Today, foreign exchange is an integral part of our daily lives. Without foreign exchange, international trade would not be possible. For example, a Swiss watchmaker will incur expenses in Swiss francs. When the company wants to sell the watches, they want to receive Swiss francs to meet those expenses. However, if they sell to an English merchant, the English company will want to pay in sterling, the home currency. In between, a transaction has to occur that converts one currency into the other. That transaction is undertaken in the foreign exchange market. However, foreign exchange does not only involve trade. Trade, today, is only a small part of the foreign exchange market; movements of international capital seeking the most profitable home for the shortest term dominates.
The main participants in the foreign exchange market are:
• commercial banks
• commercial organizations
• International Monetary Market (IMM)
• central banks
• money managers
Most participants transact in foreign currency, not only for immediate delivery but also for settlement at specific times in the future. By using the forward markets, the participant can
A spot transaction is where delivery of the currencies is two business days from the trade date (except the Canadian dollar, which is one day).
A forward transaction is any transaction that settles on a date beyond spot.
determine today the currency equivalent of future foreign currency flows by transferring the risk of currency fluctuations (hedging or covering foreign currency exposure). The market participants on the other side of any trade must either have exactly opposite hedging needs or be willing to take a speculative position. The most common method used by participants when transacting in either spot or forward foreign currency is to deal directly with a bank, although Internet trading is currently making impressive inroads.
These banks usually have large foreign exchange sales and trading departments that not only handle the requests from their clients but also take positions to make trading profits and balance foreign currency positions arising from other bank business. Typical transactions in the bank market range from $1 million to $500 million, although banks will handle smaller amounts as requested by their clients at slightly less favourable terms.
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