Foreign Exchange Market

• High Liquidity: Currencies are traded extensively, offering easy conversion.
• Market Transparency: Real-time data and pricing are available to participants.
• Dynamic Market: Currency values fluctuate continuously due to market forces.
• 24-Hour Availability: The market operates around the clock, providing flexibility for traders globally.

Participants include:

• Central Banks: Regulate and manage domestic currency values.
• Commercial Banks: Facilitate currency conversion for businesses and individuals.
• Foreign Tourists and Companies: Convert currencies for international travel and trade.
• Traders & Speculators: Profit from market fluctuations by buying and selling currencies.
• Brokers: Act as intermediaries between buyers and sellers of currency.

Foreign exchange rates are influenced by:

• Economic Factors: Inflation rates, interest rates, and trade balances.
• Political Conditions: Stability, elections, and government policies.
• Psychological Factors: Investor sentiment, confidence, and market speculation. These factors often interact and affect currency values in complex ways.

Currency strength is calculated based on its purchasing power both domestically and internationally. Domestically, it's measured by how much goods and services can be purchased with the currency, adjusting for inflation. Internationally, currency strength is determined by its exchange rate against other currencies in the Forex market.

The Chinese Yuan (CNY) is not strictly "pegged" to the US Dollar (USD), but it has historically been managed or pegged within a range to the USD. Here’s why China has adopted this policy:

1. Stability in Trade

• A stable exchange rate between the Yuan and the US Dollar helps reduce exchange rate risk for China’s export-driven economy. As China is one of the world’s largest exporters, a stable currency helps businesses price their products predictably in international markets.

2. Control Over Economic Policy

• The Chinese government prefers a managed currency to maintain control over the economy. By keeping the Yuan at a stable level relative to the Dollar, China can manage inflation, control trade surpluses, and maintain economic growth.

3. Trade Surplus and Export Competitiveness

• The Yuan being relatively weaker against the Dollar (in a controlled range) makes Chinese exports cheaper on the global market, boosting demand for Chinese products and helping to maintain a trade surplus.

4. Capital Flow Management

• China manages the capital inflows and outflows to prevent excessive volatility in the currency market. The fixed or managed peg helps to ensure that the Yuan’s value doesn’t fluctuate too wildly due to speculative trading or global market movements.

5. US-China Trade Relations

• The relationship between the US Dollar and the Yuan also stems from the fact that the US Dollar is the global reserve currency and the dominant currency in international trade. Many Chinese trade partners prefer to transact in USD, which influences China’s decision to keep its currency aligned with the Dollar.

The Forex market is a global decentralized platform for currency trading. It operates 24 hours a day and involves participants like banks, central banks, and corporations. The market facilitates the exchange of one currency for another, influencing international trade, investment, and currency valuations.

Forex reserves are assets held by a country's central bank, such as foreign currencies, gold, and International Monetary Fund (IMF) special drawing rights. These reserves help stabilize the national currency, support external financial obligations, and provide a safety net during economic crises. India’s forex reserves were about USD 640.4 billion in November 2021.

Forex reserves are crucial because they:

• Help a country meet its foreign exchange requirements and external debt obligations.
• Act as a buffer in case of a Balance of Payments (BoP) crisis.
• Stabilize the national currency and strengthen investor confidence in the economy.
• Provide the government with flexibility to handle economic challenges.

The Forex market includes:

• Spot Market: Immediate currency exchange at current prices.
• Forward Market: Agreement to exchange currencies at a set rate on a future date.
• Futures Market: Standardized contracts traded on exchanges to buy/sell currency in the future.
• Options Market: Contracts giving the right (but not obligation) to exchange currencies at a set rate within a time period.
• Swap Market: Exchange of cash flows or liabilities between parties.

• Freely Floating Exchange Rate: Exchange rates determined by market forces without government intervention (e.g., USD).
• Fixed Exchange Rate: The government sets a fixed rate and intervenes to maintain stability (e.g., Hong Kong Dollar).
• Pegged Exchange Rate: A currency is tied to another currency or basket of currencies, and the government intervenes when necessary (e.g., Saudi Riyal).
• Managed Float: The currency fluctuates within a controlled range, with occasional central bank intervention to prevent excessive volatility (e.g., Indian Rupee).