Foreign Exchange Market & Structure - Introduction
Foreign Exchange Market & Structure - Introduction
Foreign Exchange
A foreign exchange transaction is an
agreement between a buyer and a
seller that a given amount of one
currency is to be delivered at a
specified rate for some other currency.
The foreign exchange market (forex,
FX, or currency market) is a form of
exchange for the global decentralized
trading of international currencies.
Foreign Exchange
Definition
Import
&
Export
Tourism,
Educatio
n, etc
Forex
Transacti
on
Investme
nt
Avenues
Abroad
Inter
bank
Settleme
nt
Features
Largest financial market
in the world with
average daily turnover
of approximately $5
trillion
The forex market is
greater than the stock
Dominated by large
market. It is 75 times
Multinational banks,
greater than the
Central banks, Hedge
combined volumes at
funds & Currency
New York Stock
Brokers
Exchange
Round the clock market
starting from Sydney,
Tokyo, Honk Kong,
Singapore, Bahrain,
London, New York.
Almost open 24hours x
5 days
FEX types
One type of very short-term transaction is the spot
transaction between two currencies, delivering over two
days and using cash as opposed to a contract.
In a forward transaction, the money is not exchanged until
an arranged date and an exchange rate is agreed in
advance. The time period ranges from days to years.
Currency swaps are a popular type of forward
transaction; these involve the exchange of currency by two
parties for an agreed length of time and an arrangement to
swap currencies at an agreed later date.
Another type is a foreign currency future, which is inclusive
of interest. A standard contract is drawn up and a maturity
date arranged. The time schedule is about three months.
The Players
At the top of the food chain we have the
foreign exchange dealers. These are
the dealer banks which conduct foreign
exchange business for their clients or
themselves. The major banks include;
Deutsche Bank, UBS, Citigroup, Barclays
Capital, RBS, Goldman Sachs, HSBC,
Bank of America, JP Morgan, Credit
Suisse and Morgan Stanley
The Players
The dealer banks that form the
interbank market are effectively the
market makers of the forex market,
they set the prices and manage the
volume for the rest of the market to
feed off.
The Players
These banks handle approximately 2/3 of
the daily forex volume and along with
others form what is known as the
interbank market.
These banks deal with each other on
behalf of clients or for themselves,
providing much needed liquidity to the
market so large transactions whether
corporate or speculative can be facilitated
and proper market function can occur
The Players
On the next level of the forex market we have
the market that exists for financial and nonfinancial participants. This may include
smaller banks, businesses, hedge/mutual/pension
funds, CTAs and large investors.
Traditionally the majority of foreign exchange
turnover has been the result of international
trade flows, this trend has changed in recent
years with the majority of turnover being the
result of capital flows, speculative and hedging
activities.
The Players
This shift reflects the increasing
recognition of foreign exchange as a
means of generating returns by all
market participants, and the need to
manage foreign exchange risks
through hedging activities.
The Players
On the next level we have forex brokers
and retail ECNs (electronic communications
network). Traditionally forex brokers were
the intermediary party between buyers and
sellers, meaning they facilitated the
transaction between the end user and their
liquidity provider (market maker bank). For
the most part this is still the case today,
however, some brokers will run a book and
trade against their clients. .
The Players
Brokers and ECNs will usually have
an agreement with one or more
liquidity providers, through which
they can hedge positions on their
book and manage any exposure they
might have. A liquidity provider could
be any one of the above mentioned
major banks, or even another retail
broker depending on their needs.
The Players
In the background of all this we have the
central banks. The central banks follow
their respective currency, making sure its
price movements arent to erratic and
promoting stability. They are participants
in the market to diversify their currency
reserves, influence the value of their
exchange rate (less common nowadays)
and make international payments on
behalf of the government
The Players
To do all this the central bank has its own
dealers who use a number of larger banks
to help facilitate these flows of funds.
Central bank intervention used to be far
more common and have greater affect
than it has nowadays. Rather than
actively participating in the market
buying and selling their currency, central
banks instead use verbal intervention to
affect the value of their currency.