Get AHSEC Class 12 Finance Chapter: 8 FOREIGN EXCHANGE MARKET Important Questions Answers 2025.
In this Post we have provided HS 2nd Year Finance Chapter: 8 FOREIGN EXCHANGE MARKET Important Notes with Marked/highlighted previous year questions asked in AHSEC Examination.
AHSEC Class 12 Finance Notes
Chapter: 8 FOREIGN EXCHANGE MARKET
FOREIGN EXCHANGE MARKET
1. What is meant by Foreign Exchange? Give some definitions.
Ans: Foreign exchange means the process of converting one country’s currency into another’s. For example, if someone in India, exchanging Indian Rupees for US Dollars is a foreign exchange transaction. It’s crucial for international trade and finance. In simpler terms, it’s the way countries settle debts and trade with each other. It involves rates that determine how much of one currency you get in exchange for another. These rates are not fixed; they fluctuate due to supply and demand.
Foreign Exchange Regulation Act defines foreign exchange as foreign currency and includes various financial instruments that can be paid in foreign currency. In essence, foreign exchange is the currency swapping system that powers global commerce and finance. Foreign exchange is the process of converting a home country’s currency into foreign currency and vice versa. For instance, in India, the American Dollar is considered foreign exchange, while in the United States, the Indian Rupee serves as foreign exchange.
In simple words, It is the method by which nations clear their financial obligations/settlement with each other nation. When one country’s residents buy goods or services from another country, they must exchange their domestic currency for the foreign currency. This currency exchange is known as foreign exchange. Definitions:
According to Encyclopedia Britannica, “Foreign Exchange is the system by which commercial nations discharge their debts to each other”. According to Crowther, “The rate of exchange measures number of units of one currency which is exchanged in the foreign market for one unit of another”. According to Dr. Paul Einzing “Foreign Exchange is the system or process of converting one national currency into another and of transferring money from one country to another”. As per the Foreign Exchange Regulation Act (FERA) of 1973, “foreign exchange” encompasses foreign currency, covering several aspects: Deposits, credits and balances that can be settled in foreign currencies. Drafts, traveler’s cheques, letters of credit and bills of exchange, which may be expressed or drawn in Indian currency but are payable in foreign currency. Instruments that can be settled in either Indian currency or foreign currency, or a combination of both, as per the choice of the payer, holder, or any involved party. It should be noted that Exchange Rates are not constant; they continuously fluctuate. These fluctuations are influenced by the dynamics of supply and demand of currencies.
2. What do you mean by Foreign Exchange Market?
Ans: The foreign exchange market, often called the “forex market,” is where people exchange different national currencies. It plays a crucial role in international trade and investments. This market is like a platform where individuals, businesses, banks and governments trade foreign currencies.
In essence, the foreign exchange market is a place for buying and selling foreign currencies. Exporters sell foreign currencies, while importers buy them. Banks, businesses, incividuals and governments all participate in this market. It’s a part of the broader money market. Definitions: According to Kindleberger, “Foreign exchange market is a place where foreign moneys are bought and sold”. According to RBI, “The market in which national currency is a exchanged for the foreign currency is known as the foreign exchange market”.
The “Rate of Exchange” is important in this market. It tells us how much currency of one country can be exchanged for another. For instance, if the exchange rate between the American Dollar and Indian Rupee is $1 = Rs. 82.43, then buying $1 would cost us Rs. 82.43. This market is also known as the Over-the-counter (CTC) Market. Unlike traditional markets with physical locations, the foreign exchange market is electronic. It operates 24 hours a day through telephones, computers, telex and fax machines, allowing buyers and sellers to connect and trade currencies worldwide.
3. Discuss the features of foreign exchange market. [AHSEC 2024]
Ans: Following are the features of foreign exchange market:
i. Global Market: It’s a worldwide market where buyers and sellers come from various countries. They connect through global communication networks and geographical boundaries don’t restrict their transactions.
ii. Continuous Operation: The forex market operates 24 hours a day, excluding weekends. It never closes, allowing for constant trading opportunities.
iii. Over-the-Counter (OTC) Market: It’s an over-the-counter market, meaning there is no specific physical location for trading. Instead, it functions electronically across the globe.
iv. Largest Market: Due to its global nature, it’s the largest market in terms of trading volume. Massive transactions occur daily.
v. High Liquidity: Liquidity is a notable feature. Traders can buy or sell currencies at any time according to their preferences. The extensive trading activity and large transaction volumes ensure ample liquidity. vi. Market Transparency: Participants in the forex market have access to comprehensive market data and information. With an internet connection, traders can easily monitor currency price fluctuations from various countries.
4. Who are the participants in the foreign exchange market?
Ans: The primary participants in the foreign exchange market include commercial banks, non-banking financial institutions, foreign exchange brokers, acceptance houses, corporations, central banks and individuals. Buyers and sellers of foreign exchange are the key players in this market.
Participants in the foreign exchange market are: Commercial Banks: These banks are major players in the market. They have branches in different countries and handle various foreign exchange transactions. They can sell or buy foreign currencies to balance their holdings.
