Foreign Exchange Market

The existence of a number of currencies gives rise to the need to transact in these currencies for settling international payments . This resulted in the development of a market which deals specifically in currencies ,called the foreign exchange market. This is an OTC MARKET .

• The foreign exchange (currency, forex or FX) market is where currency trading takes place. FX transactions typically involve one party purchasing a quantity of one currency in exchange for paying a quantity of another. The FX market is one of the largest and most liquid financial markets in the world, and includes trading between large banks, central banks, currency speculators, corporations, governments, and other institutions. The average daily volume in the global forex and related markets is continuously growing. Traditional turnover was reported to be over US$ 3.2 trillion per day in April 2007 by the Bank for International Settlement. Since then, the market has continued to grow. According to Euromoney's annual FX Poll, volumes grew a further 41% between 2007 and 2008

• According to the Bank for International Settlements,[2] average daily turnover in global foreign exchange markets is estimated at $3.98 trillion. Trading in the world's main financial markets accounted for $3.21 trillion of this. Of the $3.98 trillion daily global turnover, trading in London accounted for around $1.36 trillion, or 34.1% of the total, making London by far the global center for foreign exchange. In second and third places respectively, trading in New York accounted for 16.6%, and Tokyo accounted for 6.0%.[4] In addition to "traditional" turnover, $2.1 trillion was traded in derivatives.

Top 10 currency traders % of overall volume, May 2008
Top 10 currency traders [5]
% of overall volume, May 2008

Rank 1 2 3 4 5 6 7 8 9 10

Name

Volume 21.70% 15.80% 9.12% 7.49% 7.30% 4.19% 4.10% 3.58% 3.47% 2.86%

Deutsche Bank UBS AG Barclays Capital Citi Royal Bank of Scotland JPMorgan HSBC Lehman Brothers Goldman Sachs Morgan Stanley

• The participants in the market are linked together by telephone ,telex, and a satellite communications network called the Society for Worldwide International Financial Telecommunications ( SWIFT ) This computer based communications system ,based in Brussels ,Belgium, links banks and brokers in just about every financial center.

When foreign exchange is trading against the US Dollar the clearing house that is used is called CHIPS ( Clearing House interbank Payments System) .It

is located in New York

• Since September 2002 a new settlement system has been provided to the foreign exchange markets by New York based CLS Bank where CLS stands for Continued Linked Settlement .

system has been provided ti the foreign exchange markets by New York based Bank ehere CLS • When foreign exchange is trading aginst stands for Continued Linked the US Dollar the clearing house that is Settlememt . used is called CHIPS ( Clearing House
interbank Payments System )

• This speed of communications makes the market the most efficient market and the efficiency is revealed in the extremely narrow spread between buying and selling price and participants of the market can not can not afford to miss a beat in the frantic pulse of this dynamic global market .

Structure of the market
• Major participants – Commercial Banks , Fore brokers, Large corporations , Central bank .

• Central Banks • The majority of developed market economies have a central bank, whose role differs from country to country. Central banks play an important role in the Forex market. They try to maintain the money supply, interest rates, inflation, and other market factors. A nation's central bank also has the fundamental responsibility of maintaining the market for its national currency. This entails monitoring and checking the prices dealt in the Forex market. Participants in the market all tend to respect the opinions of the central banks because of the power and control they have over the value of their national currency.

• •

Banks Both small and large banks, working for themselves and their clients (institutions, individual investors), participate in the Forex markets. According to the Bank for International Settlements, approximately 50% of all Forex transactions are strictly interbank trades. Some of the more active large banks may trade up to one billion dollars daily. And while some of this trading is done for customers, most of it is for the bank's own account. • In the past banks relied on Forex brokers to handle their accounts in the role of middlemen, but with the emergence of technology in the Forex arena, they have been replaced by computers and other devices. Today, transactions are made by telephone with brokers or by an electronic medium, with the transaction time being between 5 and 10 seconds.

