Unlike a stock market, the foreign exchange market is divided into levels of access. At the top is the interbank foreign exchange market , which is made up of the largest commercial banks and securities dealers. Within the interbank market, spreads, which are the difference between the bid and ask prices, are razor sharp and not known to players outside the inner circle.
The difference between the bid and ask prices widens for example from 0 to 1 pip to 1—2 pips for currencies such as the EUR as you go down the levels of access. This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread.
The levels of access that make up the foreign exchange market are determined by the size of the "line" the amount of money with which they are trading. An important part of the foreign exchange market comes from the financial activities of companies seeking foreign exchange to pay for goods or services.
Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short-term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational corporations MNCs can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants.
National central banks play an important role in the foreign exchange markets. They can use their often substantial foreign exchange reserves to stabilize the market. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would. There is also no convincing evidence that they actually make a profit from trading.
Foreign exchange fixing is the daily monetary exchange rate fixed by the national bank of each country. The idea is that central banks use the fixing time and exchange rate to evaluate the behavior of their currency. Fixing exchange rates reflect the real value of equilibrium in the market. Banks, dealers and traders use fixing rates as a market trend indicator.
The mere expectation or rumor of a central bank foreign exchange intervention might be enough to stabilize a currency. However, aggressive intervention might be used several times each year in countries with a dirty float currency regime.
Central banks do not always achieve their objectives. The combined resources of the market can easily overwhelm any central bank.
Investment management firms who typically manage large accounts on behalf of customers such as pension funds and endowments use the foreign exchange market to facilitate transactions in foreign securities.
For example, an investment manager bearing an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases.
Some investment management firms also have more speculative specialist currency overlay operations, which manage clients' currency exposures with the aim of generating profits as well as limiting risk. While the number of this type of specialist firms is quite small, many have a large value of assets under management and can therefore generate large trades.
Individual retail speculative traders constitute a growing segment of this market. Currently, they participate indirectly through brokers or banks.
Retail brokers, while largely controlled and regulated in the USA by the Commodity Futures Trading Commission and National Futures Association , have previously been subjected to periodic foreign exchange fraud. Those NFA members that would traditionally be subject to minimum net capital requirements, FCMs and IBs, are subject to greater minimum net capital requirements if they deal in Forex. A number of the foreign exchange brokers operate from the UK under Financial Services Authority regulations where foreign exchange trading using margin is part of the wider over-the-counter derivatives trading industry that includes contracts for difference and financial spread betting.
There are two main types of retail FX brokers offering the opportunity for speculative currency trading: Brokers serve as an agent of the customer in the broader FX market, by seeking the best price in the market for a retail order and dealing on behalf of the retail customer.
They charge a commission or "mark-up" in addition to the price obtained in the market. Dealers or market makers , by contrast, typically act as principals in the transaction versus the retail customer, and quote a price they are willing to deal at.
Non-bank foreign exchange companies offer currency exchange and international payments to private individuals and companies. These are also known as "foreign exchange brokers" but are distinct in that they do not offer speculative trading but rather currency exchange with payments i. The volume of transactions done through Foreign Exchange Companies in India amounts to about USD 2 billion  per day This does not compete favorably with any well developed foreign exchange market of international repute, but with the entry of online Foreign Exchange Companies the market is steadily growing.
These are typically located at airports and stations or at tourist locations and allow physical notes to be exchanged from one currency to another.
They access the foreign exchange markets via banks or non bank foreign exchange companies. There is no unified or centrally cleared market for the majority of trades, and there is very little cross-border regulation. Due to the over-the-counter OTC nature of currency markets, there are rather a number of interconnected marketplaces, where different currencies instruments are traded.
This implies that there is not a single exchange rate but rather a number of different rates prices , depending on what bank or market maker is trading, and where it is. In practice, the rates are quite close due to arbitrage. A joint venture of the Chicago Mercantile Exchange and Reuters , called Fxmarketspace opened in and aspired but failed to the role of a central market clearing mechanism.
Banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session.
Fluctuations in exchange rates are usually caused by actual monetary flows as well as by expectations of changes in monetary flows. Major news is released publicly, often on scheduled dates, so many people have access to the same news at the same time.
However, the large banks have an important advantage; they can see their customers' order flow. Currencies are traded against one another in pairs. The first currency XXX is the base currency that is quoted relative to the second currency YYY , called the counter currency or quote currency. The market convention is to quote most exchange rates against the USD with the US dollar as the base currency e.
On the spot market, according to the Triennial Survey, the most heavily traded bilateral currency pairs were:. Trading in the euro has grown considerably since the currency's creation in January , and how long the foreign exchange market will remain dollar-centered is open to debate. Until recently, trading the euro versus a non-European currency ZZZ would have usually involved two trades: The following theories explain the fluctuations in exchange rates in a floating exchange rate regime In a fixed exchange rate regime, rates are decided by its government:.
None of the models developed so far succeed to explain exchange rates and volatility in the longer time frames. For shorter time frames less than a few days , algorithms can be devised to predict prices.
It is understood from the above models that many macroeconomic factors affect the exchange rates and in the end currency prices are a result of dual forces of demand and supply.
The world's currency markets can be viewed as a huge melting pot: No other market encompasses and distills as much of what is going on in the world at any given time as foreign exchange.
