What are the primary functions of the foreign exchange market?

Who are the participants in the market? How do global companies use the foreign exchange market to hedge against foreign exchange risks?What are the primary functions of the foreign exchange market?The primary function is to facilitate the buying and selling of money of different countries. If an American company wants to buy the products of a British company, it may have to buy British pounds so that it can pay for the product. Or if it pays in US dollars, the British company sells the dollars in exchange for British pounds.



Some of the participants in foreign exchange markets are speculators who buy one currency in the hope that its value will go up relative the the currency they are paying in exchange. Speculators keep the foreign exchange market very liquid, which makes it easier for non speculators to function in the market.



Businesses can use the foreign exchange market to hedge against the risk of a particular currency increasing or decreasing in value. For example, a Brazilian farmer has a contract to sell 1000 tons of wheat to a US flour mill at a specific price in dollars. If he gets the dollars now and uses them to buy the Brazilian currency, he will make a profit at the current exchange rate, but he has to wait to get paid when the wheat is delivered after it is harvested. By that time the value of the dollar may be lower and he would have a loss in the exchange. So he contracts to sell the dollars in the future at today's exchange rate assuring himself of a profit regardless of the value of dollars when the wheat is delivered. Someone else, possibly a speculator agrees to buy the dollars in the future at today's exchange rate in the hope that the value will be higher when the contract is ready for delivery.



Just as someone can agree to buy or sell wheat six months from now, they can agree to buy or sell dollars or pounds of franks or yen six months from now. In the foreign exchange market money of different countries is a commodity that can be traded.