29 March 2014

Forex market

what is forex market

Forex is the international market for the free trade of currencies. Traders place orders to buy one currency with another currency.According  to Hartly Withers, “ Foreign exchange is the art and science of international monetary exchange”.The forex market is the world’s largest financial market. Over $4 trillion dollars worth of currency are traded each day. The amount of money traded in a week is bigger than the entire annual GDP of the United States!
The main currency used for forex trading is the US dollar.

Perfect market: The foreign exchange market is the largest and most perfect of all markets. It is the largest in terms of trading volume (turnover), which currently 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 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 yens, 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. 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.

Geographical distribution: Unlike the stock market and the futures market, which are organised 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’, but there are buildings called the ‘Sydney Stock Exchange’ and the ‘Sydney Futures Exchange’. 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.

Extended hours: 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 centres (the most important being London, New York and Tokyo) and many minor ones. Because major foreign exchange centres 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 centres, starting with the Far Eastern centres (Sydney, Tokyo and Hong Kong), passing through the Middle East(Bahrain), across Europe (Frankfurt and London), and then passing through the US centres, 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 operates 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 zone.

Liquidity: In view of the huge trading volume in the forex market, under normal conditions, you can buy or sell currency at your desired price in a mere matter of seconds with just a simple click of the mouse. You can even setup an online trading platform to buy and sell (place order) at the right price so that you can control your profit margin and cut losses. The trading platform will execute everything for you automatically. It is fast and simple.

Two main functions:
1. Determine price of currencies
2. Transfer currency risk
To maintain this function following steps are taken:
·         Transferring the purchasing power :The most important function is the transfer of purchasing power from one country to another and from one national currency to another. The purchasing power is transferred through the use of credit instruments. The main credit instrument is used for the transferring the purchasing power is the telegraphic transfer (TT) of the cabled order by one bank (in country A) to its correspondent abroad (in country B) to pay B funds out of its deposit account to its designated account or order. The telegraphic transfer is simply a sort of cheque, which is wired or radioed rather than sent by post. Purchasing power may also be transferred through bank drafts.
·         Provision of credit for foreign trade :The foreign exchange market also provides credit for foreign trade. Like all the traders, international trade also requires credit. It takes time to move the goods from seller to purchaser and during this period, the transaction must be financed. When the exporter does not need credit for the manufacture of export goods, credit is necessary for the transit of goods.  When the special credit facilities of the foreign exchange market are used, the foreign exchange department of a bank or the bill market is used; the foreign exchange department of the bank or the bill market of one country or the other extends the credit facilities to finance the foreign trade.
·         Furnishing facilities for hedging foreign exchange risks: the foreign exchange market by providing facilities of buying and selling at spot or forward exchange, enables the exporters and importers to hedge their exchange risks arising from change in the foreign exchange rate.  The forward market in exchange also enables those banks, which are unlikely to run any considerable exchange position to cover their commitments.

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