Meaning of Foreign Exchange Market

The foreign exchange markets are international market where currencies are bought and sold in the wholesale amounts. Significance of the foreign exchange market are as follows :

Liquidity – In terms of international trade, liquidity is the ease in which foreign currency is converted into domestic currency. Foreign exchange markets such as New York Mercantile Exchange, match buyers and sellers to bring about speedy and orderly transactions.

Rates – Buyers and sellers set prices using the auction method in the Foreign Exchange market. Sellers try to earn the highest ask price possible and buyers try to purchase currency at the lowest bid. Buyers and sellers meet at the spot price, the current value and exchange rate for a particular currency against others.

Reserves – International governments enter Foreign Exchange market to build and manage foreign exchange reserves. They build the reserves to make official payments and influence domestic currency values.

International Trade – Businesses rely on Foreign Exchange markets to buy currency that is spent to obtain overseas goods. Corporations will also look to Foreign Exchange markets to convert international earning back into the domestic currency.

Hedging – Traders use foreign exchange derivatives which drive their valuation and cost from the spot market. Options and futures contracts effectively lock in exchange rates for a set period to hedge against the risks of currency fluctuations.

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