The place where foreign moneys are traded (i.e. bought and sold) are called Foreign Exchange Market. It is a part of money market in the financial centers. In some of the countries, there is no particular foreign exchange market as defined above. Here the most important component of foreign exchange market is the Central bank of the country or its authorized dealers. All exporters are required to surrender the foreign exchange earnings to the central bank or its authorized dealers within specified period and then receive local currency in exchange of that. Similarly, the importer have to pay for the goods imported. They will get the foreign exchange from the Central bank or its authorized dealers for making payments to the exporters.


There are three main function of the Foreign Exchange Market.

  • Transfer Function
  • Credit Function
  • Hedging Function

Transfer Function

The basic function of foreign exchange market is to transfer foreign moneys between countries. The main credit instruments used for payments in foreign currencies are Letter of Credit, Bill of Exchange, Banker’s Draft and Telegraphic Transfer.

Credit Function

Another function of the foreign exchange market is to provide credit to the importer who is debtor. The credit facility is provided through the bill of exchange.

Hedging Function

Hedging is the forward rate contact. Foreign exchange provides the facility to the importer to pay for the goods at the foreign exchange rate prevailing in the market called ‘Spot Rate’ or at the future date called Forward Rate, called Hedging. Forward exchange rate protects the importer from all risks of fluctuations in the foreign exchange market.

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