• Market Makers • Forex market makers are the banks and brokerage companies that facilitate the 24 hour trading capabilities of the Forex market. Market makers literally "make the market" for the currencies. They ensure that the market is always functional and that the currencies in it will always obtain the market rate. To achieve this level and efficiency of trading, Forex market makers update their prices at least two times per minute allowing the trader to get the most complete up to date price and information as possible.

• Corporations • Small and large companies also play an important role in the Forex market. These companies often use foreign exchange to pay for goods or services. Compared to banks and hedge funds, corporations trade less amounts of currency. Although they also do not hold the influence of banks and hedge funds, they keep the market strong through international trade and foreign currency exchange between multinational companies.

• Fund Managers • Forex fund manager are similar to money managers in the investment field. However, fund managers do business in both the domestic and international arena for individual investors, corporate pension funds, governments, and even central banks. Fund managers usually have a large pool of investments to oversee for a wide variety of clients. Dealing with hundreds of millions of dollars, they invest money across a range of countries to maximize returns

• Hedge Funds • Hedge funds have a reputation for aggressive currency speculation. Their influence in the market over the past decade has increased immensely. Hedge funds oversee billions of dollars of equity, and, due their tremendous borrowing power, may have rivaled the power and influence of central banks, if investments and market rends are in their favor. As opposed to banks and fund managers, hedge funds are primarily more concerned with managing the total risk of their investment pools.

• Investment Management Firms • Investment management firms typically manage large accounts on behalf of corporate pension funds, trusts, charity organization and similar institutions. They use the Forex market to facilitate transactions in foreign securities. An example of an investment firm's activity in the Forex market is given by trading markets.com: an investment manager in charge of an international equity portfolio needs to purchase and sell several pairs of foreign currencies to pay for foreign securities purchases. Like hedge funds, investment firms are concerned with limiting risk (while, of course, maximizing returns).

• •

Brokers and Electronic Brokers The Forex broker is very similar to a stockbroker. One difference, though, is that Forex brokers only deal with banks. They, in a very efficient manner, act as the primary agent for bank transactions of the Forex market. Due to technological innovations in the market, many traditional brokering duties have been computerized, decreasing the need for human handling of the orders. • This technological takeover of the brokerage aspect of the Forex market, has led to the emergence of 'straight through processing.' Straight through processing is the automatic processing of an order as soon as it becomes. This has opened up Forex trading to a new, wide range of individuals and companies. Some of the most popular trading platforms include Forex.com, FXconnect, and FX Solutions. These sights, and others like them, allow Forex market participants, mostly the larger banks and corporations, to access the market directly, instead of going through a broker or a middleman, ultimately cutting costs significantly.

Forex market is a 24 hour market

It has long trading hours: 24 hours a day except on weekends (from 5pm EST on Sunday until 4pm EST Friday),
Eastern Time is the Eastern Time Zone of the United States of America (USA) and Canada. Eastern Standard Time (EST) is 5 hours behind Greenwich Mean Time (GMT-5).

The spot foreign exchange market
• The spot exchange rate which is determined in the spot exchange market is the number of units of one currency per unit of another currency ,where both are in form of bank deposits . The settlement of trade is completed by transferring of deposits electronically denominated in relevant currencies between the parties involved .

Some important Aspects
• • • • • Nostro Account Vostro Acount A nostro is our account of our money, held by you A vostro is our account of your money, held by us Delivery date and procedure for spot exchange : generally 1+ 2 concept is applicable with some exceptions. • Retail versus interbank spot rates : The world over ,about 85% of forex trading arises as a result of transaction between market makers and speculative transactions .only 15 % of the transactions being trade or commerce related .

Factors Affecting Foreign Exchange Currency Market Trade Political Factors Economic Factors Market Psychology

Foreign Exchange Market in India
• The Indian foreign exchange market consists of the buyers, sellers, market intermediaries and the monetary authority of India. The main center of foreign exchange transactions in India is Mumbai, the commercial capital of the country. There are several other centers for foreign exchange transactions in the country including Kolkata, New Delhi, Chennai, Bangalore, Pondicherry and Cochin. In past, due to lack of communication facilities all these markets were not linked. But with the development of technologies, all the foreign exchange markets of India are working collectively.

