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Foreign Exchange Market

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Financial markets · Exam notes

The foreign exchange market

The world’s largest and most liquid financial market: what it is, who trades, the instruments, and how the Indian forex market works. Includes the latest figures and 20 practice questions.

For JAIIB and CAIIB, RBI Grade B, IBPS PO and Clerk, SBI PO and SO, and UPSC Economy.

What to remember first

  • Forex is OTC, decentralised and open 24 hours
  • Functions: Transfer, Credit, Hedging
  • Spot settles T+2; forwards are OTC; futures are exchange-traded
  • India uses direct quotes (₹ per $); the main pair is USD/INR
  • Regulator: RBI under FEMA 1999

Latest data

Latest figures

₹95.46per US dollar (25 Aug 2026, provisional close)PTI report; check a daily source for today’s rate
$734.6 bnIndia’s forex reserves (week ended 2 Oct 2026)Down $12.95 bn that week (RBI weekly data)
$9.6 trnglobal daily forex turnover (April 2025)BIS Triennial Survey 2025
$250,000LRS limit per resident per financial yearUnused limit lapses on 31 March
Note: the rupee rate and reserves change every week. The figures above are the latest I could confirm, so check RBI and a daily FX report before quoting them.

01 · What is the foreign exchange market?

What is the foreign exchange market?

The foreign exchange (forex, or FX) market is where currencies are bought and sold against each other. It has no single location. Most trading happens electronically, over the counter (OTC), directly between banks around the world.

Key features

  • Largest market: highest daily turnover of any market
  • OTC and decentralised: no central exchange
  • 24-hour market: runs across time zones
  • High liquidity: large trades can be made instantly
  • USD-dominated: the US dollar is the main vehicle currency

Who trades

  • Central banks (e.g. RBI): manage reserves and intervene
  • Commercial banks and Authorised Dealers: the biggest players
  • Brokers: match buyers and sellers for a commission
  • Corporates, exporters, importers, travellers, speculators, arbitrageurs

02 · Functions and market structure

Functions and market structure

FunctionWhat it does
TransferMoves purchasing power between countries (converts money for trade and payments)
CreditProvides credit for foreign trade (bills of exchange, letters of credit)
HedgingProtects against exchange-rate risk using forwards, futures and options

Memory hook: T-C-H = Transfer, Credit, Hedging.

SegmentWho tradesNature
Wholesale / interbankBanks, large dealers, central banksThe core of the market; very large deals at fine rates. Sets the benchmark rate.
RetailIndividuals, small firms, money changersSmaller deals at a margin over interbank rates

03 · Types of forex transactions

Types of forex transactions

TransactionMeaningTraded on
SpotImmediate exchange, settled within 2 business days (T+2)OTC
ForwardRate fixed today for delivery on a future date; customisedOTC
FuturesLike a forward, but standardisedExchange
OptionsRight (not obligation) to buy or sell at a set rateOTC / Exchange
SwapSimultaneous buy and sell for different value datesOTC
Exam point: FX swaps are the most traded instrument, followed by spot. Forwards are customised and OTC; futures are standardised and exchange-traded.

04 · Quotes, pairs and spreads

Quotes, pairs and spreads

Reading a rate

  • Currency pair: USD/INR = 95 means ₹95 for 1 US dollar
  • Base currency is first; quote currency is second
  • Direct quote: home currency per unit of foreign (₹/$). India uses this.
  • Indirect quote: foreign currency per unit of home

Bid, ask and spread

  • Bid: the rate at which a dealer buys
  • Ask (offer): the rate at which it sells; always higher
  • Spread: the gap between bid and ask
  • Cross rate: a rate derived through a third currency, usually the dollar
  • Major pairs: EUR/USD, USD/JPY, GBP/USD, USD/CHF

05 · The Indian forex market

The Indian forex market

Institution or ruleRole
FEMA, 1999Governs forex transactions; replaced FERA 1973 (effective June 2000)
RBIRegulator; manages reserves and intervenes to stabilise the rupee
FEDAI (1958)Self-regulatory body for banks’ forex dealings
Authorised Dealers (AD)Banks licensed by RBI to deal in forex
CCIL (FX-CLEAR)Clearing and settlement of forex trades
FBILPublishes the official USD/INR reference rate
FX-Retail platformLets retail customers buy and sell forex at transparent rates
NDF marketOffshore non-deliverable rupee forwards; Indian banks allowed to take part since 2020

Exchange-rate system

  • Managed float since 1993
  • Main traded pair: USD/INR
  • India accepted IMF Article VIII (current-account convertibility) in August 1994

Recent developments

  • Rupee trade settlement allowed from July 2022
  • LRS: $250,000 per resident per financial year
  • RBI intervenes to smooth sharp moves, not to fix a rate

06 · Forex reserves

Forex reserves

ComponentWhat it is
Foreign currency assets (FCA)Largest part; mostly US dollar holdings and other major currencies
GoldGold held by the RBI
SDRsSpecial Drawing Rights issued by the IMF
Reserve position with the IMFIndia’s reserve tranche in the IMF
Latest (week ended 2 Oct 2026): total $734.61 bn, down about $12.95 bn. FCA about $604.7 bn, gold about $106.4 bn. Reserves are still about $43.5 bn higher than at end-March 2026.

