How Foreign Exchange Market Works?

The present foreign exchange market structure and the recent developments in the market. This article explains how the market functions? and various factors which affect the exchange rates, and implication on reserves of the economy.

Forex market, the world largest emerged financial market where 1 ½ trillion dollar worth of currencies are exchanged per day, and only market which is open 24 hours a day.  A Forex market is where, a domestic national monetary unit is exchanged with a foreign market monetary unit for various reasons, where the exchange rate of two currencies is determined by the government and private participants in the foreign exchange rate market.  The structure of market is divided into two parts namely Wholesale and Retail market, where bank deposits are transferred by huge commercial player and exchange of bank instruments between private customers are carried respectively.

Foreign currencies are needed for payments across national borders, which allow carrying business or other financial transaction between two or more country residents which is acceptable by either party for the transaction to be completed smoothly. Statistics says that in the foreign exchange market nature of transaction traded constitutes only 15% for goods and services and rest is traded by the Institutional/individual for speculation. Thus a heterogeneous group participate in this market, some conduct transaction for purchase/sale of merchandise well other get involved in direct and portfolio investment across the borders, some engages in money market trading in instrument like short-term debt internationally.

This is the most liquid market in the world, because the volume of transactions which are carried out in for-ex market is extremely huge because of many big players in foreign exchange market.  Mainly the exchange rate is influenced by the factors like growth in GDP, interest rates, foreign debt, terms of trade, risk, and money supply are few of them. 

In can be concluded that Foreign exchange reserves in an country is an indicator of a good sign of economy, where the country can import more goods, cope up with the crisis, and absorb the uncertainty, but the nature of the reserves has to be observed because it could adverse impact if the large part is form of NRI deposits where the interest burden of the economy increases.