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International financial Environment Important questions from the topic: • Functions of foreign exchange market • Short note on foreign exchange risk • Types of foreign exchange rate • Foreign exchange risk and foreign exchange exposure International financial environment • International financial system relates to the management of and trading in international money and monetary assets. These monetary assets are claims on foreign currency, foreign deposits and investments and/or foreign assets. The claims may be denominated in various foreign currencies purchased and sold and involve exchange as between various currencies. Thus, these transactions give rise to (i) Borrowing and lending operations in foreign currencies or trading in financial assets denominated in foreign currencies and (ii) A foreign exchange transaction involving an exchange of one currency for another. The first is called the foreign currency market and the second is the foreign exchange market. Foreign Exchange Market: • International economic and commercial relations between countries involve exchange of goods and services and payments for these exchanges. The payments lead to conversion of one currency into another. • Each country has its own financial system and its own currency and financial assets. Exchanges between the money and financial assets of one country for money or financial assets of another country constitutes international financial transactions. • THE DEMAND FOR ANY CURRENCY AS AGAINST ITS SUPPLY IN SUCH MARKETS DETERMINES THE EXCHANGE RATE. THESE FINANCIAL ASSETS COULD BE MONEY OR NEAR-MONEY ASSETS, CHEQUES, DRAFTS, MAIL TRANSFERS AND OTHER NEGOTIABLE INSTRUMENTS. Functions of foreign exchange market 1. Transfer Function: It transfers purchasing power between the countries involved in the transaction. This function is performed through credit instruments like bills of foreign exchange, bank drafts and telephonic transfers. 2. Credit Function: It provides credit for foreign trade. Bills of exchange, with maturity period of three months,
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