Foreign Exchange Markets
The foreign exchange market or forex market as it is often called is the market in which currencies are traded. Currency Trading is the world's largest market consisting of almost trillion in daily volume and as investors learn more and become more interested, the market continues to rapidly grow. Not only is the forex market the largest market in the world, but it is also the most liquid, differentiating it from the other markets. In addition, there is no central marketplace for the exchange of currency, but instead the trading is conducted over-the-counter. Unlike the stock market, this decentralization of the market allows traders to choose from a number of different dealers to make trades with and allows for comparison of prices. Typically, the larger a dealer is the better access they have to pricing at the largest banks in the world, and are able to pass that on to their clients. The spot currency market is open twenty-four hours a day, five days a week, with currencies being traded around the world in all of the major financial centers. Learn more about currency trading online.
All trades that take place in the foreign exchange market involve the buying of one currency and the selling of another currency simultaneously. This is because the value of one currency is determined by its comparison to another currency. The first currency of a currency pair is called the "base currency," while the second currency is called the counter currency. The currency pair shows how much of the counter currency is needed to purchase one unit of the base currency. Currency pairs can be thought of as a single unit that can be bought or sold. When purchasing a currency pair, the base currency is being bought, while the counter currency is being sold. The opposite is true, when the sale of a currency pair takes place. There are four major currency pairs that are traded most often in the foreign exchange market. These include the EUR/USD, USD/JPY, GBP/USD, and USD/CHF. Participants
The participants in the foreign exchange market comprise;
- Commercial banks
- Exchange brokers
- Central banks
Corporates: The business houses, international investors, and multinational corporations may operate in the market to meet their genuine trade or investment requirements. They may also buy or sell currencies with a view to speculate or trade in currencies to the extent permitted by the exchange control regulations. They operate by placing orders with the commercial banks. The deals between banks and their clients form the retail segment of foreign exchange market.
In India the foreign Exchange Management (Possession and Retention of Foreign Currency) Regulations, 2000 permits retention, by resident, of foreign currency up to USD 2,000. Foreign Currency Management (Realisation, Repatriation and Surrender of Foreign Exchange) Regulations, 2000 requires a resident in India who receives foreign exchange to surrender it to an authorized dealer:
- Within seven days of receipt in case of receipt by way of remuneration, settlement of lawful obligations, income on assets held abroad, inheritance, settlement or gift: and
- Within ninety days in all other cases.
Any person who acquires foreign exchange but could not use it for the purpose or for any other permitted purpose is required to surrender the unutilized foreign exchange to authorized dealers within sixty days from the date of acquisition. In case the foreign exchange was acquired for travel abroad, the unspent foreign exchange should be surrendered within ninety days from the date of return to India when the foreign exchange is in the form of foreign currency notes and coins and within 180 days in case of travellers cheques.
Similarly, if a resident required foreign exchange for an approved purpose, he should obtain from and authorized dealer.
Commercial Banks are the major players in the market. They buy and sell currencies for their clients. They may also operate on their own. When a bank enters a market to correct excess or sale or purchase position in a foreign currency arising from its various deals with its customers, it is said to do a cover operation. Such transactions constitute hardly 5% of the total transactions done by a large bank. A major portion of the volume is accounted buy trading in currencies indulged by the bank to gain from exchange movements. For transactions involving large volumes, banks may deal directly among themselves. For smaller transactions, the intermediation of foreign exchange brokers may be sought.
Exchange brokers facilitate deal between banks. In the absence of exchange brokers, banks have to contact each other for quotes. If there are 150 banks at a centre, for obtaining the best quote for a single currency, a dealer may have to contact 149 banks. Exchange brokers ensure that the most favorable quotation is obtained and at low cost in terms of time and money. The bank may leave with the broker the limit up to which and the rate at which it wishes to buy or sell the foreign currency concerned. From the intends from other banks, the broker will be able to match the requirements of both. The names of the counter parities are revealed to the banks only when the deal is acceptable to them. Till then anonymity is maintained. Exchange brokers tend to specialize in certain exotic currencies, but they also handle all major currencies.
In India, banks may deal directly or through recognized exchange brokers. Accredited exchange brokers are permitted to contract exchange business on behalf of authorized dealers in foreign exchange only upon the understanding that they will conform to the rates, rules and conditions laid down by the FEDAI. All contracts must bear the clause “subject to the Rules and Regulations of the Foreign Exchanges Dealers ‘Association of India’.
Central Bank : A country's central bank plays a very critical role as a participant in the market. A central bank controls money supply, interest rates, and inflation. This participant has a huge foreign exchange reserve that can be used to stabilize the market. Some governments give control to their central banks regarding the monitoring of target rates for their country's currency. At times central banks would intervene in the forex market. Central banks may not always achieve their target rates. Often enough when the resources of a certain market would be combined it may easily overwhelm any central bank's efforts. Scenarios like this have been observed in Southeast Asia in more recent times.