Supply and demand for any given currency, and thus its value, are not influenced by any single element, but rather by several. These elements generally fall into three categories: Internal, regional, and international political conditions and events can have a profound effect on currency markets. All exchange rates are susceptible to political instability and anticipations about the new ruling party.
Political upheaval and instability can have a negative impact on a nation's economy. For example, destabilization of coalition governments in Pakistan and Thailand can negatively affect the value of their currencies. Similarly, in a country experiencing financial difficulties, the rise of a political faction that is perceived to be fiscally responsible can have the opposite effect.
Market psychology and trader perceptions influence the foreign exchange market in a variety of ways:. A spot transaction is a two-day delivery transaction except in the case of trades between the US dollar, Canadian dollar, Turkish lira, euro and Russian ruble, which settle the next business day , as opposed to the futures contracts , which are usually three months. Spot trading is one of the most common types of Forex Trading. Often, a forex broker will charge a small fee to the client to roll-over the expiring transaction into a new identical transaction for a continuation of the trade.
This roll-over fee is known as the "Swap" fee. One way to deal with the foreign exchange risk is to engage in a forward transaction. In this transaction, money does not actually change hands until some agreed upon future date. A buyer and seller agree on an exchange rate for any date in the future, and the transaction occurs on that date, regardless of what the market rates are then. The duration of the trade can be one day, a few days, months or years.
Usually the date is decided by both parties. Then the forward contract is negotiated and agreed upon by both parties. NDFs are popular for currencies with restrictions such as the Argentinian peso. In fact, a Forex hedger can only hedge such risks with NDFs, as currencies such as the Argentinian Peso cannot be traded on open markets like major currencies.
The most common type of forward transaction is the foreign exchange swap. In a swap, two parties exchange currencies for a certain length of time and agree to reverse the transaction at a later date. These are not standardized contracts and are not traded through an exchange.
A deposit is often required in order to hold the position open until the transaction is completed. Futures are standardized forward contracts and are usually traded on an exchange created for this purpose.
The average contract length is roughly 3 months. Futures contracts are usually inclusive of any interest amounts. Currency futures contracts are contracts specifying a standard volume of a particular currency to be exchanged on a specific settlement date.
Thus the currency futures contracts are similar to forward contracts in terms of their obligation, but differ from forward contracts in the way they are traded. They are commonly used by MNCs to hedge their currency positions. In addition they are traded by speculators who hope to capitalize on their expectations of exchange rate movements. A foreign exchange option commonly shortened to just FX option is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a pre-agreed exchange rate on a specified date.
The FX options market is the deepest, largest and most liquid market for options of any kind in the world. Controversy about currency speculators and their effect on currency devaluations and national economies recurs regularly. Economists, such as Milton Friedman , have argued that speculators ultimately are a stabilizing influence on the market, and that stabilizing speculation performs the important function of providing a market for hedgers and transferring risk from those people who don't wish to bear it, to those who do.
Large hedge funds and other well capitalized "position traders" are the main professional speculators. According to some economists, individual traders could act as " noise traders " and have a more destabilizing role than larger and better informed actors. Currency speculation is considered a highly suspect activity in many countries.
He blamed the devaluation of the Malaysian ringgit in on George Soros and other speculators. Gregory Millman reports on an opposing view, comparing speculators to "vigilantes" who simply help "enforce" international agreements and anticipate the effects of basic economic "laws" in order to profit. In this view, countries may develop unsustainable economic bubbles or otherwise mishandle their national economies, and foreign exchange speculators made the inevitable collapse happen sooner.
A relatively quick collapse might even be preferable to continued economic mishandling, followed by an eventual, larger, collapse. Mahathir Mohamad and other critics of speculation are viewed as trying to deflect the blame from themselves for having caused the unsustainable economic conditions.
Risk aversion is a kind of trading behavior exhibited by the foreign exchange market when a potentially adverse event happens which may affect market conditions. This behavior is caused when risk averse traders liquidate their positions in risky assets and shift the funds to less risky assets due to uncertainty. In the context of the foreign exchange market, traders liquidate their positions in various currencies to take up positions in safe-haven currencies, such as the US dollar.
An example would be the Financial Crisis of The value of equities across the world fell while the US dollar strengthened see Fig. These companies engage in specialized activities, such as consumer finance and securities business. Overseas banks may establish local representative offices in Hong Kong, but they are not allowed to engage in any banking business and their role is confined mainly to liaison work between the bank and its customers in Hong Kong.
Bank of Communications Co. The Bank of East Asia, Limited. China Construction Bank Asia. Fubon Bank Hong Kong. Hongkong and Shanghai Banking Corporation. Industrial and Commercial Bank of China Asia. Public Bank Hong Kong. Standard Chartered Hong Kong. Tai Sang Bank Limited. Agricultural Bank of China. Australia and New Zealand Banking Group.
Banca Monte dei Paschi di Siena. Banco Bilbao Vizcaya Argentaria. United States of America. Bank of Communications Hong Kong Branch. Bank of New York Mellon, The. Bank of Nova Scotia, The. Bank of the Philippine Islands. Canadian Imperial Bank of Commerce. China Minsheng Banking Corporation. Commonwealth Bank of Australia.
Crédit Agricole Corporate and Investment Bank.
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