The foreign exchange market is a global marketplace in which banks, non-financial corporations, governments, and institutional investors trade currencies around the clock. It is one of the most extensive financial markets in the world. It is an over-the-counter market, meaning deals1 are made directly between market participants instead of deals made on an exchange.
The term ‘foreign exchange’ can have two related meanings:
1. A transaction for the exchange of one currency for another; and
2. Any currency other than domestic currency.
Key Features of the FX market
- Approximately USD 7 trillion equivalent is estimated to be traded every day. This huge trading volume results in a highly liquid market.
- The high volumes, geographical dispersion, and range of factors influencing movements in FX rates result in highly volatile prices.
- Due to the number of participants and size of the market, profit margins are shallow on any individual transaction.
- It is increasingly technological, and while the telephone is still used, most prices are posted, and deals are struck using electronic media.
- There is no physical marketplace or exchange for foreign currency.
- The foreign exchange markets are dominated by traders who take speculative positions, effectively a ‘bet’ on the strengthening or weakening of particular currencies. The traders may work for a bank or for institutions such as hedge funds.
- With trade becoming more global, there is an increasing business need to buy and sell currencies in to order to make foreign currency payments or convert foreign currency receipts. However, the volume of corporate hedging activity (i.e., exchange of currency flows associated with firms’ businesses) is comparatively small.
- The foreign exchange markets facilitate the movement of capital around the world.
Users of the FX Market
Inter-bank participants, e.g., commercial and investment banks