange banks or discount houses. The foreign exchange market performs the hedging function covering the risks on foreign exchange transactions. There are frequent fluctuations in exchange rates. If the rate is favourable, the exporter will gain and vice verse. In order to avoid the risk involved, the foreign exchange market provides hedges or actual claims through forward contracts in exchange against such fluctuations. The agencies of foreign currencies guarantee payment of foreign exchange at a fixed rate. The exchange agencies bear the risks of fluctuation of exchange rates.

Functions of the Forex Market The Gold Standard

A gold standard is a system in which countries agree to buy and sell gold at a defined number of currency units (Ball et al., 2006). This, in effect, created the exchange rate between nations currency by taking the difference between the currency determinations and creating a product that would be valued the same if the currencies were identical (Ball et al., 2006). There are positive and negative aspects of using a gold standard. The exchange rates in FOREX are set then by the market and not by governments (Ball et al., 2006), thus referred to as the floating currency exchange rate. Other approaches to determining the exchange rate like the purchasing power parity (PPP) theory which states that exchange rates in the long run will adjust to equalize the purchasing power of differing currencies (Ball et al., 2006). Therefore, products in competitive markets will sell for identical prices when valued in the same currency (Cross, 1998). The PPP relies on a portion of another approach in determining exchange rates, balance of payments (BOP). BOP approach relies on assessing foreign exchange flows and evaluating balance of payments on current and capital accounts (Cross, 1998). Even with these determinations, the biggest player in defining the exchange rates rely on supply and demand of American goods and currency.

Points of Bretton Woods System The main points of the postwar system evolving from the Bretton Woods agreement that are important for our purposes can be summarized as follows: 1. A new institution, The International Monetary Fund (IMF), would be established in Washington, D.C. Its purpose would be to lend foreign exchange to any member whose supply of foreign exchange had become scarce. This lending would not be automatic, but would be conditional on the member's pursuit of economic policies consistent with the other points of the agreement, a determination that would be made by the IMF.

2. The U.S. dollar (and, de facto, the British pound) would be designated as reserve currencies, and other nations would maintain their foreign exchange reserves principally in the form of dollars or pounds. 3. Each Fund member would establish a par value for its currency, and maintain the exchange rate for its currency within 1 percent of par value. In practice, since the principal reserve currency would be the U.S. dollar, this meant that other countries would peg their currencies to the U.S. dollar, and--once convertibility was restored-would buy and sell U.S. dollars to keep market exchange rates within the 1 percent band around par value. The United States, meanwhile, separately agreed to buy gold from or sell gold to foreign official monetary authorities at $35 per ounce in settlement of international financial transactions. The U.S. dollar was thus pegged to gold, and any other currency pegged to the dollar was indirectly pegged to gold at a price determined by its par value. 4. A Fund member could change its par value only with Fund approval and only if the country's balance of payments was in "fundamental disequilibrium." The meaning of fundamental disequilibrium was left unspecified, but everyone understood that par value changes were not to be used as a matter of course to adjust economic imbalances. 5. After a postwar transition period, currencies were to become convertible. That meant, to anyone who was not a lawyer, currencies could be freely bought and sold for other foreign currencies. Restrictions were to be removed, and hopefully eliminated. So, in order to keep market exchange rates within 1 percent of par value, central banks and exchange authorities would have to build up a stock of dollar reserves with which to intervene in the foreign exchange market.

6. The Fund would get gold and currencies to lend through "subscription." That is, countries would have to make a payment (subscription) of gold and currency to the IMF in order to become a member. Subscription quotas were assigned according to a member's size and resources. Payment of the quota normally was 25 percent in gold and 75 percent in the member's own currency. Those with bigger quotas had to pay more but also got more voting rights regarding Fund decisions.