Globalization and integration of the financial markets, coupled with the progressive
increase of the cross border flow of the capital, have transformed the dynamics
of the Indian Financial markets. This has increased the need for dynamic currency
risk management. The steady rise in the India’s foreign trade along with liberalization
in foreign exchange regime has led to a large inflow of foreign currency into the
system in the form of FDI and FII’s Investments. The foreign exchange (currency
or FX) market is where currency trading takes place. FX transactions typically involve
one party purchasing a quantity of one currency in exchange for paying a quantity
of another. The Foreign Exchange Market that we see today started evolving during
the 1970s when world over countries gradually switched to floating exchange rate
from their erstwhile exchange rate regime, which remained fixed as per the Bretton
Woods system till 1971.
Today FX market is one of the largest and most liquid financial markets in the world,
and includes trading between large banks, central banks, currency speculators, corporations,
governments, and other institutions. The average daily volume in the global forex
and related markets is continuously growing. Traditional daily turnover was reported
to be over US$ 3.2 trillion in April 2007 by the Bank for International Settlements.
Since then, the market has continued to grow. According to Euromoney's annual FX
Poll, volumes grew a further 41% between 2007 and 2008.
The purpose of FX market is to facilitate trade and investment. The need for a foreign
exchange market arises because of the presence of multifarious international currencies
such as US Dollar, Pound Sterling, etc, and the need for trading in such currencies.
Market Size and Liquidity
The foreign exchange market is unique because of
- Its trading volumes
- The extreme liquidity of the market
- The large number of, and variety of, traders in the market
- Its geographical dispersion
- The variety of factors that affect exchange rates
- The low margins of profit compared with other markets of fixed income (but profits
can be high due to very large trading volumes)
- The use of leverage