Foreign Exchange as a subject deals with the means and methods by which rights to income and wealth in one country’s currency are converted into similar rights in terms of another country’s currency. It involves the investigation of the methods by which the currency of one country is exchanged for that of another, the causes which render such exchange necessary, the forms in which exchange may take place and the ratios or equivalent values at which such exchanges are effected.
Such exchange may be in the form of one currency to another or of conversion of credit instruments denominated in different currencies such as cheques, drafts, airmail transfers, fax and telegraphic transfers, cable transfers, bills of exchange, trade bills, bankers’ bills or any promissory notes. It is through these instruments and foreign currency accounts of banks that the banks are able to effect such exchange of currencies or claims to currencies.
RBI has, however, responded to emerging situation in the foreign exchange market quickly and promptly. Since rupee convertibility was launched in March 1992, RBI is publishing a reference rate around which it operates in the market to stabilise the rate of exchange of rupee in terms of US dollar.
International Financial System and Foreign Exchange Market:
One of the important components of the international financial system is the foreign exchange market. The various commercial and financial transactions as between countries result in receipts and payments as between them. The items of balance of payments leading to receipts and payments are trade, travel, transporta-tion, royalties, fees, investment income, unilateral transfers, short-term and long- term capital receipts and payments etc. Such receipts and payment involve exchange of one currency for another.
Each economy has a foreign sector representing that economy’s external transactions. All such external transactions are either economic and commercial or financial transactions. These result in receipts into and payments out of the domestic economy. Such receipts and payments involve exchange of domestic currency as against all foreign currencies of countries with which domestic economy has deal-ings. Such exchange transactions are put through in the exchange market for that currency. For each nation, therefore, there is an exchange market for that country’s currency vis-a vis other currencies. These national foreign exchange markets are components of the international financial system There are three major components of this market, depending upon the level at which transactions are put through:
1. Transactions between the public and the market at the base level involve receipts from any payments to the public or purchases from and sales to public.
2. Transactions as between the banks dealing in foreign exchange involving conversion of currencies taking place in the same centre or as between centres in the same country (inter-bank market) or as between countries involving the correspondent or agent banks abroad or branches of the domestic banks abroad.
3. Transactions between banks and central bank involving purchase and sale of foreign currencies for cover or final disposal of excess foreign balances The rate of exchange is determined at any moment by the forces of demand for and supply of a currency, which in turn depends on the demand for and supply of commodities and services as between India and the USA.