1. The foreign exchange market facilitates international trade and investment by allowing companies to convert currencies and engage in cross-border transactions. 2. The market serves two main functions - converting one currency to another and providing insurance against foreign exchange risk through hedging instruments. 3. Hedging allows companies to protect against unpredictable exchange rate changes through financial tools like forward contracts, options, and swaps in the foreign exchange market.

1. The Foreign Exchange Market
Sudhanshu Bhatt (https://www.linkedin.com/in/sudhanshu-bhatt-b3665115/)
MBA –IBA
25.04.2023
References
Bulatov, A. (2023). World Economy and International Business Theories, Trends, and Challenges. In Springer. https://doi.org/10.12737/16614
Hill, C. W. L. (2022). Global Business Today 12e Charles.
Hill, C. W. L. (2023). International Business: Competing in Global Marketplace. In McGraw Hill LLC. https://doi.org/10.4324/9780203879412
Shenkar, O., Luo, Y., & Chi, T. (2022). International Business, Routledge. Routledge.
Images sourced from the internet

2. What is the role of the foreign exchange
market in facilitating international trade and
investment?
• The foreign exchange market is a market for converting the currency
of one country into that of another country.
• An exchange rate is the rate at which one currency is converted into
another.
• The foreign exchange market allows companies to trade with each
other even if they are based in countries that use different
currencies.
• The foreign exchange market functions as a lubricant for
international trade and investment, making it possible for companies
to exchange currencies and engage in cross-border transactions.
• The functions of the foreign exchange market include providing a
mechanism for converting one currency into another, facilitating the
settlement of international trade and investment transactions, and
providing a means for hedging against currency risk.

3. How can companies use the foreign exchange market to
manage currency risk?
OR
What are the Functions of the Foreign Exchange Market
The foreign exchange market serves 2 main functions.
1. Convert the currency of one country into the currency of another.
• Companies can use the foreign exchange market to convert the currency they earn from
their international trade and investment activities into the currency they need to pay for
imports or make payments to foreign suppliers.
2. Provide some insurance against foreign exchange risk or unpredictable changes in
exchange rates.
• Companies can also use the market to hedge against currency risk by entering into
currency forward contracts, currency options, or currency swaps.
• This helps them to protect against unexpected changes in exchange rates that could have
a negative impact on their financial position.

4. What do you mean by Hedging?
Hedging is a risk management strategy that firms use to protect
themselves against unpredictable changes in future exchange
rates that could have negative financial consequences. When a
firm engages in hedging, it is essentially insuring itself against
foreign exchange risk.
• In the context of the foreign exchange market, hedging is
achieved through a variety of financial instruments for which
understanding the following concepts is important:-
1. Spot exchange rates
2. Forward exchange rates
3. Currency swaps

5. Differentiate between spot exchange rate forward
exchange rate and currency swaps?
1. Spot exchange rates refer to the rate at which a foreign exchange dealer converts
one currency into another currency on a particular day, when the exchange is
executed immediately, or "on the spot". Spot exchange rates are constantly
changing based on supply and demand for different currencies, and are reported on
a real-time basis on many financial websites. They can be quoted in two ways: as the
amount of foreign currency one U.S. dollar will buy or as the value of a dollar for one
unit of foreign currency.
2. Forward exchange rates, on the other hand, refer to the rate at which two parties
agree to exchange currency and execute the deal at some specific date in the future.
Exchange rates governing such future transactions are referred to as forward
exchange rates. For most major currencies, forward exchange rates are quoted for
30 days, 90 days, and 180 days into the future, although it is possible to get forward
exchange rates for several years into the future. Forward exchange rates differ from
spot exchange rates and reflect the expectations of the foreign exchange market
about future currency movements.
3. Currency swaps are financial transactions in which two parties agree to exchange a
series of payments in different currencies over a specific period of time. In a currency
swap, the two parties agree to exchange principal and interest payments on an
agreed-upon schedule. Currency swaps are used to hedge against foreign exchange
rate risk or to obtain lower borrowing costs in a particular currency. Unlike spot and
forward exchange rates, which involve only two currencies, currency swaps