07 · Risks and strategies

Risks and strategies

RiskMeaning
Exchange-rate (currency) riskLoss from adverse rate movements
Settlement risk (Herstatt risk)One party pays and the other fails, because of time-zone gaps. Reduced by CLS (Continuous Linked Settlement).
Country (sovereign) riskPolitical or economic conditions in a country

Strategies

  • Hedging: reduce or remove risk (e.g. book a forward)
  • Speculation: take risk to profit from expected moves
  • Arbitrage: earn a risk-free profit from price gaps

Global snapshot (BIS)

  • Top centres: UK, USA, Singapore, Hong Kong (about 75% of turnover, 2022 survey)
  • USD on one side of about 88% of trades (2022 survey)
  • Most traded instrument: FX swaps, then spot
  • Turnover: about $9.6 trillion a day (April 2025)

08 · Practice MCQs

Practice MCQs

Attempt each question first, then tap to check. Questions 17–20 cover newer exam points.

Q1. The foreign exchange market is mainly a:

  1. Centralised exchange
  2. Over-the-counter (OTC) market
  3. Commodity exchange
  4. Stock exchange

Answer: (b) Over-the-counter (OTC) market. It is decentralised, with no single physical location.

Q2. The largest and most liquid financial market in the world is:

  1. Stock market
  2. Bond market
  3. Foreign exchange market
  4. Commodity market

Answer: (c) Foreign exchange market. Its daily turnover is the highest of any market.

Q3. The US dollar is on one side of about what share of all forex trades (2022 survey)?

  1. 50%
  2. 65%
  3. 88%
  4. 100%

Answer: (c) 88%. The US dollar is the main vehicle currency.

Q4. The world’s largest forex trading centre is:

  1. New York
  2. Tokyo
  3. London
  4. Singapore

Answer: (c) London. The UK is first, followed by the USA, Singapore and Hong Kong.

Q5. The three functions of the forex market are:

  1. Transfer, Credit, Hedging
  2. Saving, Lending, Investing
  3. Buying, Selling, Storing
  4. Import, Export, Tax

Answer: (a) Transfer, Credit, Hedging. Transfer of purchasing power, credit for trade, and protection against rate risk.

Q6. A spot forex transaction is settled within:

  1. Same day
  2. 2 business days (T+2)
  3. 7 days
  4. 1 month

Answer: (b) 2 business days (T+2). Forwards settle on an agreed future date.

Q7. In the pair USD/INR, the base currency is:

  1. INR
  2. USD
  3. Both
  4. Neither

Answer: (b) USD. The first currency in a pair is the base.

Q8. The gap between the bid and ask rate is called the:

  1. Margin
  2. Spread
  3. Premium
  4. Pip

Answer: (b) Spread. The ask is always higher than the bid.

Q9. The self-regulatory body for forex dealers in India is:

  1. SEBI
  2. IBA
  3. FEDAI
  4. NABARD

Answer: (c) FEDAI. FEDAI was established in 1958.

Q10. Settlement risk in forex is also known as:

  1. Market risk
  2. Herstatt risk
  3. Credit risk
  4. Liquidity risk

Answer: (b) Herstatt risk. It arises from time-zone gaps; CLS reduces it.

Q11. Earning a risk-free profit from price gaps in two markets is called:

  1. Hedging
  2. Speculation
  3. Arbitrage
  4. Swapping

Answer: (c) Arbitrage. Hedging reduces risk; speculation takes it on.

Q12. The standardised forex contract traded on an exchange is:

  1. Forward
  2. Futures
  3. Swap
  4. Spot

Answer: (b) Futures. Forwards are customised and OTC.

Q13. Clearing and settlement of forex trades in India is handled by:

  1. NPCI
  2. CCIL
  3. SEBI
  4. NSDL

Answer: (b) CCIL. CCIL runs the FX-CLEAR platform.

Q14. India follows which quote system?

  1. Indirect quote
  2. Direct quote
  3. Both equally
  4. Fixed quote

Answer: (b) Direct quote. Home currency per unit of foreign currency (₹ per $).

Q15. Globally, the most traded forex instrument is:

  1. Spot
  2. FX swaps
  3. Options
  4. Futures

Answer: (b) FX swaps. FX swaps account for the largest share of turnover.

Q16. NDF in forex stands for:

  1. New Dollar Fund
  2. Non-Deliverable Forward
  3. National Forex Desk
  4. Net Dealing Facility

Answer: (b) Non-Deliverable Forward. It is the offshore rupee forward market.

Q17. FEMA 1999 replaced which earlier Act?

  1. FERA 1973
  2. RBI Act 1934
  3. Banking Regulation Act 1949
  4. SEBI Act 1992

Answer: (a) FERA 1973. FEMA came into effect in June 2000.

Q18. India accepted IMF Article VIII (current-account convertibility) in:

  1. 1991
  2. 1994
  3. 1998
  4. 2004

Answer: (b) 1994. August 1994.

Q19. Which is a component of India’s forex reserves?

  1. Gold
  2. Bank deposits of customers
  3. GST collections
  4. Income tax

Answer: (a) Gold. Reserves hold foreign currency assets, gold, SDRs and the IMF reserve position.

Q20. The Liberalised Remittance Scheme (LRS) limit per resident per financial year is:

  1. $25,000
  2. $100,000
  3. $250,000
  4. $1,000,000

Answer: (c) $250,000. Unused limit lapses on 31 March.

60-second revision

  • Forex = largest, OTC, 24-hour, global
  • Functions: Transfer, Credit, Hedging
  • Spot = T+2 · Forward = future date (OTC)
  • Futures = exchange-traded and standardised
  • Most traded instrument: FX swaps
  • USD/INR: USD is the base currency
  • Bid, ask, and the gap = spread
  • India: direct quote · managed float since 1993
  • FEDAI (1958) · CCIL settles trades · FBIL reference rate
  • FEMA 1999 replaced FERA 1973
  • Settlement risk = Herstatt risk (CLS reduces it)
  • LRS = $250,000 per resident per year