Central Bank: The central bank of country is a key official participant. It regulates and supervises the foreign exchange market to stabilize exchange rates. Central banks act as both buyers and sellers to prevent extreme rate fluctuations.
Brokers: Banks often use foreign exchange brokers as intermediaries to connect buyers and sellers. Brokers bring them together, saving time and effort. They receive a commission for their services.
Non-Banking Financial Institutions: Other financial institutions also engage in foreign exchange transactions alongside their primary operations.
Acceptance Houses: These entities assist exporters and importers by accepting bills on their behalf, facilitating foreign fund transfers,
Corporations: Many multinational corporations operate in different countries, requiring them to handle foreign currencies for employee payments and other financial transactions.
Individuals: Individuals may participate to obtain foreign currency for travel or business needs, although their involvement is relatively small compared to the overall market.
5. What are the functions of foreign exchange market?
Ans: The foreign exchange market serves several functions: Transfer Function: Its primary role is transferring foreign currencies between countries. This involves converting one currency into another, achieved through methods like telegraphic transfers, foreign bills of exchange, letters of credit and bank drafts. Credit Function: The market offers credit facilities to promote international trade. Importers and exporters can access short-term credit. Exporters can obtain pre-shipment and post-shipment credit, while importers use it for financing their imports.
Hedging Function: Another crucial function is providing hedging opportunities. Hedging is a way to protect against exchange rate fluctuations. It helps exporters and importers safeguard themselves from potential losses due to currency value changes.
6. What are the sub divisions of foreign exchange market?
Ans: The foreign exchange market can be divided into two main segments:
1. Retail Market 2. Wholesale Market
1. Retail Market: In the retail market, transactions take place between regular customers and commercial banks or Authorized Money Changers (AMC). Here, individuals exchange currencies like banknotes, traveler’s cheques and drafts. Foreign currency can be obtained from commercial banks or authorized money changers and selling foreign currency is also possible through these entities. Transaction volumes are relatively small, with certain businesses in India holding RBI licenses to handle foreign currency. AMC entities operate under RBI authorization as per the Foreign Exchange Management Act, 1999.
2. Wholesale Market[AHSEC 2024]: This market exists to help individual banks manage large purchases or sales. The wholesale market can be further categorized based on how it operates: a. Interbank Market: This is essentially the core of the wholesale market. Banks trade in currencies held in different currency-dominated bank accounts. They assist in transferring bank deposits from the seller’s account to the buyer’s account. No physical exchange of currency occurs; instead, it involves accounting entries in the customer’s deposit accounts with the bank. While there are only a few traders in the interbank market, the transaction volumes are very high. Banks don’t charge commissions for currency transactions but profit from the differences between buying and selling rates.
The interbank market can be divided into:
i. Direct Market: Banks directly negotiate buying and selling exchange rates with each other. 11. Indirect Market: Banks in this segment don’t engage directly with customers but use foreign exchange brokers.
b. Central Bank: The central bank is another component of the wholesale market. It doesn’t interact directly with the public for foreign exchange transactions. Instead, it works through authorized dealers, typically commercial banks. The central bank’s primary role is to oversee, monitor and control the foreign exchange market. It aims to stabilize foreign exchange rates. In India, the RBI has strict rules for foreign exchange, where all foreign exchange needed for payments to foreigners or foreign countries must be purchased from the government and all payments received in foreign currency must be deposited with the government.
7. Write a short note on: (a) Retail Market (b)Interbank Market (c) Central Bank as a part of wholesale market
(a) Retail Market: In the retail market, transactions take place between regular customers and commercial banks or Authorized Money Changers (AMC). People exchange banknotes, traveler’s cheques, drafts among themselves, banks and tourists in this market. If someone needs foreign currency, they can get it from commercial banks or authorized money changer businesses. Conversely, those wanting to sell foreign currency can do so through these banks or authorized money changer outlets. While there are many traders in the retail market, the transactions are relatively small in volume. Some shops, hotels and firms have licenses from the Reserve Bank of India (RBI) to deal in foreign currency notes, coins and traveler’s cheques. AMC entities are authorized by the RBI under the Foreign Exchange Management Act, 1999.
(b) Interbank Market: This forms the core of the wholesale market. Banks trade currencies held in various accounts. They facilitate the transfer of bank deposits between seller and buyer accounts. No physical currency changes hands; instead, it involves accounting entries in customer deposit accounts. Few traders are involved, but transaction volumes are substantial. Banks do not charge commissions but profit from rate differences. It can be divided into: Direct Market: Banks directly negotiate exchange rates with each other.
Indirect Market: Banks in this segment use foreign exchange brokers, not dealing directly with customers.
(c) Central Bank: The central bank, a part of the wholesale market, operates through authorized dealers, mainly commercial banks. Its key role is to oversee and control the foreign exchange market to stabilize exchange rates. In India, the RBI enforces strict rules, requiring all foreign exchange for payments to foreigners to be bought from the government and payments received in foreign currency to be deposited with the government.
8. What is meant by the rate of exchange in foreign exchange
market? [AHSEC 2024]
Answer: The rate of exchange, or exchange rate, in the foreign exchange market is the price of one currency in terms of another currency.
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