Functions of foreign exchange market
The first essential function of the foreign exchange market is the transfer of foreign currency from one nation to the other with an objective settling a particular payment. Foreign exchange market achieves this objective through the conversion of a coin from one country to the money of another nation (Mitra, 2017). For instance, if a trader in China imports a commodity from the United States and the payment should be made in dollars, foreign exchange market becomes the media for transferring such yens into dollars considering the purchasing power parity. This information indicates that the role of FOREX is moving the purchasing power parity from one country to the other. Credit function forms the essential function of foreign exchange market. This market achieves its objective by offering short-term loans to importers with a goal for facilitating the transfer of goods and services from one country to the other. Under such circumstances, the importers can use such currencies to finance the purchase of commodities from other countries, thus resulting in the smooth operation of the market. For example, if a Chinese company intends to purchase a machine from the United States, they can achieve this objective of the purchase by issuing a bill of exchange to the foreign exchange market with a three-month maturity.
Relationship between money supply and inflation
In an economy, there is a connection between money supply and rise as the level of money supply affects the level of demand for commodities and prices of such products. Money supply refers to the money in notes and coins that are in circulation in the economy (Mitra, 2017). As a supply of money in an economy through the central bank increases, the level of inflation and balance of payment in an economy also raises, resulting in an increment in the sustained level of prices of commodities. When people have disposable income, they spend on luxury goods, thus increasing demand for such products. In effect, there will be a general increase in prices of the commodities, thus resulting in inflation. Central Bank and the government of any country plays an essential role in controlling the level of the money supply. For instance, when the central bank lowers interest rate, there will be a high rate of borrowing, thus increasing the money supply in an economy. Government expenditure also increases the amount of money, thus stimulating demand in the country, resulting in market pull inflation.
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The level of inflation occurs depending on the level of real output. If the money supply grows faster than the level of actual production, inflation will happen because there will be increased demand for commodities than the economy can produce. Shortage of products results in increased prices resulting in inflation. If the supply of money increases at the same rate with real output, there will be a balance between money demand and supply, thus resulting in a steady demand for goods and services.
Difference between convertible and non-convertible currency
A convertible currency is a currency that is easily purchased or sold without government interventions such as restrictions to buy another currency. The decision to sell currency is based on the policies of the foreign exchange market with no government restrictions. A convertible currency is referred to as a liquid instrument when compared to other currencies remain under the control of Central Bank and other authorities that determine the circulation of that currency (Mitra, 2017). An example of a convertible currency is the US dollar, which is highly circulated across the world central banks as they hold the US dollar as their primary reserve.
On the other hand, the non-convertible currency is a currency that remains under control of the government through the central bank and is commonly used for domestic transactions. In effect, such money is not openly traded in the foreign exchange markets, making it difficult for traders to purchase other currencies freely. The most recognized difference is that non-convertible currency is under control of the central bank, government, and other monetary authorities.
Technological Risks Facing Foreign Exchange Market
Most of the changes in foreign exchange markets relate to the computing power and automation in the financial market resulting in high-frequency technology. Automation has become the driving force in the financial markets as computers have become increasingly used in mortgage applications. The implementation of such technology has increasingly supported workers in processing trading orders as well as making investment decisions in the market (Domanski, Kohlscheen, & Moreno, 2016). Automation also has the advantage of reducing the operational costs as they reduce the number of workers needed in the market as well as reducing the time spent by customers in the market, thus improving customer experience.
Despite the advantages, automation and high-frequency trading technology have some disadvantages. For instance, financial instruments with more top aggressive high-frequency trading tend to be volatile, producing a condition that quickly affects the managerial portfolios (Domanski, Kohlscheen, & Moreno, 2016). In circumstances of high-frequency trading imbalance, it is evident that the market results in the production of substandard results. However, the benefits exceed disadvantages, and foreign market exchange managers can control such changes to maximize on profits of technological advancement.
References
Domanski, D., Kohlscheen, E., & Moreno, R. (2016). Foreign exchange market intervention in EMEs: what has changed?. BIS Quarterly Review September.
Mitra, P. K. (2017). Dynamics of volatility spillover between the Indian stock market and foreign exchange market return. Academy of Accounting and Financial studies Journal, 21(2), 1-11.
