Foreign exchange market is a market where you can buy or sell currencies according to your demand. It’s a market like other market. Market transaction occurs according to demand and supply. In finance exchange rate between two currencies determines the value of one currencies against the other. For example you live in Bangladesh and you need dollar. So in foreign exchange market you can get dollar by selling your t aka according to a given day exchange rate. Foreign exchange market is a large market and about 3 trillion dollar market. The market is open 24 hours except weekend.
Exchange rate plays an important role in export and import. Transaction beyond the home country always occurs in foreign currencies. Suppose you are a chinese national export goods or services in U.S.A . Your payment will be taken place in Dollar.
Exchange rate is not constant. Its volatile. Supply and demand is the key factor. There are different sorts of exchange rate system. Which are very important in different situation.
Characteristics of foreign exchange market:
Foreign exchange market ruled by some characteristics. Unlike stock market foreign exchange market does not charge any transaction cost, no commission charge or any unusual price hike or short selling. Some unique characteristics are given below:
- Transaction occurs round the clock. A twenty four hour market. Only weekly holiday no transaction made.
- No commission charged for buying or selling.
- Usually six types of major currencies attract traders.
- Traders have the right to make transaction freely. Short selling is not restricted. Usually the market totally depends on demand and supply.
- Foreign exchange market is riskier than the stock market. The market is not suitable for inexperienced investor.
Different types of Exchange rate :
Fixed or pegged exchange rate : In fixed exchange rate market exchange rate fixed by the central bank or by the government. Government can take advantages by selling or buying its own currencies when the exchange rate rise or fall beyond the expected level.
Floating Exchange Rate: In floating exchange rate currencies are free to float according to market demand and supply. Developing country may be benefited by the floating exchange rate system. Some times central bank or government of the respective country put a ceiling on upper and lower rate of exchange rate. In exchange rate when government intervene the market to gain some advantages over its own currencies is known as managed float or dirty float exchange rate system.
In recent times dollarigation gain popularity in many countries. Dollarization refers to use foreign currencies instead of home countries currencies or simultaneously use two currencies. Many countries adopted the method . The main advantages of dollarization is curbing inflation gaining financial stability. In recent times Ecuador, el Salvador followed the method.