The foreign exchange market

Market

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Foreign Exchange Market
  • What is an Exchange Rate?
  • Why do Exchange Rates Change?

Foreign Exchange Market

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It is the most liquid financial market in the world. Traders include large banks, central banks, institutional investors, currency speculators, corporations, governments, other financial institutions, and retail investors. The average daily turnover in the global foreign exchange and related markets is continuously growing. According to the 2010 Triennial Central Bank Survey, coordinated by the Bank for International Settlements, average daily turnover was US$3.98 trillion in April 2010 (vs. $1.7 trillion in 1998). Of this $3.98 trillion, $1.5 trillion was spot transactions and $2.5 trillion was traded in outright forwards, swaps and other derivatives.

In April 2010, trading in the United Kingdom accounted for 36.7% of the total, making it by far the most important centre for foreign exchange trading. Trading in the United States accounted for 17.9% and Japan accounted for 6.2%.

In April 2013, for the first time, Singapore surpassed Japan in average daily foreign-exchange trading volume with $383 billion per day. So the rank became: the United Kingdom (41%), the United States (19%), Singapore (5.7) %, Japan (5.6%) and Hong Kong (4.1%).

Turnover of exchange-traded foreign exchange futures and options have grown rapidly in recent years, reaching $166 billion in April 2010 (double the turnover recorded in April 2007). Exchange-traded currency derivatives represent 4% of OTC foreign exchange turnover. Foreign exchange futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts.

Most developed countries permit the trading of derivative products (like futures and options on futures) on their exchanges. All these developed countries already have fully convertible capital accounts. Some governments of emerging economies do not allow foreign exchange derivative products on their exchanges because they have capital controls. The use of derivatives is growing in many emerging economies. Countries such as Korea, South Africa, and India have established currency futures exchanges, despite having some capital controls.

According to the Bank for International Settlements, as of April 2010, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume as of April 2007. Some firms specializing on foreign exchange market had put the average daily turnover in excess of US$4 trillion.

The following diagram shows a glimpse of the average of daily noon buying rates in NY

Foreign Exchange Market

WHAT IS AN EXCHANGE RATE?

It is notable that in forex markets the exchange rate between two currencies changes constantly. The foreign exchange market is a global decentralized marketplace which regulates the values of wide range of currencies.Unlike other markets, there is no centralized depository or exchange where transactions are conducted. Instead, these transactions are conducted by several market participants in several locations.

WHY DO EXCHANGE RATES CHANGE?

Currencies trade on an open market, just like stocks, bonds, computers, cars, and many other goods and services. A currency’s value fluctuates as its supply and demand fluctuates, just like anything else.

  • An increase in supply or a decrease in demand for a currency can cause the value of that currency to fall.
  • A decrease in the supply or an increase in demand for a currency can cause the value of that currency to rise.
  • A big benefit to forex trading is that you can buy or sell any currency pair, at any time subject to available liquidity.
  • So if you think the Eurozone is going to break apart, you can sell the euro and buy the dollar (sell EUR/USD). If you think the price of gold is going to go up, based on historical correlation patterns you can buy the Australian dollar and sell the U.S. dollar (buy AUD/USD).
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