The foreign exchange market

 

 

• Definition
• What makes the foreign exchange market unique?
• Foreign exchange market participants
• Currency pair
• The majors
• Cross pairs

 

 

 

 

The foreign exchange market is a network of financial institutions and brokers in which individuals, businesses, banks and governments buy and sell the currencies of different countries.

They do so in order to finance international trade, invest or do business abroad, or speculate on currency price changes. On average, the equivalent of about $1.9 trillion in different currencies is traded daily in the FX market around the world .

Foreign exchange is an 'over the counter' (OTC) market, that means that there is no central exchange and clearing house where orders are matched. Geographic trading 'centers' exist around the world however and are : London, New York, Tokyo, Singapore, Frankfurt, Geneva & Zurich, Paris and Hong Kong.

 

What makes the foreign exchange market unique?

huge trading volume, leading to high liquidity

continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday

the variety of factors that affect exchange rates

the use of leverage to enhance profit margins with respect to account size

 

Foreign exchange market participants:

 

Foreign exchange dealers: they are large commercial banks, which buy and sell foreign exchange. Specifically, they are the international departments of large commercial banks in the financial centers of the world: London, New York, Tokyo, Zurich, Frankfurt, Paris, Singapore, Hong Kong, Toronto. In New York City, there are about 100 such banks. Large banks outside the center also participate through their affiliates. Small regional banks do not directly participate in the foreign exchange market. But to meet their customers' foreign exchange need, they deal with correspondent banks. Almost 14,000 commercial banks maintain correspondent relationship with foreign exchange dealers

 

Financial and non-financial customers: smaller commercial banks and investment banks that do not act as major dealers, firms and corporations that are buying or selling foreign exchange because they (or the customers for whom they are acting) are in the process of buying or selling something else (a product, a service, or a financial asset), managers of money funds, mutual funds, hedge funds, and pension funds. For such intermediaries and end-users, the foreign exchange transaction is part of the payments process that is a means of completing some commercial, investment, speculative, or hedging activity.

 

Central banks: All central banks participate in their nations’ foreign exchange markets to some degree, and their operations can be of great importance to those markets. But central banks differ, not only in the extent of their participation, but also in the manner and purposes of their involvement Intervention operations designed to influence foreign exchange market conditions or the exchange rate represent a critically important aspect of central banks’ foreign exchange transactions. However, the intervention practices of individual central banks differ greatly with respect to objectives, approaches, amounts, and tactics.

 

Brokers : The role of a broker in the OTC market is to bring together a buyer and a seller in return for a fee or commission

 

A currency pair is the quotation of the relative value of a currency unit against the unit of another currency in the foreign exchange market. The currency that is used as the reference is called the counter currency or quote currency and the currency that is quoted in relation is called the base currency or transaction currency

 

The majors The most traded pairs of currencies in the world are called the Majors. They constitute the largest share of the foreign exchange market, and therefore they exhibit high market liquidity.

The Majors are: EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF and USD/CAD

 

Cross pairs The currency pairs that do not involve the US dollar are called cross currency pairs, such as GBP/JPY. Pairs that involve the euro are often called euro crosses, such as EUR/GBP