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The Purpose of the Foreign Exchange Market

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What is the purpose of the foreign exchange markets? What are the advantages and disadvantages of a virtual foreign exchange market?

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What is the purpose of the foreign exchange markets? What are the advantages and disadvantages of a virtual foreign exchange market?

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The FOREX market is the mechanism by which participants transfer purchasing power between countries, obtains or provides credit for international trade, and minimizes exposure to exchange rate risk. Transferring of purchasing power is necessary because international trade and capital transactions normally involve parties in countries with different currencies yet each party wishes to transact in their own currency.

Because the movement of goods between countries takes time, inventory in transit must be financed. The FOREX market provides a source of credit via specialized instruments such as letters of credit.

The FOREX market provides "hedging" facilities for transferring foreign exchange risk to someone else more willing to carry that risk.

Source: http://www.businessfaculty.utoledo.edu/pkozlowski/FINA3500/ch06.ppt.

Advantages of a virtual foreign exchange market or floating exchange rate:

Automatic balance of payments adjustment - Any balance of payments disequilibrium will tend to be ...

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Sandeep Bardia, MBA
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  • MBA, Rochester Institute of Technology
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