Definitions and characteristics of the foreign exc...
The foreign exchange market is the market in which national currencies are bought and sold against one another.This market is called the “foreign exchange” market and not the “foreign currency” market because the “commodity” that is traded on the market is more appropriately called “foreign exchange” than “foreign currency”.The latter is only a small part of what is traded.Foreign exchange consists mainly of bank deposits denominated in various currencies.Still, the term “foreign currency” will be used interchangeably with the term “foreign exchange”.
The foreign exchange market is the largest and most perfect of all markets.It is the largest in terms of trading volume (turnover), which stands at over one trillion US dollars per day.It is the most perfect market because it possesses the requirements for market perfection: a large number of buyers and sellers; homogenous products; free flow of information; and the absence of barriers to entry.The foreign exchange market is made up of a vast number of participants (buyers and sellers).The products traded on the foreign exchange market are currencies: no matter where you buy your terms, euros, dollars or pounds they are always the same.There is no restriction on access to information, and insider trading is much less important than, for example, in the stock market.Finally, anyone can participate in the market to trade currencies.
The importance of the foreign exchange market stems from its function of determining a crucial macroeconomic variable, the exchange rate, which affects to a considerable extent the performance of economies and business.This market is needed because every international economic transaction requires a foreign exchange transaction.Unfortunately, however, its function of exchange rate determination is not very well understood in the sense that economists are yet to come up with a theory of exchange rate determination that appears empirically valid.
Unlike the stock market and the futures market, which are organized exchanges, the foreign exchange market is an over-the-counter (OTC)market, as participants rarely meet and actual currencies are rarely seen.There is no building called the “Sydney Foreign Exchange Market”.It is an OTC market in the sense that it is not limited to a particular locality or a physical location where buyers and sellers meet.Rather, it is an international market that is open around the clock, where buyers and sellers contact each other via means of telecommunication.The buyers and sellers of currencies operate from approximately 12 major centers (the most important being London, New York and Tokyo)and many minor ones.Because major foreign exchange centers fall in different time zones, any point in time around the clock must fall within the business hours of at least one centre.The 24 hours of a day are almost covered by these centers, starting with the Far Eastern centers (Sydney, Tokyo and Hong Kong Special Administrative Region of China), passing through the Middle East (Bahrain), across Europe (Frankfurt and London), and then passing through the US centers, ending up with San Francisco.This is why the first task of a foreign exchange dealer on arrival at work in the morning is to find out what happened while he or she was asleep overnight.Some banks and financial institutions may for this reason operate a 24-hour dealing room or install the necessary hardware (Reuters’ screen, etc.)in their dealers’ homes.Others may delegate the task to foreign affiliates or subsidiaries in active time zones.