Foreign exchange risk is linked to

unexpected fluctuations in the value of

currencies.
A Strong Currency can very well be
risky,while a weak currency may not be
risky.The risk level depends on whether the
flucations can be predicted.Short and long-
term fluctuations have a direct impact on the
profitability and competitiveness of business.
Foreign Exchange Risk is the exposure of a
companys financial strength to the potential
impact of movements in foreign exchange
rate.The risk is that adverse flucations in
exchange rates may result in reduction in
measure of financial strength.e.g.,if an indian
firm imports goods and pays in foreign currency
(say dollar),its outflow is in dollars,thus it is
exposed to foreign exchange risk.if the value of
the foreign currency rises(i.e.,the dollar
appreciates),the indian firms has to pay more
domestic currency to get the required amount of
foreign currency.
A security whose price is dependent upon or
derived from one or more underlying assets. The
derivative itself is merely a contract between two
or more parties. Its value is determined by
fluctuations in the underlying asset. The most
common underlying assets include stocks,
bonds, commodities, currencies, interest rates
and market indexes. Most derivatives are
characterized by high leverage.



Derivatives are financial instruments whose value changes
in response to the changes in underlying variables. The
main types of derivatives are futures, forwards, options,
and swaps. The main use of derivatives is to reduce risk
for one party. The diverse range of potential underlying
assets and pay-off alternatives leads to a huge range of
derivatives contracts available to be traded in the market.
Derivatives can be based on different types of assets such
as commodities, equities (stocks), bonds, interest rates,
exchange rates, or indexes (such as a stock market index,
consumer price index (CPI) see inflation derivatives
or even an index of weather conditions, or other
derivatives). Their performance can determine both the
amount and the timing of the pay-offs.
(a) a security derived from a debt instrument,
share, loan, whether secured or unsecured,
risk instrument or contract for differences or
any other form of security ;
(b) a contract which derives its value from the
prices, or index of prices, of underlying
securities.



They help in transferring risks from risk adverse
people to risk oriented people.
They help in the discovery of future as well as
current prices.
They catalyze entrepreneurial activity.
They increase the volume traded in markets
because of participation of risk adverse people in
greater numbers.
They increase savings and investment in the long
run.




Derivative contracts are of several types. The
most common types are forwards, futures,
options and swap.



Forward Contracts
A forward contract is an agreement between
two parties a buyer and a seller to purchase
or sell something at a later date at a price
agreed upon today. Forward contracts,
sometimes called forward commitments , are
very common in everyone life. Any type of
contractual agreement that calls for the
future purchase of a good or service at a
price agreed upon today and without the
right of cancellation is a forward contract.

Future Contracts
A futures contract is an agreement between two
parties a buyer and a seller to buy or sell
something at a future date. The contact trades on
a futures exchange and is subject to a daily
settlement procedure. Future contracts evolved
out of forward contracts and possess many of the
same characteristics. Unlike forward contracts,
futures contracts trade on organized exchanges,
called future markets. Future contracts also differ
from forward contacts in that they are subject to
a daily settlement procedure. In the daily
settlement, investors who incur losses pay them
every day to investors who make profits.

Options Contracts
Options are of two types calls and puts.
Calls give the buyer the right but not the
obligation to buy a given quantity of the
underlying asset, at a given price on or before
a given future date. Puts give the buyer the
right, but not the obligation to sell a given
quantity of the underlying asset at a given
price on or before a given date.



Swaps
Swaps are private agreements between two parties to
exchange cash flows in the future according to a
prearranged formula. They can be regarded as portfolios
of forward contracts. The two commonly used swaps are
interest rate swaps and currency swaps.
Interest rate swaps: These involve swapping only the
interest related cash flows between the parties in the same
currency.
Currency swaps: These entail swapping both principal and
interest between the parties, with the cash flows in one
direction being in a different currency than those in the
opposite direction.



The foreign exchange market is the
market where the currency of one country
is exchanged for the currency of another
country. Most currency transactions are
channelled through the world-wide
interbank market. Interbank market is the
wholesale market in which major banks
trade with each other.
We can also say this the forein exchange
market is onein which currencies are
bought and sold against each other.


