Functions of the Foreign Exchange
Market
The Foreign Exchange Market is the mechanism by which participants Transfer purchasing power between countries
Obtain/provide credit for international trade transactions
Minimize exposure to the risks of exchange rate changes
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Concordia University Summer 2015
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Structure of the Foreign Exchange
Market
There are four main dimensions of the foreign
exchange markets which will be discussed
Structure
Transactions
Size
Methods of stating exchange rates, quotations, and changes in exchange rates
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Concordia University Summer 2015
1-3
Structure of the Foreign Exchange
Market
• Geographically, the foreign exchange market spans the globe with
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prices moving and currencies trading every hour of every business day Major world trading starts each morning in Sydney and Tokyo
Then moves west to Hong Kong and Singapore
Continuing to Europe and finishing on the West Coast of the U.S.
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Exhibit 5.1 Global Currency Trading: The Trading Day
FINA470
Concordia University Summer 2015
1-5
Structure of the Foreign Exchange
Market
The foreign exchange market consists of two tiers
the interbank or wholesale market, and
the client or retail market
Five broad categories of participants operate within these two tiers Bank and nonbank foreign exchange dealers
Individuals and firms conducting commercial or investment transactions
Speculators and arbitragers
Central banks and treasuries
Foreign exchange brokers
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Concordia University Summer 2015
1-6
Bank and Nonbank Dealers
They profit from buying foreign exchange at a “bid” price and reselling it at a slightly higher “offer” or
“ask” price
Large international banks often function as “market makers” These dealers stand willing at all times to buy and sell those currencies in which they specialize and thus maintain an “inventory” position in those currencies
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Concordia University Summer 2015
1-7
Individuals and Firms
Individuals (such as tourists) and firms (such as
importers, exporters and MNEs) conduct commercial and investment transactions in the foreign exchange market. Their use of the foreign exchange market is necessary but nevertheless incidental to their underlying commercial or investment purpose.
Some of the participants use the market to “hedge” foreign exchange risk.
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Concordia University Summer 2015
1-8
Speculators and Arbitragers
Speculators and arbitragers operate for their own
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interest
Speculators seek all their profit from exchange rate changes Arbitragers try to profit from simultaneous differences in exchange rates in different markets
A large proportion of speculation and arbitrage is conducted by major banks
Concordia University Summer 2015
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Central Banks and Treasuries
Use the market to acquire or spend their country’s currency reserves as well as to influence the price at which their own currency trades
Support the value of their currency because of their government’s policies or obligations
Their motive is not to profit but rather influence the foreign exchange value
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Concordia University Summer 2015
1 - 10
Foreign Exchange Brokers
Agents who facilitate trading between dealers without themselves becoming principals in the transaction
Dealers use brokers to expedite the transaction and to remain anonymous, since the identity of participants may influence short-term quotes
2002) eliminates losses if either party unable to settle
CLS links real time settlement systems in different currencies Eventually same-day settlements instead of the current lag of two days
The U.S. Commodity Futures Trading
