Foreign Exchange Market | Overview & Research Examples (2024)

...1 Introduction to the Foreign Exchange Markets International trade creates a need for buying, selling or borrowing foreign currencies. When, for example, an exporter in Japan sells goods to a customer in the US, the sale will be priced in yen, dollars, or perhaps a third currency such as sterling. •If the sale is priced in yen, the customer will purchase yen with dollars in order to make the payment. •If the sale price is in dollars, the Japanese supplier normally will wish to convert the receipts into his domestic currency, yen, and will sell dollars in exchange for yen. •If the sale price is in a third currency, such as sterling, the customer will buy sterling in exchange for dollars to make the payment and the supplier will then sell the sterling in exchange for yen. On occasion, international trade transactions do not result in the sale or purchase of foreign currency because companies either have foreign currency bank accounts for receipts and payments, or might pay for a purchase with a foreign currency bank loan. Buying and selling currencies, depositing foreign currency in a bank and currency borrowing and lending are all financial market activities that in turn support international trade. Currency is bought and sold in foreign exchange markets that are commonly referred to as FX or y Foreign currency lending and borrowing takes place in the eurocurrency markets. Together, the FX markets and the eurocurrency markets make up the foreign currency cash markets. Currencies also are traded in other forms as derivative instruments, such as currency swaps, options and futures. These are more sophisticated instruments for trading in foreign currencies that are derived from an underlying foreign exchange market or eurocurrency market transaction, and were first devised during the 1970s. The Currency Markets Exchange Rates The price at which one currency is traded in exchange for another in the FX markets is the exchange rate between the two currencies...

...10 The Foreign Exchange Market The currency depreciation that we have experienced of late should eventually help to contain our current account deficit as foreign producers export less to the United States. On the other side of the ledger, the current account should improve as U.S. firms find the export market more receptive. —Alan Greenspan 1 L EARNING O BJECTIVES • To understand the role of foreign currencies in international trade • To comprehend the historical use of money and foreign exchange as a medium of exchange • To appreciate the growth of the foreign exchange market into the largest financial market in the world • To examine the factors that affect foreign exchange rates • To understand the importance of foreign exchange markets to multinational corporations If goods are purchased by a citizen of one country, with one currency, from a citizen of another country, with a different currency, the buyer in most cases prefers to make the payment in his or her own currency. This requires an exchange of currencies from that of the buyer to that of the seller. The purchase or sale of any goods from a citizen of one country to a citizen of another will always result in two simultaneous transactions: 1. Physical exchange of the commodity 2. Purchase or sale of a foreign currency The purchase or sale of the foreign currency affects only one of the parties in the exchange. If an American importer purchases US$100,000 worth of goods from a Japanese manufacturer and the invoice is billed in Japanese yen, the burden falls on the American importer to purchase Japanese yen to complete the transaction. If the contract is invoiced in U.S. dollars, the Japanese seller is responsible for converting the American dollars that were received into Japanese yen to complete the transaction...

...However, studies have shown that these interventions were usually only temporarily successful. Currency market speculation The influence of classic (voice) brokers has decreased significantly in recent years, as more and more volume is traded via electronic trading platforms such as EBS. Especially when it comes to exotic currencies or large sums, the phone is still used, but in everyday trading the proportion of electronic systems is already an estimated 90 percent. Although the share of real economic transactions cannot be determined beyond doubt, it is estimated to be a maximum of ten percent of the volume, with most sources assuming less than five percent. Most of these transactions can be traced back to international groups. As part of globalization, large industries and service companies come into contact with a variety of currencies. As goods and services are often billed in the local currency, companies have an increasing need for currency transactions. The majority of all transactions on the foreign exchange market are not based on real economic processes and transactions, but are based on speculative motives. The foreign exchange market is dominated by some large commercial and investment banks, as well as central banks. Together they form the core of the foreign exchange market, which is presented in the following chapter 2.3. Interbank Market One of the main differences between trading stocks and foreign exchange, for example, is how you trade. While stocks are usually traded on a stock exchange, foreign exchange is traded "over the counter" (OTC). There is no marketplace that bundles supply and demand like an exchange, but the trading partners trade directly with one another. For example, if a bank wants to complete a foreign exchange transaction, they call other banks until they have found a trading partner for their transaction...

...Chapter 2: What is foreign exchange? The abbreviations and words ‘FX’, ‘forex’ and ‘foreign exchange’ are all interchangeable terms used to describe the market in which the currency of one country is exchanged for that of another country. Foreign exchange transactions may be as simple as those encountered by a tourist when visiting a local money changer to conduct a physical exchange of one currency for another, or as complex as multi-legged option strategies executed between global investment banks over electronic trading platforms with multiple settlement dates in multiple currencies. Each transaction forms a part of the foreign exchange market. An important concept to understand from the beginning is that, unlike the equities and futures markets, the foreign exchange market does not have a physical ‘exchange’ in which transactions are conducted. Nor is there a single electronic platform for the execution of FX trades. Foreign exchange is what is known as an ‘over-the-counter’ (OTC) market. In basic terms, this means that any two parties that come together and exchange currencies between one another on agreed terms are participating in the foreign exchange market. Unlike an ‘exchange-traded market’, like that which operates through the Australian Securities Exchange (ASX), with an OTC market there is no need for either party to report a trade to a central exchange, or for any other third party to ever know of the existence of the trade. While it is possible for every foreign exchange transaction to have a unique set of characteristics agreed to by each party, for the sake of simplicity and efficiency certain market conventions have emerged that allow for trading to take place within a framework of standard rules and conditions. These FX market conventions cover issues such as quoting methodology, terminology, and settlement dates and procedures...

