Why Does the Foreign Exchange Market Exist? The Significance of the Foreign Exchange Market

Have you ever wondered why the foreign exchange market exists? What is the significance of the foreign exchange market? Below, we’ll explain it to you.

The Significance of the Foreign Exchange Market:

1. Trade and Investment
   Importers and exporters pay in one currency when importing goods and receive another currency when exporting goods. Since they deal in different currencies for settlements, they need to convert the currencies they receive into their preferred currency. Similarly, when investing abroad, it is necessary to convert funds into the local currency of the target country.

2. Hedging
   Due to exchange rate fluctuations between two currencies, companies holding foreign assets may face risks when converting those assets into their domestic currency. If the value of a foreign asset remains unchanged in foreign currency terms over a period, a change in the exchange rate will result in profits or losses when converting the asset back to the domestic currency. Companies can use hedging to eliminate such potential gains or losses, ensuring that the transaction results offset the impact of exchange rate fluctuations on foreign-denominated assets.
   
   

Current Challenges in China’s Foreign Exchange Market:

1. Limited Diversity of Market Participants
   Transactions between banks and non-financial clients account for only about 30%, while interbank transactions dominate China’s foreign exchange market, making up over 60% of total activity. As a result, the number of participants in China’s forex market remains limited.

2. Limited Variety of Trading Instruments and Currencies
   Currently, the range of currencies traded is narrow, primarily limited to major currencies such as the US dollar, Japanese yen, British pound, and euro.

3. Imperfect Market Regulation and Inadequate Legal Framework
   China’s participation in the foreign exchange market is relatively recent, and the country still lacks effective economic and legal tools for macroeconomic regulation. Consequently, China’s forex market experiences significant volatility.
   
   

From the above, we hope you now have a clearer understanding of the significance of the foreign exchange market. Only by gaining an in-depth knowledge of the forex market and its rules can you invest more effectively!