Introduction

All open economies are economically interdependent. Their internal macroeconomic

conditions are affected by the economic changes outside the country. The effects of
outside changes get transmitted to other economies through foreign trade changes in
exchange rate, inflow and outflow of foreign exchange and international flow of
capital.

Foreign Exchange Rate

Foreign exchange rate can be expressed as the foreign price of a domestic currency.
Ex: Rupee of Dollar

Foreign Exchange Market

foreign exchange market is the market in which foreign currencies are bought and
sold. It is a system not a place.

The major constituents and dealers of foreign exchange market

 Central bank
 Brokers
 Commercial banks
 Exporters, importers, tourists, investors, immigrants

Major Functions of Foreign Exchange Market

1. Transferring foreign currency from one country to another
2. Provide short -term credit facilities to importers to and thereby facilitating
smooth flow of goods and services between the countries.
3. Stabilizing the foreign exchange rate.

Kinds of foreign Exchange Market

 Spot market
 Forward market

Transactions in foreign Market

 Hedging
 Arbitrage
 Speculation

Floating (flexible) Exchange Rate System

The system of exchange rate in which the value of a currency is allowed to adjust
freely or to float as determined by demand and supply of foreign exchange is called a
flexible exchange rate system, which is also known as floating exchange rate system.
Fixed Exchange Rate System
If the exchange rate determined by the Govt it is called as fixed exchange rate
system.
Disequilibrium of balance of payment cause to rise either excess demand or excess
demand or excess supply of foreign exchange -under the fixed exchange rate system
central bank of the country has to buy and sell the required quantities of foreign
exchange to eliminate the excess demand and supply.