These days, going abroad to work or for vacation is pretty
common. In order to travel out of our country, we need the currency that the
destination country uses. So, if you are going to the United States you will
need US Dollars if you go to Europe Euros and so on...
What is Foreign
Exchange?
Foreign Exchange (forex in short) is the blanket term used
to refer to the currencies of countries that are not our own. I am an Indian,
so US Dollar, Singapore Dollar, Malaysian Ringets, and UK Pounds etc are all
Foreign Exchange for me. Similarly, for citizens of those respective countries,
the Indian Rupee is forex.
Purchasing foreign
exchange
Foreign exchange can be bought from any authorized dealer,
such as banks that deal in foreign currency. Besides these, money changers also
provide an exchange for business and private visits. Large banks like ICICI,
HDFC, Axis Bank etc have a dedicated Forex department that deals with currency
exchanges. If you give them Indian Rupees, they will give you the Forex
equivalent to that amount. If the amount you are converting is less than Rs.
50,000/- banks will accept a cash payment. However, if the rupee equivalent
exceeds Rs 50,000, the entire payment should be made through a crossed cheque
or demand draft.
A point to note here is that, if your company is sending you
on an official visit to any foreign country, they will take care of the
currency conversion. You do not have to worry about it (Unless you feel, the
amount they are giving is too small). For Personal Business Trips or for
Vacations, it is our responsibility to get the currency converted ahead of
time.
Instruments of
Foreign Exchange Market
The instruments, with the help of which the international
payments are affected. They are:
Cheques and Bank
Drafts: Persons dealing with foreign exchanges can use bank cheques as well
as bank drafts in order to make payments. The cheque is drawn on particular
bank instead of a person.
Bills of Exchange:
It is also called as a foreign bill of exchange which is an unconditional order
in writing addressed by one person to another. It mentions the person to whom a
certain sum is to be paid either on demand or on a specific date.
Mail Transfer (MT):
Under this, funds are transferred from one account of a destination to another
destination in the nation by mail. For international payments, air-mail is
used.
Telegraphic Transfers
(TT): By this method, a sum can be transferred from one place to another
place in the world by cable or telex. This is the quickest method of
transferring fund from one place to another.
Thus, these are various instruments/methods used for
inflecting International payments.
Operation of Foreign
Exchange Market
There are thousands
of securities traded on a stock market. But in the foreign exchange market,
there are only eight currencies in which trade takes place. These are:
• U.S. Dollar ($)
• European Currency Unit (€)
• Japanese Yen (¥)
• British Pound Sterling (£)
• Swiss franc (Sf)
• Canadian Dollar (Can$)
• Australian Dollar
• New Zealand Dollar
Financial Instruments of Foreign
Exchange Market
Spot: Spot
transaction is a two-day process. It is the fastest transaction in the foreign
exchange market. This trade involves a direct exchange between two currencies,
has the shortest time span and directly involves cash. The transactions are
based on the spot rates i.e. rates existing in the market at the time of the
deal.
Forward: The
forward contract is another mechanism used in the foreign exchange market. In
this type of transaction, the rate is agreed upon by the parties at which the
exchange takes place on some future date. The market rate does not play any
role in forwarding contracts. The time period of the contract may be one day,
one month or one year as agreed upon by both the parties.
Future: Futures
are the contracts traded on standardized exchanges with standard contracts and
maturity dates. The average time span of futures is 3 months and they involve
some interest which is to be paid to exchanges as fees to the contracts.
Swap: Swaps are
the contracts wherein the buyer and the seller agree to exchange currencies for
a certain time period and reverse the transaction on the maturity date of the
contract. These contracts are not standardized and can be traded without
exchanges.
Option: Options
are the derivatives wherein the owner has the right, but not the obligation, to
exchange the currencies at an agreed exchange rate and on a specified future
date. These are much similar to forwarding contracts, the difference being that
a ‘forward’ puts an obligation on both buyer and seller to perform the contract
whereas the ‘options’ give the owner a right which he may, or may not,
exercise.
Conclusion:
The foreign exchange market is a place where the major eight
currencies of the world are traded through different financial instruments at
different types of the rates. This market is the most liquid market in the
world which operates 24 hours a day except on weekends. The major participants
in the market are banks, firms, and companies, individuals (through brokers),
central banks, nonbanking financial institutions, foreign exchange companies,
etc. who trade in different financial instruments like options, forward
contracts, futures, swaps and spot transactions.
