The foreign exchange market (forex, FX, or currency market) is a form of exchange for the global decentralized trading of international 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. EBS and Reuters' dealing 3000 are two main interbank FX trading platforms. The foreign exchange market determines the relative values of different currencies.[1]
The foreign exchange market assists international trade and investment by enabling currency conversion. For example, it permits a business in the United States to import goods from the European Union member states especially Eurozone members and pay Euros, even though its income is in United States dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation based on the interest rate differential between two currencies.[2]
In a typical foreign exchange transaction, a party purchases some quantity of one currency by paying some quantity of another currency. The modern foreign exchange market began forming during the 1970s after three decades of government restrictions on foreign exchange transactions (the Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states after World War II), when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.
The foreign exchange market is unique because of the following characteristics:
- its huge trading volume representing the largest asset class in the world leading to high liquidity;
- its geographical dispersion;
- its continuous operation: 24 hours a day except weekends, i.e., trading from 20:15 GMT on Sunday until 22:00 GMT Friday;
- the variety of factors that affect exchange rates;
- the low margins of relative profit compared with other markets of fixed income; and
- the use of leverage to enhance profit and loss margins and with respect to account size.
The $3.98 trillion break-down is as follows:
- $1.490 trillion in spot transactions
- $475 billion in outright forwards
- $1.765 trillion in foreign exchange swaps
- $43 billion currency swaps
- $207 billion in options and other products
History
Ancient
Forex first occurred in ancient times.[5] Money-changing people, people helping others to change money and also taking a commission or charging a fee were living in the times of the Talmudic writings (Biblical times). These people (sometimes called "kollybistẻs") used city-stalls, at feast times the temples Court of the Gentiles instead.[6] The money-changer was also in more recent ancient times silver-smiths and, or, gold-smiths.[7]During the fourth century the Byzantium government kept a monopoly on forexes.[8]
Medieval and later
During the fifteenth century the Medici family were required to open banks at foreign locations in order to exchange currencies to act for textile merchants.[9][10] To facilitate trade the bank created the nostro (from Italian translated - "ours") account book which contained two columned entries showing amounts of foreign and local currencies, information pertaining to the keeping of an account with a foreign bank.[11][12][13][14] During the 17th (or 18th ) century Amsterdam maintained an active forex market.[15] During 1704 foreign exchange took place between agents acting in the interests of the nations of England and Holland.[16]Early modern
The firm Alexander Brown & Sons traded foreign currencies exchange sometime about 1850 and were a leading participant in this within the U.S. of A.[17] During 1880 J.M. do Espírito Santo de Silva (Banco Espírito e Comercial de Lisboa) applied for and was given permission to begin to engage in a foreign exchange trading business.[18][19]1880 is considered by one source to be the beginning of modern foreign exchange, significant for the fact of the beginning of the gold standard during the year.[20]
Prior to the first world war there was a much more limited control of international trade. Motivated by the outset of war countries abandoned the gold standard monetary system.[21]
Modern to post-modern
Before WWII
From 1899 to 1913 holdings of countries foreign exchange increased by 10.8%, while holdings of gold increased by 6.3%.[22]At the time of the closing of the year 1913, nearly half of the world's forexes were being performed using sterling.[23] The number of foreign banks operating within the boundaries of London increased in the years from 1860 to 1913 from 3 to 71. In 1902 there were altogether two London foreign exchange brokers.[24] In the earliest years of the twentieth century trade was most active in Paris, New York and Berlin, while Britain remained largely uninvolved in trade until 1914. Between 1919 and 1922 the employment of a foreign exchange brokers within London increased to 17, in 1924 there were 40 firms operating for the purposes of exchange.[25] During the 1920s the occurrence of trade in London resembled more the modern manifestation, by 1928 forex trade was integral to the financial functioning of the city. Continental exchange controls, plus other factors, in Europe and Latin America, hampered any attempt at wholesale prosperity from trade for those of 1930's London.[26]
During the 1920s foreign exchange the Kleinwort family were known to be the leaders of the market, Japhets, S,Montagu & Co. and Seligmans as significant participants still warrant recognition.[27] In the year 1945 the nation of Ethiopias' government possessed a foreign exchange surplus.[28]
After WWII
