Organization of the Foreign Exchange Market
Outline: Organization of the Foreign Exchange Market
Definition of the foreign exchange market: a market that facilitates the purchase and sale of money denominated within a specific currency to another different currency. It also comprises foreign capital and trade transactions supported with the transfer of purchasing power amid states.
- Participants in the Foreign Exchange Market
- Participants within two levels. These comprise the wholesale level and the retail level.
- Types of currency markets: These include the spot and the forward market.
III. Participants by Market
- Spot Market. Mainly comprised of brokers, commercial banks, and clients of central and commercial banks
- Forward Market. Mainly comprised of hedgers, traders, arbitrageurs, and speculators
III. Size of Market
- Size based on transactions: Largest in the world with recent transactions amounting to $5.3 trillion per day
- Size based on popular market centers: These comprise New York, London, and Tokyo.
In conclusion, the organization of foreign market is best studied by researching on the participants within the market, the participants by market, and the size of the market.
The Organization of the Foreign Exchange Market
The market based on foreign exchange involves the sale and purchase of national currencies. Foreign exchange markets exist due to the employment of national currencies by economies. Usually, the money that is denominated within one currency is sold and purchased with money denominated within another currency. Simply, if the global economy utilized one currency, then there would be null demand for the use of foreign exchange markets. The foreign exchange market is excessively active. Transactions that take place are based on exchange trade futures and options. However, most of the transactions comprise OTC. These elements comprise foreign capital and trade transactions, which are aided with the capability of transferring purchasing power between states. Due to its considerable size, the foreign market assumes an important part in the development of the global economy. In this context, the research will focus specifically on the organization of the foreign market.
Participants in the Foreign Market
Wholesale Level and Retail Level
Due to its operations, the foreign exchange market is usually organized into different segments. Foremost, the first categorization is based on the participants within the foreign market. These participants exist in different levels depending on the bull of currency reserves they hold in relation to trade. Foremost, there is the wholesale level, which commands 95 percent of the market participants. In this particular level, the main participants generally comprise banks and central governments. In a number of states, central banks are appendages of the states’ governments and carry out their policy in harmony with the respective government. Aside from central banks, major banks are also part of the wholesale level (Weisweiller, 2010).
Together with the government, banks comprise among the largest participants in forex transactions. Most individuals, who require international currency for limited transactions, tend to transact with local banks. Nonetheless, personal transactions are small in contrast with the dollars traded among banks, generally identified as interbank markets. The second level of participants comprises the retail level. This particular level is comprised of major business customers. These usually constitute international businesses that rely on the forex market for currency exchange. Accordingly, in the event that a business is purchasing from a foreign supplier or selling to a foreign customer, it will inexorably require engaging in transactions based on the unpredictability of variable currencies.
Spot and Forward Markets
The uncertainty of risks arising from foreign exchange further introduces more elements that are imperative to the organization of the foreign exchange market. In this respect, different currency markets exist in order to avert such risks. The first one comprises the spot market. This deals in the facilitation of immediate transactions for the foreign currency required by the respective customer. Usually, transactions between clients undergo listing by the start of the second business day (Goodhart & Payne, 2012). Alternately, businesses may lack sufficient liquid cash to engage in such immediate transactions within the spot market. In other instances, such clients may need to reserve amounts for a long period. The second market type, forward market, caters to these needs by allowing the transactions to occur at a particular future date.
Participants by Market
The foreign exchange market is also comprised of customers or entities that conduct transactions depending on the market types that exist. For the spot market, a range of customers is evident. These comprise commercial banks, brokers, and clients of central and commercial banks. Usually, such participants engage in spot market transactions due to the immediacy of transactions. In addition, these institutions tend to possess significant liquid cash, which allows them to engage in the necessary transactions at an instant. Moreover, for purposes of reducing the risks associated with foreign exchange transactions, the respective participants use the spot market. The forward market is comprised of participants who want to transact using certain exchange rates in the future. These involve hedgers, traders, arbitrageurs, and speculators (Clark & Ghosh, 2011).
Size of the Market
The foreign exchange market is the largest trading market across the globe. By 2014, the foreign exchange market traded $5.3 trillion for each day within a month. This further illustrates the superiority of the market as a preferred trading vessel in comparison to the futures and equities markets. Additionally, the size of the foreign market is also represented by the collective earnings of major market centers, such as New York, London, and Tokyo, which document billion-based transactions on a daily basis.
The organization of the foreign market is based on three aspects. The first aspect is comprised of the participants that conduct transactions within the market. These participants are categorized by the wholesale level and retail level. The second aspect is based on the market used by the participants. This normally constitutes transactions that take place in the spot and the forward market. Lastly, the size of the foreign exchange market is also another factor to consider in researching on the organization of the foreign market.
Clark, E., & Ghosh, D. K. (2011). Arbitrage, hedging, and speculation: The foreign exchange market. Westport, CO: Praeger.
Goodhart, C. A. E., & Payne, R. (2012). The foreign exchange market: Empirical studies with high-frequency data. Boston, MA: Bedford/St. Martin’s Press.
Weisweiller, R. (2010). How the foreign exchange market works. New York, N.Y: New York Institute of Finance.
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