Functions of the Foreign Exchange Market

There are three main functions of the foreign exchange market
(1) Transfer Function
The basic and primary function of foreign exchange market is to transfer purchasing power between countries. The transfer function is performed through T.T, M.T, Draft, Bill of Exchange, Letters of Credit, etc. The bill of exchange is the most important and effective method of transferring purchasing power between two parties located in different countries.
(2) Credit Function
Another important function of foreign exchange market is to provide credit to the importer debtor. The exports draw the bill of exchange on Importers or on their bankers. On acceptance of the bills by importer or their banker, the exporter will get the money realized on the maturity of the bills. In case the exporters are anxious to receive the payment earlier, the bills can be discounted from their bankers, or foreign exchange banks or discount houses.
(3) Hedging Function
The foreign exchange market performs the hedging function covering the risks on foreign exchange transactions. There are frequent fluctuations in exchange rates. If the rate is favourable, the exporter will gain and vice versa. In order to avoid the risk involved, the foreign exchange market provides hedges or actual claims through forward contracts in exchange against such fluctuations. The agencies of foreign currencies guarantee payment of foreign exchange at a fixed rate. The exchange agencies bear the risks of fluctuation of exchange rates.