13
Recent years have witnessed a phenomenal growth in
foreign exchange market, as it attracts more and more
people. A. favorite for international investors let us
study the main characteristics of the foreign exchange
market as summarized below.
In simple words, Foreign exchange is the trade in which
exchange of the currencies between different nations
takes place. Coins, taking the same form as the
currency within a country, bulk of monetary assets are
traded on foreign exchange markets. The foreign
exchange rate is the price of the currency of a country
in terms of the currency of another. The main focus of
this article is to help you understand the real nature of
foreign exchange market.

No trading field
Unlike the stock trading, foreign exchange
transactions take place without any trading
market and trading field. The absence of any
unification of the operation market and business
network, one of the main features of the foreign
exchange currency market is that it has no
centralized market like a stock exchange.
Consisting of an advanced information system,
foreign exchange trading network has formed
into a global, non-formal organization. Although
the foreign exchange traders are not required to
hold a membership of any organization, they
must obtain their colleagues trust and approval.
Freedom to operate
Different geographical position of the various
financial centers and with the foreign exchange
market functions 24 hours each working day, the
foreign exchange market remains in complete
circulation. With 24 hours of uninterrupted
operation, from Monday to Friday each week, free
from any time and spatial barrier is an ideal
environment for investors. The freedom to operate
in multiple markets is an interesting aspect of
foreign exchange nature.
Perpetual motion in prices
One of the other characteristics of the foreign
exchange is that the fluctuations in the exchange
rate will cause one currency to lose its monetary
value, while others to gain. So there is a
continuous motion in prices. In the foreign
exchange market, the exchange rate refers to the
exchange ratio between the currencies of two
countries. Fluctuations in the exchange rate
change will cause one currency to lose its
monetary value, and at the same time increase
the monetary value of another currency.
Unlimited Potential for Profit and Loss
The most effective manner to illustrate the "unlimitedness" of
the market environment is to compare it to gambling. With
any gambling game you will always know exactly how much
you can win or lose each time you play. You decide exactly
how much you want to wager, you know exactly how much
you can win as well as lose, and you may even know the
mathematical odds of either possibility. This is not the case in
market environment. In any particular trade you never really
know how far prices will travel from any given point. If you
never really know where the market may stop, it is very easy
to believe there are no limits to how much you can make on
any given trade.
Several psychological factors go into
assessing the market's potential accurately
for the price movement in any given
direction. The possibility for unlimited profits
may in fact exist, but how realistic it is in any
given trade is another matter.
Going through the comprehensive guide on
studying the nature of foreign exchange
above will surely help you understand the
market psychology

1. Minimal or no commissions - There are no
clearing fees, no exchange fees, no
government fees and no brokerage fees.
2. Easy access if you compare the money
you need on the market in comparison with
the amount needed for entering the stock,
options or futures market, its a huge
difference. The amount of capital is very low
and it allows numerous types of people to
easily enter the foreign exchange market.
No middlemen spot currency trading is
decentralized and eliminates middlemen,
allowing you to trade directly.
Time and location flexibility the market is
open 24 hours each day, so you dont have to
match your schedule with the one of the
market. It doesnt require a full-time
engagement and you can choose the hours
that suit your best. Also, you can operate
from any corner of the world, as long as you
have an Internet connection.
Transparency - due to multi-day market
movement, its size and the high number of
participants, it is virtually impossible to
market manipulation
Differences between retail and wholesale pricing
around two-thirds of the trades are made
between dealers and large organizations such as
hedge funds and banks. They trade at wholesale
prices, while the investor trades at a retail price.
Like this it can become a challenge to compete
against bigger organization that start with a
lower entry point and sell more profitably.
Risk of choosing an inexperienced broker you
can find on the internet many people who are
targeting fraud so be careful when choosing
the broker.
Requires knowledge and time Without
completely knowing the markets rules and
without having patience, your investment
might very well soon vanish.