...Chapter 3: The foreign exchange markets and major participants Now that we have an insight into the major currencies and their economies, and the important role that central banks play within an economy and the foreign exchange, or forex, markets, we now need to deepen our understanding of the forex market before we begin forex trading. We need to understand who the major players in these markets are and the types of forex markets available. Forex market participants As well as the central banks and their role in and influence on the global foreign exchange market, many other participants are involved in the trading of foreign exchange. It is important to know who these other players are, where they fit in the market and the roles they play within the foreign exchangemarket. Tip The foreign exchange, or forex, market is divided into levels of access that are determined by the size of the line, or amount of money, being traded in each transaction. The inter-bank market After the central banks, the large global commercial banks and financial institutions are the major participants in the forex market, and together they form the inter-bank market. While central bank operations in the market may be sporadic, the large commercial banks are actively involved in foreign exchange trading every day. Their trading activities add massive liquidity and volume to the market daily and are the main cause of price movement in the markets. Major international banks deal either directly with each other or through two main electronic platforms, EBS and Reuters, which offer trading in the major currency pairs. The banks regularly undertake trades worth billions of dollars on behalf of clients or, more commonly, speculateing on their own accounts. They are responsible for the majority of forex trading volume. The inter-bank market is an unregulated and decentralised wholesale market that works around the world and around the clock...

...Chapter 9 Foreign Exchange Abstract Most currencies are free to fluctuate. These have “floating” exchange rates and can be contrasted with “fixed” exchange rates which are determined and maintained by governments. Foreign exchange is traded in the spot market and the forward market. These over-the-counter markets are dominated by dealer banks trading trillions of dollars each day. Most trading is electronic on Thomson Reuters, EBS, and Bloomberg platforms. There are also exchange traded futures, options, and swaps. The theory of “purchasing power parity” states that relative exchange rates will equilibrate to the point where the price of a basket of goods in one country will equal the price of the same basket of goods in a second country. TransferWise is the most successful P2P currency exchange. Others are Xoom, WorldRemit, SettlePay, and InstaRem. Cryptocurrencies such as Bitcoin and Ethereum can also be used as a means of exchanging currency Keywords Currencies; exchange rates; Thomson Reuters; EBS; Bloomberg; purchasing power parity; law of one price; TransferWise; Xoom; WorldRemit; SettlePay; InstaRem Foreign trade has been a crucial factor in lifting global living standards, and over the centuries, trade among countries has increased dramatically. Most countries have their own currency. When countries trade goods with each other, payment is made in local currency; so there needs to be some means to value the buyer’s currency relative to the seller’s. This relative value is called the exchange rate and can be defined as the amount of one currency that needs to be exchanged in order to obtain an amount of a second currency. Three-character currency codes have been established by the International Standards Organization. The format is that the first two letters of the code refer to the country name and where possible the third character corresponds to the first letter of the currency name...

...333), although Professor Friedman and his followers may well be classed as mercantilists in a new guise. Whatever the theoretical significance of an adverse balance of payments, it is at least a signal—whether or not it involves a loss of gold—that the foreign exchange position requires attention. In the era of the gold standard official action began to be taken—generally by the central banks—to correct adverse trends in the balance of payments (Einzig, 1970, chapter 18), and in the modern era such intervention determines the whole course of foreign exchanges. In part this is because, with the abandonment of the gold standard, the scope of the market is no longer defined by the gold-points, so that some other expedient—which only the authorities can provide—is necessary to maintain any sort of stability. The world market in foreign exchange The world market, at its present stage of development, is most usefully described in two ways. The first is to describe it as an institution, in largely mechanical terms. The second is to present the ways in which the monetary authorities, in different countries, may intervene to protect the position of their own currency, according to different types of monetary policy. The principals in the international foreign exchange market are a number of institutions of the pure-money complex, established mainly in the leading financial centres, but represented, in one form or another, throughout the world. The currencies transacted are much the same as in the era of the gold standard, and the course of dealing is in principle no different to what it was then. Barter, rather than sale and purchase, is the basis of the market’s operations, as a visit to any one part of the market, such as the foreign exchange trading-floor of the Paris Bourse, immediately makes clear. There, exchange transactions may be carried out in all possible combinations of the currencies traded—with D-marks being exchanged for dollars, guilders for lire, and so on...

...CHAPTER 5 The Foreign Exchange Spot Market THE SPOT MARKET The foreign exchange markets revolve around spot (that, is the FX spot market). Confusion—Right from the Start When I first walked onto our bank’s trading floor in the United States (the floor on which FX transactions were carried out), I distinctly remember a large, rather animated man jump from his chair to his feet and yell out, seemingly to no one in particular, “I buy dollar yen!”—to which I naturally thought, “Well,. . . make up your mind.” This is but one example of a foreign exchange spot dealer communicating in their unique vernacular. This leads us, first and foremost, to consider the quoting conventions associated with foreign exchange—one of the most confusing things around! We said that the foreign exchange markets revolve around the FX spot market. Let’s be more specific about this statement in two ways. 1. When we say “the foreign exchange markets” (an expression that appears in abbreviated form in the subtitle of this book), what do we mean? By identifying these as plural, we do not only mean to indicate the main geographic trading centers for the various time zones (more dispersed in AustralAsia: Wellington, New Zealand; Sydney, Australia; Singapore; Hong Kong; Tokyo and Osaka, Japan; more concentrated in Europe: London, Zurich, Frankfurt, Paris; and very concentrated in North America: Stamford, Connecticut, New York, and a couple of other locations), but also the markets for different FX products (spot, forwards, futures, swaps, options, exotics—pretty much everything beside spot being labeled “a derivative”). 2. Also, let’s be explicit about what we mean by “the spot market in foreign exchange” and understand how prices are quoted in this context. Recall our earlier assertion that there are five major currencies: USD, EUR, JPY, GBP, and CHF...