Foreign Exchange Markets

Essay by pfoster282005College, UndergraduateB+, February 2009

download word file, 4 pages 5.0

The foreign exchange market is the function in which individuals transfer the power of purchase between countries, offers credit for international trade, and minimizes the exposure risk to rate exchange. Transferring the power of purchase is necessary because international trade and capital deals normally require individuals in countries with other currencies yet each individual wishes to deal in their own currency. Because the shipment of goods throughout countries take time, the goods in passage must be financed. The exchange market supplies a source of credit via specialized instruments such as letters of credit. The foreign exchange market also supplies "hedging" facilities for moving the risk to someone else more willing to carry that risk.

The foreign exchange market consists of:Two levels, the comprehensive market, and the retail market.

Five wide areas of individuals who work around these levels.

Dealers that deal with a bank and non-banks.

Parties leading commitment deals.

Traders and arbitragers.

Mid-way banks and collections.

Exchange mediators.

Advantages of a virtual foreign exchange market (Bank of Biz/ed, 1996):"Freeing internal policy - With a floating exchange rate, balance of payments not equal should be rectified by a change in the external price of the currency. However, with a fixed rate, curing a deficit could involve a general deflationary policy resulting in unpleasant consequences for the whole economy such as unemployment. The floating rate allows governments freedom to pursue their own internal policy objectives such as growth and full employment without outside constraints.

Automatic balance of payments adjustment - Any balance of payments not equal will tend to be rectified by a change in the exchange rate. For example, if a country has a balance of payments deficit then the currency should depreciate. This is because imports will be greater than exports meaning the supply of sterling on the foreign...