• The foreign exchange market India is regulated by the reserve bank of India through the Exchange Control Department. At the same time, Foreign Exchange Dealers Association (voluntary association) also provides some help in regulating the market. The Authorized Dealers (Authorized by the RBI) and the accredited brokers are eligible to participate in the foreign Exchange market in India. When the foreign exchange trade is going on between Authorized Dealers and RBI or between the Authorized Dealers and the Overseas banks, the brokers have no role to play

• Apart from the Authorized Dealers and brokers, there are some others who are provided with the restricted rights to accept the foreign currency or travelers cheque. Among these, there are the authorized money changers, travel agents, certain hotels and government shops. The IDBI and Exim bank are also permitted conditionally to hold foreign currency.

• The whole foreign exchange market in India is regulated by the Foreign Exchange Management Act, 1999 or FEMA. Before this act was introduced, the market was regulated by the FERA or Foreign Exchange Regulation Act ,1947. After independence, FERA was introduced as a temporary measure to regulate the inflow of the foreign capital. But with the economic and industrial development, the need for conservation of foreign currency was felt and on the recommendation of the Public Accounts Committee, the Indian government passed the Foreign Exchange Regulation Act,1973 and

Exchange Rate quotations
• An exchange rate quotation is the price of a Currency sated in terms of another • American Vs European quote: British pound, Irish pound and South African Rand are few examples of American Quotes . • Direct Vs Indirect quotes

The spot foreign exchange market
• The spot exchange rate which is determined in the spot exchange market is the number of units of one currency per unit of another currency , . The settlement of trade is completed by transferring of deposits electronically denominated in relevant currencies between the parties involved .

• Bid and ask rate :selling rate are called ask, offer rate . Buying rate is called bid rate . • The difference of the two is the spread . • Interbank Vs Merchant quotes • INVERSE Quotes : Arbitrage • Cross rates :Cross rate and arbitrage

Types of transaction
• Forward Quotes : A forward contract also called an outright forward is one where the parties of the transactions agree to bye or sell a currency at a predetermined future date at particular price . Forward contracts generally mature after 1,2,3,6,9,12 months. • The difference of the spot rate and forward rates can be expressed in terms of swap points . When swap points are low high ,currency B is at premium and A is at discount .Add the swap points to the spot rate to get the outright forward rate .If the points are high /low B is at discount and A is at premium . Deduct the swap points from the spot rate to arrive at the outright forward rate ,add them to the outright forward rate to arrive at spot rate. • Discount and premium :

• Discount and premium :

Calculation of annual premium and discount
• Forwarded rate vs expected spot rates : • While the price paid for a forward currency equals the future spot rate expected by the market a the time of purchase , when the forward contract matures its value is determined by the realized spot rate at that time . The greater the extent to which the eventually realized spot rate differs from the spot rate that was expected at the time of buying the contract ,the larger is the change in the value of the forward contract vis-à-vis the purchase price.

• Stated differently ,the larger is the unexpected change in the spot exchange rate greater is the change in the value of a forward contract between the purchase and maturity,

Outright forward exchange and swap
• An outright forward exchange contract consists of an agreement to exchange currencies at an agreed price at a future date . • A swap has two components , usually a spot transaction plus a forward transaction in the reverse direction./,although swap could involve two forward transaction in opposite directions.

• Swap in : to buy at spot and sell forward • Swap out : to sell at spot and buy forward • . Forward forward swap: contract to buy for 1 month forward and sell 2month forward . • When the purchase and sale are separated by only one day the swap is called a rollover ,.

• The uses of Swaps : Swaps are valuable to those who are investing or borrowing in foreign currency but not for traders . • Swaps are important for banks . For some dates and currencies ,a bank will be long in foreign exchange by having agreed to purchase more of the foreign exchange than it had agree to sell. For other dates and currencies a bank will be short , having agreed to sell more of these currencies than it had agreed to buy . Swaps help the bank to economically reduce risk .

• If a bank is long on spot British pound and short on 30 days pound , it will try to find another bank ,bank B, in the opposite situation . Bank A will sell pound spot and buy pounds forward. –a swap out of sterling with bank B .

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