FOREIGN EXCHANGE MARKETS

Praveen H J (31) Sneha F N (48) Anurag S (03) Ramesh N (36) Preeti D (32)

Introduction

Foreign Exchange (Forex) Market is the market where one currency is traded for another. Some of the participants in this market are simply seeking to exchange a foreign currency for their own, like multinational corporations which must pay wages and other expenses in different nations than they sell products in. However, a large part of the market is made up of currency traders, who speculate on movements in exchange rates, much like others would speculate on movements of stock prices. Currency traders try to take advantage of even small fluctuations in exchange rates

Introduction

Exchange rate fluctuations are usually caused by actual monetary flows as well as anticipations on global macroeconomic conditions. Currencies are traded against one another. Each pair of currencies thus constitutes an individual product and is traditionally noted XXX/YYY, where YYY is the ISO 4217 international three-letter code of the currency into which the price of one unit of XXX currency is expressed. For instance, EUR/USD is the price of the euro expressed in US dollars, as in 1 euro = 1.2045 dollar.

Introduction

Unlike stocks and futures exchange, foreign exchange is indeed an interbank, over-thecounter (OTC) market which means there is no single universal exchange for specific currency pair. The foreign exchange market assists international trade and investment by enabling currency conversion.

Nature

The foreign exchange market operates 24 hours per day throughout the week between individuals with Forex brokers, brokers with banks, and banks with banks. If the European session is ended the Asian session or US session will start, so all world currencies can be continually in trade. Traders can react to news when it breaks, rather than waiting for the market to open, as is the case with most other markets.

Nature
The foreign exchange market is unique because of 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.

Nature

The main trading center is London, but New York, Tokyo, Hong Kong and Singapore are all important centers as well. Banks throughout the world participate. Currency trading happens continuously throughout the day; as the Asian trading session ends, the European session begins, followed by the North American session and then back to the Asian session, excluding weekends.

Market participants

Commercial companies Central banks Foreign exchange fixing Hedge funds as speculators Investment management firms Retail foreign exchange traders Non-bank foreign exchange companies Money transfer/remittance companies and bureaux de change

Factors influencing exchange rates:

The following factors can influence exchange rates: National economic performance Central bank policy Interest rates Trade balances imports and exports Political factors such as elections and policy changes Market sentiment expectations and rumours Unforeseen events terrorism and natural disasters

Determinants of exchange rates

Economic factors Economic policy comprises government fiscal policy (budget/spending practices) and monetary policy Government budget deficits or surpluses Balance of trade levels and trends. Inflation levels and trends. Economic growth and health: GDP, employment levels, retail sales, capacity utilization. Productivity of an economy.

Determinants of exchange rates

Market psychology Market psychology and trader perceptions influence the foreign exchange market in a variety of ways. Flights to quality. Long-term trends. "Buy the rumor, sell the fact Economic numbers. Technical trading considerations.

Carry Trade

Currency carry trade refers to the act of borrowing one currency that has a low interest rate in order to purchase another with a higher interest rate. A large difference in rates can be highly profitable for the trader, especially if high leverage is used. However, with all levered investments this is a double edged sword, and large exchange rate fluctuations can suddenly swing trades into huge losses.

Risk aversion

Risk aversion is a kind of trading behavior exhibited by the foreign exchange market when a potentially adverse event happens which may affect market conditions. This behavior is caused when risk averse traders liquidate their positions in risky assets and shift the funds to less risky assets due to uncertainty.

Option

A foreign exchange option (commonly shortened to just FX option) is a derivative where the owner has the right but not the obligation to exchange money denominated in one currency into another currency at a preagreed exchange rate on a specified date. The options market is the deepest, largest and most liquid market for options of any kind in the world.

Advantages

It's already the world's largest market and it's still growing quickly It makes extensive use of information technology making it available to everyone Traders can profit from both strong and weak economies Trader can place very short-term orders which are prohibited in some other markets The market is not regulated Brokerage commissions are very low or nonexistent The market is open 24 hours a day during weekdays

CURRENCY CONVERTIBILITY
Currency convertibility refers to a useful tool which allows a certain amount of one currency to be converted into a different currency, using up to date currency values.

Factors affecting currency convertibility

Short terms factors

Interest rates Trade flows Natural disasters

Links to commodity based currencies

Long terms factors

Long term inflation Economic growth

Government Policy