When a company operates only in the domestic market then both for buying the inputs as well as selling its output it needs to deal only in the domestic currency but as companies began to go for international markets both for buying cheap inputs and selling their produce to the international markets that’s when foreign exchange market comes into the picture.
Foreign exchange market is the market where the currency of one country is exchanged for the currency of another country. In other words it is a market where currencies are bought and sold. The purpose of the foreign exchange market is to help international trade and investment, Foreign exchange market is a 24 hours market and it does not exist in a physical form like stock market, but it is a network of telephone and computers.
The foreign exchange market is the largest and most liquid financial market in the world. Traders include large banks, central banks, currency speculators, governments, and other financial organizations. A foreign exchange rate is the price of currency of one’s country in terms of another currency. There are two types of rates prevalent in the market
1. Spot exchange rate – It is the rate at which a currency can be bought or sold for immediate delivery, in other words it is the current rate at which one currency can be immediately converted into another currency.
2. Forward exchange rate – It can be defined as the rate which is fixed today but the settlement of transactions takes place at some specified date in the future, in other words exchange rate is agreed today though the actual transactions of buying and selling will take place at future specified date.