Foreign Exchange Market Report

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Transcript of Foreign Exchange Market Report

IntroductionThe foreignexchangemarket (forex, FX, or currencymarket) isaglobal decentralized market for the trading of currencies. The mainparticipantsinthismarket arethelarger international banks. Financialcenters around the world function as anchors of trading between a widerange of multiple types of buyers and sellers around the clock, with theexceptionof weekends. Theforeignexchangemarket determines therelative values of dierent currencies. Theforeignexchangemarketworks through !nancialinstitutions, and it operatesonseveral levels. "ehindthescenes banks turn to asmaller number of !nancial!rms known as #dealers,$ whoareactivelyinvolvedinlarge%uantities of foreign exchangetrading. &ost foreignexchangedealersarebanks,so this behind'the'scenesmarket is sometimes calledthe #interbank market$,although a few insurancecompanies and other kinds of !nancial !rms are involved. Trades betweenforeign exchange dealers can be very large, involving hundreds of millionsof dollars. "ecause of the sovereignty issue when involving twocurrencies, Forex has little (if any) supervisory entity regulating its actions.The foreign exchange market assists international trade and investmentsby enabling currency conversion. For example, it permits a business in the(nited)tates toimportgoodsfromthe *uropean(nion memberstates,especially *urozone members, and pay euros, even though its income is in(nited)tatesdollars. +talsosupportsdirectspeculationandevaluationrelative to the value of currencies, and the carry trade, speculation basedon the interest rate dierential between two currencies. +n a typical foreign exchange transaction, a party purchases some%uantity of one currency by paying for some %uantity of another currency.Themodernforeignexchangemarket beganformingduringthe,-./safter three decades of government restrictions on foreign exchangeForeign *xchange &arket 0 , transactions (the "retton 1oods system of monetary managementestablishedtherulesforcommercial and!nancial relationsamongtheworld2s ma3or industrial states after 1orld 1ar ++), when countriesgradually switched to 4oating exchange rates from the previous exchangerate regime, which remained !xed as per the "retton 1oods system.The foreign exchange market is uni%ue because of the followingcharacteristics5 its huge trading volume representing the largest asset class in theworld leading to high li%uidity6 its geographical dispersion6 its continuous operation5 78hours adayexcept weekends, i.e.,tradingfrom775// 9&T on)unday()ydney) until 775//9&TFriday(:ew ;ork)6 the variety of factors that aect exchange rates6 the lowmargins of relative pro!t compared with other markets of!xed income6 and theuseof leverage toenhancepro!t andlossmarginsandwithrespect to account size. @erivatives &arkets hinese yen >:; 7.7D,/ :ew Vealanddollar:V@ 7./D,, )wedish krona )*Q ,.CD,7 Sussian ruble S(" ,.ED,= Kong QongdollarKQ@ ,.8D,8 )ingaporedollar)9@ ,.8D,B Turkish lira TS; ,.=D?ther ,7.7DTotal 7//Dto arbitrage. @ue to Pondon2s dominance in the market, a particularcurrency2s %uoted price is usually the Pondon market price. &a3or tradingexchanges include *lectronic "roking )ervices (*")) and Thomson Seuters@ealing, while ma3or banks also oer trading systems. < 3oint venture ofthe >hicago &ercantile *xchange and Seuters,called Fxmarketspace opened in 7//. and aspired but failed to the role ofa central market clearing mechanism.Themaintradingcentersare :ew;ork and Pondon, though Tokyo, KongQong and )ingapore are allimportant centers as well. "anks throughoutthe world participate. >urrency trading happens continuously throughoutthe day6 as the anadian@ollar, TurkishPira, *uroandSussian Suble, which settle the next business day), as opposed tothe futures contracts, which are usually three months. This traderepresents a #direct exchange$ between two currencies, has the shortesttimeframe, involves cashrather thanacontract, andinterest is notincluded in the agreed'upon transaction. )pot trading is one of the mostcommon types of Forex Trading. ?ften, a forex broker will charge a smallfee to the client to roll'over the expiring transaction into a new identicaltransaction for a continuum of the trade. This roll'over fee is known as theF)wapF fee.For4ard?ne way to deal with the foreign exchange risk is to engage in a forwardtransaction. +nthistransaction, moneydoesnotactuallychangehandsuntil someagreeduponfuturedate. urrency futures contracts are contracts specifying a standard volume of aparticular currency to be exchanged on a speci!c settlement date. Thusthe currency futures contracts are similar to forward contracts in terms oftheir obligation, but dier fromforwardcontractsinthewaytheyaretraded. They are commonly used by &:>s to hedge their currencypositions. +n addition they are traded by speculators who hope tocapitalize on their expectations of exchange rate movements.:ptionurrency speculationis consideredahighly suspect activity inmanycountries. 1hile investment in traditional !nancial instruments like bondsor stocks often is considered to contribute positively to economic growthby providing capital, currency speculation does not6 according to this view,it is simply gambling that often interferes with economic policy. Forexample, in ,--7, currency speculation forced the >entral "ank of)weden toraiseinterestratesforafewdaystoB//Dperannum, andlater to devalue the krona. Former &alaysian Orime &inister &ahathir&ohamad is one well known proponent of this view. Ke blamed thedevaluationof the &alaysianringgit in,--.on 9eorge)oros andotherspeculators.9regory &illman reports on an opposing view, comparing speculators toFvigilantesF who simply help FenforceF international agreements andanticipate the eects of basic economic FlawsF in order to pro!t. +nthis view, countries maydevelopunsustainable!nancial bubbles orotherwise mishandle their national economies, and foreign exchangespeculators made the inevitable collapse happen sooner. < relatively %uickcollapsemight evenbepreferabletocontinuedeconomicmishandling,followedbyaneventual, larger, collapse.&ahathir&ohamadandothercritics of speculationareviewedas tryingtode4ect theblamefromthemselves for having caused the unsustainable economic conditions. (isk aversionSisk aversion is a kindof trading behavior exhibitedby the foreignexchange market when a potentially adverse event happens which mayaect market conditions. This behavior is caused when risk adversetraders li%uidate their positions in risky assets and shift the funds to lessrisky assets due to uncertainty. Foreign *xchange &arket 0 7/ +nthecontext of theforeignexchangemarket, tradersli%uidatetheirpositions in various currencies to take up positions in safe'havencurrencies, such as the () @ollar. )ometimes, the choice of a safe havencurrency is more of a choice based on prevailing sentiments rather thanoneofeconomicstatistics.risisof7//C. Thevalueof e%uitiesacrosstheworldfell whilethe()@ollarstrengthened. This happened despite the strong focus of the crisis in the()urrency carry trade refers to the act of borrowing one currency that has alow interest rate in order to purchase another with a higher interest rate.