Strategic Financial Management · Foreign Exchange Market

Foreign Exchange Market: Structure and Participants

Updated 11 October 2026 · Fact-checked

The foreign exchange market is the over-the-counter network where currencies are bought and sold. It transfers purchasing power, provides credit and allows hedging. It has spot, forward and derivative segments. Participants are authorised dealer banks, corporates, brokers, the RBI and others, with FEDAI setting market rules. Answer by classifying the segment and the participant.

Understand Foreign Exchange Market Structure and Participants

The foreign exchange (forex) market is where one currency is exchanged for another. It is not a single building. It is a network of banks, dealers and brokers linked by telephone and electronic platforms. Because trades are negotiated directly between parties, most of it is an over-the-counter (OTC) market. Exchange-traded currency futures and options are the exception.

The market does three main jobs. It transfers purchasing power between countries, so an importer can pay in a foreign currency. It provides credit for foreign trade, for example through bills and letters of credit. It provides hedging facilities, so firms can fix the rupee value of future foreign currency flows and avoid exchange risk.

The market has segments by timing of delivery. In the spot market the deal is settled at the spot rate, normally within two business days. In the forward market the rate is fixed today but delivery is on a future date. The derivatives segment includes currency futures, options and swaps, whose value depends on an exchange rate. Futures and options are available on recognised exchanges, while swaps are OTC.

It also helps to see two tiers. The interbank (wholesale) market is where banks deal with each other in large amounts. The retail (merchant) market is where banks deal with customers such as importers, exporters and travellers.

Participants include authorised dealers (ADs), mostly commercial banks, who may deal in forex under RBI permission. Others are corporates, exporters, importers, individuals, brokers, and speculators or arbitrageurs. The RBI regulates the market under FEMA, manages the rupee, and may intervene by buying or selling currency. FEDAI is the Foreign Exchange Dealers' Association of India, an association of authorised dealers. It frames rules of conduct and guidelines for its members, such as rules on quoting rates and dealing practices, and advises on market matters.

Key rules to remember

Spot settlement: Spot delivery = trade date + 2 business days (T+2); Standard for most major currency pairs. Say 'normally' in answers, as some pairs settle differently.
Bid-ask spread: Spread = Ask rate − Bid rate; The dealer buys at the bid and sells at the ask. The spread is the dealer's margin.
Spread percentage: Spread % = (Ask − Bid) ÷ Ask × 100; Use the base given in the question. Some use the bid or mid-rate, so state your base.
Market tiers: Interbank (wholesale) market + Merchant (retail) market; Banks deal among themselves in the first and with customers in the second.

How to solve Foreign Exchange Market Structure and Participants questions

Use this method for theory questions and short case MCQs on the market's structure.

1Read the question and identify what is asked: meaning, functions, segments or participants.
2If a transaction is described, decide whether delivery is immediate (spot), future (forward) or contract-based (futures, options, swap).
3Decide whether it is interbank or customer (merchant) dealing.
4Identify who acts: authorised dealer, corporate, broker, speculator, RBI or FEDAI.
5Match the role to the correct body: regulation and intervention to RBI, dealer rules to FEDAI.
6Write the answer as short headed points, each with one line of explanation.
7For numbers, compute the spread or rate and state the unit and the currency.

Quickest way: Three-question check

When to use it: Use it for MCQs with two minutes or less per question.

Ask when delivery happens: now means spot, later means forward.
Ask whether it is traded on an exchange: yes means futures or options, no means OTC.
Ask who is acting: regulator (RBI), dealers' association (FEDAI) or a market player. Eliminate options that mix up these roles.

Common mistakes in Foreign Exchange Market Structure and Participants

Saying FEDAI is a regulator like the RBI
Both appear in rules and guidelines, so the roles blur.
Fix: RBI is the regulator under FEMA. FEDAI is an association of authorised dealers that frames rules for members.
Calling the whole forex market exchange-traded
Students link currency futures to the entire market.
Fix: Most dealing is OTC. Only currency futures and options trade on exchanges.
Treating forward and futures contracts as the same
Both fix a future rate.
Fix: A forward is a customised OTC deal. A futures contract is standardised and exchange-traded.
Applying the bid and ask the wrong way round
Students take the viewpoint of the customer, not the dealer.
Fix: Quotes are from the dealer's view: the dealer buys at the bid and sells at the ask.
Listing functions without explaining them
Students memorise headings only.
Fix: Give a one-line example for each function, such as an importer paying a foreign supplier.

Worked examples

Example 1

A dealer bank quotes USD/INR at ₹83.20 – ₹83.28. (a) State the bid, ask and spread. (b) A customer wants to buy USD 10,000 from the bank. How much rupee does the customer pay? (c) Name the market segment, if delivery is after two business days.

Show the solution

The bid is ₹83.20 and the ask is ₹83.28.
Spread = 83.28 − 83.20 = ₹0.08.
The customer buys dollars, so the bank sells. The bank sells at the ask rate of ₹83.28.
Amount payable = 10,000 × 83.28 = ₹8,32,800.
Delivery after two business days is normal spot settlement, and the deal is between a bank and a customer, so it is the retail (merchant) spot market.

Answer: Bid ₹83.20, ask ₹83.28, spread ₹0.08. The customer pays ₹8,32,800 in the spot merchant market.

Example 2

Explain the functions of the foreign exchange market and the role of RBI and FEDAI in it.

Show the solution

Functions: transfer of purchasing power, so a buyer in one country can pay in another currency.
Credit function: it supports foreign trade through instruments such as bills of exchange and letters of credit.
Hedging function: forwards, futures, options and swaps let firms fix the rupee value of future flows.
RBI: regulates the market under FEMA, authorises banks as dealers, manages the rupee and may intervene by buying or selling foreign currency.
FEDAI: an association of authorised dealers that frames rules and guidelines on dealing practice for its members.
Conclude that RBI is the regulator and FEDAI is a self-regulating industry body.

Answer: The market transfers purchasing power, provides credit and offers hedging. The RBI regulates and intervenes, and FEDAI frames dealing rules for authorised dealers.

Exam tips

Expect 2-mark MCQs that test classification: spot vs forward, OTC vs exchange-traded, RBI vs FEDAI.
In descriptive answers, use headings for functions, segments and participants, then one example each.
When a quote is given, label bid and ask from the dealer's side before computing anything.
Write 'normally T+2' for spot settlement rather than an absolute claim.
Link the topic to hedging: a closing line that forwards and derivatives manage exchange risk earns easy marks.

Practice questions from Foreign Exchange Market

Foreign Exchange Market Structure and Participants in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Foreign Exchange Market Structure and Participants: frequently asked questions

What are the main functions of the foreign exchange market?

It transfers purchasing power between countries, provides credit for international trade and offers hedging against exchange rate risk. Some books add a speculation or arbitrage role. Give an example for each function.

What is the role of FEDAI in the forex market?

FEDAI is the Foreign Exchange Dealers' Association of India, made up of authorised dealers. It frames rules and guidelines on dealing practice for its members and acts as a link with the regulator. It is not the regulator itself.

Is the forex market OTC or exchange-traded?

Most trading is over the counter, with banks and dealers negotiating directly. Currency futures and options are exchange-traded, which is a smaller part. Swaps and forwards are OTC.

Who are the participants in the forex market?

Authorised dealer banks, corporates, exporters and importers, individuals, brokers, speculators and arbitrageurs take part. The RBI takes part as regulator and sometimes as an intervening buyer or seller of currency.