The need for a foreign exchange market therefore arises out of the fact that the power of
domestic legal tender, circulating in the form of currency notes, to redeem commercial
liabilities legally, is limited by national boundaries. Both the seller and the buyer want to
receive and make payment in their respective domestic currencies. The task of fulfilling
this requirement is handled by international commercial banks.
All countries have their own Currencies like India – Indian Rupee, United States – US
Dollars, United Kingdom – Sterling Pound, etc. Any economic transaction that takes place
between residents of two different countries involves exchange of some currency between
those two different countries involves exchange of some currency between those two
This may involve import / export of goods or services, investments or redemptions,
borrowing / lending, or personal transfers such as family maintenance, tourism etc. In all
these cases, the source of purchasing power is available in one currency whereas its
utilization after conversion is in another currency. When these transactions get executed
through the intermediation of banks, one currency gets converted into another. This
process is called ‘Foreign Exchange’.