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Foreign exchange market: The foreign exchange market (forex, FX, or currency market) is a worldwide decentralized over-the-counter financial market for the trading of currencies.Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock,with the exception of weekends.The foreign exchange market determines the relative values of different currencies. The primary purpose of the foreign exchange market is to assist international trade and investment,by allowing businesses to convert one currency to another currency. For example, it permits a US business to import European goods and pay Euros, even though the business's income is in US dollars.It also supports speculation, and facilitates the carry trade, in which investors borrow low-yielding currencies and lend (invest in) high-yielding currencies, and which (it has been claimed) may lead to loss of competitiveness in some countries. In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency.The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime,which remained fixed as per the Bretton Woods system.
Market size and liquidity:
The foreign
exchange market is the largest and most liquid financial market in the
world.Traders include large banks,central banks, currency speculators,
corporations, governments, and other financial institutions.The average
daily volume in the global foreign exchange and related markets is
continuously growing. Daily turnover was reported to be over US$3.2
trillion in April 2007 by the Bank for International Settlements.Since
then, the market has continued to grow. According to Euromoney's annual
FX Poll,volumes grew a further 41% between 2007 and 2008.
Market participants: Unlike a stock market,the foreign exchange market is divided into levels of access. At the top is the inter-bank market,which is made up of the largest commercial banks and securities dealers.Within the inter-bank market,spreads,which are the difference between the bid and ask prices, are razor sharp and usually unavailable,and not known to players outside the inner circle.The difference between the bid and ask prices widens (from 0-1 pip to 1-2 pips for some currencies such as the EUR).This is due to volume. If a trader can guarantee large numbers of transactions for large amounts,they can demand a smaller difference between the bid and ask price,which is referred to as a better spread. The levels of access that make up the foreign exchange market are determined by the size of the "line" (the amount of money with which they are trading). The top-tier inter-bank market accounts for 53% of all transactions. After that there are usually smaller banks,followed by large multi-national corporations (which need to hedge risk and pay employees in different countries),large hedge funds, and even some of the retail FX-metal market makers.According to Galati and Melvin, “Pension funds, insurance companies, mutual funds,and other institutional investors have played an increasingly important role in financial markets in general,and in FX markets in particular,since the early 2000s.” (2004) In addition, he notes,“Hedge funds have grown markedly over the 2001–2004 period in terms of both number and overall size” Central banks also participate in the foreign exchange market to align currencies to their economic needs. |
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