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by Jagannath and Santosh (R.N.S.I.T
It is where banks and other official
institutions facilitate the buying and selling of
foreign currencies.
FX transactions typically involve one party
purchasing a quantity of one currency in
exchange for paying a quantity of another.
BACKGROUND
The foreign exchange market that we see
today started evolving during the 1970s when
world over countries gradually switched to
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floating exchange rate from their erstwhile
exchange rate regime, which remained fixed
as per the Bretton Woods system till 1971.
Presently, 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.
PARTICIPANTS
Individuals:tourists, migrants
Firms: importers and exporters
Banks
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Governments/ monetary authorities
International agencies
Two tier market:
First
tier: ultimate customer and banker
Second tier: between banks
Arbitrageurs: profit seeking from
variations in rates in different markets
Speculators: profit seeking from
movements in exchange rates
TRADING CENTERS
The main trading center is London, but
New York, Tokyo, Hong Kong and
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Singapore are all important centers as
well.
FEATURES
liquidity: the market operates the enormous
money supply and gives absolute freedom in
opening or closing a position in the current
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market quotation.
availability: a possibility to trade round-the-
clock; a market participant need not wait to
respond to any given event.
flexible regulation of the trade
arrangement system: a position may be
opened for a pre-determined period of time
in the FOREX market, at the investor’s
discretion, which enables to plan the timing
of one’s future activity in advance.
CONT..
one-valued quotations: with high market
liquidity, most sales may be carried out at
the uniform market price, thus enabling to
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avoid the instability problem existing with
futures and other forex investments where
limited quantities of currency only can be
sold concurrently and at a specified price;
margin: the credit “leverage” (margin) in
the FOREX market is only determined by an
agreement between a customer and the
bank or the brokerage house that pushes it
to the market and is normally equal to 1:100.
DETERMINANTS OF FX RATES
Economic factors
1. Government budget deficits or surpluses
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• The market usually reacts negatively to
widening government budget deficits, and
positively to narrowing budget deficits. The
impact is reflected in the value of a country's
currency.
2. Balance of trade levels and trends
• The trade flow between countries illustrates
the demand for goods and services, which in
turn indicates demand for a country's
currency to conduct trade.
CONT..
3. Inflation levels and trends
• Typically a currency will lose value if there is
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a high level of inflation in the country or if
inflation levels are perceived to be rising
4. Economic growth and health
• Reports such as GDP, employment levels,
retail sales, capacity utilization and others,
detail the levels of a country's economic
growth and health.
Political conditions
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Canadian dollar and the Mexican Nuevo Peso,
which settle the next day), as opposed to the
futures contracts, which are usually three
months.
• Currency arbitrage: buying a currency at
cheaper rate in one market and selling at a
higher rate in another market
• Currency speculation: buying and holding
a currency for sale at a higher rate in the
near future
• Spot transactions has the second largest
turnover by volume after Swap.
FINANCIAL INSTRUMENTS
2. Forward
• In this transaction, money does not actually
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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 a one day, a
few days, months or years. Usually the date
is decided by both parties
FINANCIAL INSTRUMENTS
3. Swap
• The most common type of forward
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transaction is the currency 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
FINANCIAL INSTRUMENTS
4. Option
• A foreign exchange option (commonly
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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.
FOREX VS. STOCKS
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Trade Around the Clock Yes Limited
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and investment banks, hedge funds,
corporations & private speculators
The free-floating currency system arose from
the collapse of the Bretton Woods agreement
in 1971
Online trading began in the mid to late
1990's
SIZE
One of the largest financial markets in the world
$3.2 trillion average daily turnover, equivalent to:
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More than 10 times the average daily turnover
of global equity markets1
More than 35 times the average daily turnover
of the NYSE2
Nearly $500 a day for every man, woman, and
child on earth3
An annual turnover more than 10 times world
GDP4
The spot market accounts for just under one-third
of daily turnover
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AVERAGE DAILY TURNOVER BY
GEOGRAPHIC LOCATION
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ISO 4217 code % daily share
Rank Currency
(Symbol) (April 2007)
1 United States dollar USD ($) 86.3%
2 Euro EUR (€) 37.0%
3 Japanese yen JPY (¥) 17.0%
4 Pound sterling GBP (£) 15.0%
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5 Swiss franc CHF (Fr) 6.8%
6 Australian dollar AUD ($) 6.7%
7 Canadian dollar CAD ($) 4.2%
8-9 Swedish krona SEK (kr) 2.8%
8-9 Hong Kong dollar HKD ($) 2.8%
10 Norwegian krone NOK (kr) 2.2%
11 New Zealand dollar NZD ($) 1.9%
12 Mexican peso MXN ($) 1.3%
13 Singapore dollar SGD ($) 1.2%
14 South Korean won KRW (₩) 1.1%
Other 14.5%
Total 200%
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