After WWII the Bretton Woods Accord was signed allowing currencies to fluctuate within a range of 1% to the currencies par.[29] In Japan the law was changed during 1954 by the Foreign Exchange Bank Law, so, the Bank of Tokyo was to become because of this the centre of foreign exchange by September of that year. Between 1954 and 1959 Japanese law was made to allow the inclusion of many more Occidental currencies in Japanese forex.[30]President Nixon is credited with ending the Bretton Woods Accord, and fixed rates of exchange, bringing about eventually a free-floating currency system. After the ceasing of the enactment of the Bretton Woods Accord (during 1971 [31]) the Smithsonian agreement allowed trading to range to 2%. During 1961-62 the amount of foreign operations by the U.S. of America's Federal Reserve was relatively low.[32][33] Those involved in controlling exchange rates found the boundaries of the Agreement were not realistic and so ceased this in March 1973, when sometime afterward none of the major currencies were maintained with a capacity for conversion to gold, organisations relied instead on reserves of currency.[34][35] During 1970 to 1973 the amount of trades occurring in the market increased three-fold.[36][37][38] At some time (according to Gandolfo during February–March 1973) some of the markets' were "split", so a two tier currency market was subsequently introduced, with dual currency rates. This was abolished during March 1974.[39][40][41]
Reuters introduced during June 1973 computer monitors, replacing the telephones and telex used previously for trading quotes.[42]
-markets close
Due to the ultimate ineffectiveness of the Bretton Woods Accord and the European Joint Float the forex markets were forced to close sometime during 1972 and March 1973.[43][44] The very largest of all purchases of dollars in the history of 1976 was when the West German government achieved an almost 3 billion dollar acquisition (a figure given as 2.75 billion in total by The Statesman: Volume 18 1974 → [5]), this event indicated the impossibility of the balancing of exchange stabilities by the measures of control used at the time and the monetary system and the foreign exchange markets in "West" Germany and other countries within Europe closed for two weeks (during February and, or, March 1973. Giersch, Paqué, & Schmieding state closed after purchase of "7.5 million Dmarks" Brawley states "... Exchange markets had to be closed. When they re-opened ... March 1 " that is a large purchase occurred after the close).[45][46][47][48]after 1973
In fact 1973 marks the point to which nation-state, banking trade and controlled foreign exchange ended and complete floating, relatively free conditions of a market characteristic of the situation in contemporary times began (according to one source),[49] although another states the first time a currency pair were given as an option for U.S.A. traders to purchase was during 1982, with additional currencies available by the next year.[50][51]On 1 January 1981 (as part of changes beginning during 1978 [52]) the Bank of China allowed certain domestic "enterprises" to participate in foreign exchange trading.[53] Sometime during the months of 1981 the South Korean government ended forex controls and allowed free trade to occur for the first time. During 1988 the countries government accepted the IMF quota for international trade.[54]
Intervention by European banks especially the Bundesbank influenced the forex market, on February the 27th 1985 particularly.[55] The greatest proportion of all trades world-wide during 1987 were within the United Kingdom, slightly over one quarter, with the U.S. of America the nation with the second most places involved in trading.[56]
During 1991 the republic of Iran changed international agreements with some countries from oil-barter to foreign exchange.[57]
Market size and liquidity
Main foreign exchange market turnover, 1988–2007, measured
in billions of USD.
The foreign exchange market is the most liquid
financial market in the world. Traders include large banks, central
banks, institutional investors, currency speculators,
corporations, governments, other financial institutions, and retail
investors. The average daily turnover in the global foreign exchange and
related markets is continuously growing. According to the 2010 Triennial
Central Bank Survey, coordinated by the Bank for International Settlements,
average daily turnover was US$3.98 trillion in April 2010 (vs $1.7 trillion in 1998).[3]
Of this $3.98 trillion, $1.5 trillion was spot transactions and $2.5 trillion
was traded in outright forwards, swaps and other derivatives.Trading in the United Kingdom accounted for 36.7% of the total, making it by far the most important centre for foreign exchange trading. Trading in the United States accounted for 17.9%, and Japan accounted for 6.2%.[58]
Turnover of exchange-traded foreign exchange futures and options have grown rapidly in recent years, reaching $166 billion in April 2010 (double the turnover recorded in April 2007). Exchange-traded currency derivatives represent 4% of OTC foreign exchange turnover. Foreign exchange futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts.
Most developed countries permit the trading of derivative products (like futures and options on futures) on their exchanges. All these developed countries already have fully convertible capital accounts. Some governments of emerging economies do not allow foreign exchange derivative products on their exchanges because they have capital controls. The use of derivatives is growing in many emerging economies.[59] Countries such as Korea, South Africa, and India have established currency futures exchanges, despite having some capital controls.
|
Rank
|
Name
|
Market
share
|
|
1
|
14.57%
|
|
|
2
|
12.26%
|
|
|
3
|
10.95%
|
|
|
4
|
10.48%
|
|
|
5
|
6.72%
|
|
|
6
|
6.6%
|
|
|
7
|
5.86%
|
|
|
8
|
4.68%
|
|
|
9
|
3.52%
|
|
|
10
|
3.12%
|
|
Foreign exchange is an over-the-counter market where brokers/dealers negotiate directly with one another, so there is no central exchange or clearing house. The biggest geographic trading center is the United Kingdom, primarily London, which according to TheCityUK estimates has increased its share of global turnover in traditional transactions from 34.6% in April 2007 to 36.7% in April 2010. Due to London's dominance in the market, a particular currency's quoted price is usually the London market price. For instance, when the International Monetary Fund calculates the value of its special drawing rights every day, they use the London market prices at noon that day.
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