The foreign exchange market provides the physical and institutional structure through which three typical functions are accomplish. List and explain three functions of the foreign exchange market

Question

What will be an ideal response?

Answer 1

Answer: The foreign exchange market is the mechanism by which participants transfer purchasing power between countries by exchanging money, obtain or provide credit for international trade transactions, and minimize exposure to the risks of exchange rate changes. 1) The transfer of purchasing power is necessary because international trade and capital trans-actions normally involve parties living in countries with different national currencies. Usually each party wants to deal in its own currency, but the trade or capital transaction can be in-voiced in only one currency. Hence, one party must deal in a foreign currency. 2) Because the movement of goods between countries takes time, inventory in transit must be financed. The foreign exchange market provides a source of credit. Specialized instruments, such as bankers' acceptances and letters of credit are available to finance international trade. 3) The foreign exchange market provides "hedging" facilities for transferring foreign exchange risk to someone else more willing to carry risk.