Transactions are exchange of currenct, bank draft, bank notes ordinary and traveller‘ s cheques etc. Retail banking consists of a large number of small customers who consume personal banking and small business services. Retail banking is largely intra-bank: the bank itself.
The wholesale market comprises of commercial banks and investment banks. This is broadly classified as inter-bank market and central bank market.
Wholesale banking typically involves a small number of very large customers such as large corporate and governments, Wholesale banking is largely interbank: banks use the inter -bank markets to borrow from or lend to other banks, to participate in large bond issues, and to engage in syndicated lending.
The interbank network consists of a global network of financial institutions that trade currencies between each other to manage exchange rate and interest rate risk. The largest participants in this network are private banks.
Most transactions within the interbank network are for a short duration, anywhere between overnight to six months. The interbank market is not regulated.
a) Spot market
Spot market refers to the transactions involving sale and purchase of currencies for immediate delivery. In practice, it may take one or two days to settle transactions. Transactions are affected at prevailing rate of exchange at that point of time and delivery of foreign exchange is affected instantly. The exchange rate that prevails in the spot market for foreign exchange is called Spot Rate.
b) Forward Market
A market in which foreign exchange is bought and sold for future delivery is known as Forward Market. It deals with transactions (sale and purchase of foreign exchange) which are contracted today but implemented sometimes in future. Exchange rate that prevails in a forward contract for purchase or sale of foreign exchange is called Forward Rate. Thus, forward rate is the rate at which a future contract for foreign currency is made.
Within the fields of trading and finance, a derivative is considered to be an instrument used for investment via a contract. Its value is "derived" from (or based upon) that of another asset, typically referred to as the underlying asset or simply "the underlying." In other words, a derivative contract is an agreement that allows for the possibility to purchase or sell some other type of financial instrument or non-financial asset. Common types of derivative contracts include options, forwards, futures and swaps.
- Future Market: Standardized forward contracts are called futures contracts and traded on a futures A futures contract (more colloquially, futures) is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality for a price agreed upon today (the futures price or strike price) with delivery and payment occurring at a specified future date.
- Option Market: A currency option gives an investor the right, but not the obligation, to buy or sell a quantity of currency at a pre-established price on or before the date that the option expires. The right to sell a currency is known as a "call option" and the right to buy is known as a "put option." Options can be understood as a type of insurance where buyers or sellers can take advantage of more favourable prices should market conditions change after the option is purchased.
- Swap Market: The idea of a swap by definition normally refers to a simple exchange of property or assets between parties. A currency swap also involves the conditions determining the relative value of the assets involved. That includes the exchange rate value of each currency and the interest rate environment of the countries that have issued them. A foreign exchange swap, forex swap, or FX swap is a simultaneous purchase and sale of identical amounts of one currency for another with two different value dates (normally spot to forward).
National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. They work as the lender of the last resort and the custodian of foreign exchange of the country. The central bank has the power to regulate and control the foreign exchange market so as to assure that it works in the orderly fashion. One of the major functions of the central bank is to prevent the aggressive fluctuations in the foreign exchange market, if necessary, by direct intervention. Intervention in the form of selling the currency when it is overvalued and buying it when it tends to be undervalued.
The commercial banks are the second most important organ of the foreign exchange market. The banks dealing in foreign exchange play a role of ―market makers‖, in the sense that they quote on a daily basis the foreign exchange rates for buying and selling of the foreign currencies. Also, they function as clearing houses, thereby helping in wiping out the difference between the demand for and the supply of currencies. These banks buy the currencies from the brokers and sell it to the buyers.
The foreign exchange brokers function as a link between the central bank and the commercial banks and also between the actual buyers and commercial banks. They are the major source of market information. These are the persons who do not themselves buy the foreign currency, but rather strike a deal between the buyer and the seller on a commission basis.