Foreign exchange

From ArticleWorld

The foreign exchange market is the market where the currency of one country is exchanged for the currency of another country. Most currency transactions are channeled through the world wide inter-bank market. Inter-bank market is the wholesale market in which major banks trade with each other. Forex market is a world-wide market of an informal network of telephone, telex, satellite, facsimile and computer communications between the forex market participants which include banks, dealers, arbitrageurs and speculators.

A foreign exchange rate is the price of one currency quoted in terms of another currency. For example, an exchange rate of US dollar (US$) 0.02538 per Indian rupee (INR) means that the price of INR is $0.02538. When the rate is written as US$ 0.02538/INR, it is referred to as indirect quote. The rate can be expressed differently. We can say that the price of one US dollar in INR39.40 that is INR39.40/US$. This is referred to as direct quote.

A cross rate is also important to understand in foreign exchange. A cross rate is an exchange rate between the currencies of two countries that are not quoted against each other, but are quoted against one common currency. Currencies of many countries are not freely traded in the forex market so this has to be done.

For understanding foreign exchange better spot exchange rates are to be known. The spot exchange rate is the rate at which a currency could be bought or sold for immediate delivery which is within the two business days after the day of the trade. In the spot exchange market the currencies are traded for immediate delivery.

The foreign exchange dealers are always ready to buy or sell the currencies. The quotations are given as bid-ask price. The difference between the buying (bid) and selling (ask) is the forex operator’s spread. Bid-ask spread is the difference between the bid and ask rates of the currency. It is based on the breadth and depth of the market of that currency and its volatility.

The forward exchange rate is the rate that is currently paid for the delivery of the currency at some future date. In the forward market, currencies are traded for future delivery. In terms of the volume of currency transactions, the spot exchange market is much larger than the forward exchange market.