6. What is the Nature of the Foreign
Exchange Market?
1. The foreign exchange market is a decentralized global
network of banks, brokers, and dealers connected by electronic
communication systems.
2. It has been growing rapidly due to the increase in cross-
border trade and investment. London, New York, Zurich,
Tokyo, Hong Kong, and Singapore are the most important
trading centers, with London being the largest due to its history
and location.
3. The foreign exchange market operates 24/7 and is integrated
through computer linkages, meaning that exchange rates
quoted in different trading centers cannot differ significantly.
4. The U.S. dollar plays an important role in most transactions,
with 88% of all foreign exchange transactions involving dollars

7. What is currency forecasting and the 2 school
of thoughts?
Currency forecasting is the process of predicting future exchange
rate movements.
There are two schools of thought on whether investing in exchange rate
forecasting services is worthwhile.
1. The efficient market school argues that forward exchange rates,
which represent market participants' collective predictions of future
spot exchange rates, are the best possible predictor of future
exchange rates. Therefore, investing in forecasting services would
be a waste of money.
2. The inefficient market school argues that companies can improve
the foreign exchange market's estimate of future exchange rates by
investing in forecasting services. This school of thought believes
that forward exchange rates are not the best possible predictors of
future spot exchange rates, and professional forecasting services
might provide better predictions. However, the track record of
professional forecasting services is not always good.

8. Two approaches to exchange rate forecasting
Fundamental analysis
• It uses economic theory to construct models that predict exchange rate
movements. The models include variables such as relative money supply growth rates,
inflation rates, interest rates, and balance-of-payments positions.
• For example, a country with a persistent balance-of-payments deficit (importing more
goods and services than it is exporting) may experience a depreciation of its currency
on the foreign exchange market, as people in other countries convert their dollars into
other currencies.
• It is suitable for long-term investors who want to understand the underlying economic
factors that affect exchange rates
Technical analysis
• on the other hand, relies on price and volume data to determine past trends that are
expected to continue into the future.
• This approach does not consider economic fundamentals but assumes that there are
analyzable market trends and waves that can be used to predict future trends and
waves.
• Despite skepticism from economists, technical analysis has gained favor in recent
years. It is suitable for short-term traders who are interested in identifying trends and

9. What is Currency Convertibility?
• Currency convertibility refers to the ability to convert one country's currency
into another freely and without restrictions. A currency is said to be freely
convertible when residents and non-residents are allowed to purchase
unlimited amounts of a foreign currency with it. In contrast, a non-convertible
currency is one that cannot be exchanged for foreign currency by residents or
non-residents.
• Governments often impose restrictions on currency convertibility to protect their
foreign exchange reserves from capital flight, a phenomenon that occurs
when people rush to convert their domestic currency into foreign currency.
Capital flight can lead to a depletion of foreign exchange reserves,
making it difficult for a country to service its international debt
obligations and purchase imports.
• External convertibility restrictions, where only non-residents are allowed to
convert the currency, may limit domestic companies' ability to invest abroad.
However, it presents fewer problems for foreign companies wishing to do
business in that country. To overcome the non-convertibility problem,
companies can engage in countertrade, a range of barter-like agreements

10. What are the 3 types of foreign exchange
risk
1. Transaction Exposure refers to the extent to which the income from
individual transactions is affected by fluctuations in foreign exchange
values. This exposure includes obligations for the purchase or sale of goods
and services at previously agreed prices and the borrowing or lending of
funds in foreign currencies. Transaction exposure arises from the fact that
exchange rates can change between the time when a transaction is agreed
upon and when it is settled.
2. Translation Exposure, on the other hand, is the impact of currency
exchange rate changes on the reported financial statements of a
company. Translation exposure is concerned with the present measurement
of past events. The resulting accounting gains or losses are said to be
unrealized, but they can still be important. Translation exposure arises from
the fact that a company may have assets or liabilities denominated in a
foreign currency, which must be translated into the reporting currency for
financial statement purposes.
3. Economic Exposure refers to the extent to which a firm's future international
earning power is affected by changes in exchange rates. Economic exposure
is concerned with the long-run effect of changes in exchange rates on future
prices, sales, and costs. Economic exposure arises from the fact that
exchange rate changes can affect a company's competitive position in the

11. • IBA to be continued………