Like any market, it also has the function of determining exchange prices, that is to say the exchange rate between each pair of currencies.

The largest market in the world

In 2019, the Bank for International Settlements (BIS) report on the triennial survey of central banks estimated the daily trading volume at nearly $6.59 trillion. The volumes traded on this market have increased by almost 30% since the previous survey (2016) and by more than 65% during the 2010 decade. This makes it the largest and most liquid market in the world. in terms of transaction volume.

The adoption of a floating exchange rate regime by many countries from the 1970s, combined with technical progress (notably with High Frequency Trading software, and almost continuous access to the foreign exchange market) largely explains why this market is today the most active and largest in the world.

A market dominated by the City of London

Although there are coins and bank notes in all countries, the foreign exchange market is entirely dematerialized and decentralized. It is not linked to any particular stock exchange. Almost all transactions are carried out over the counter. It allows you to carry out currency transactions almost 24 hours a day, every day of the week. while other financial securities are often linked to a specific financial center (Paris, New York, Tokyo, London, etc.) with daily opening and closing times.

In 2019, the foreign exchange market is largely dominated by the City of London. This financial center represents more than 50% of foreign exchange transactions in the world. The weight of Asian places is growing but remains lower than London. France, for its part, only welcomes 2 % of global currency exchanges.

Who operates in the foreign exchange market?

The foreign exchange market brings together extremely diverse participants. We find there :

  • individuals (very rarely) and businesses (SMEs and multinationals) who need to sell and buy different currencies depending on their activities;

  • commercial banks, investment banks and brokers who execute their clients' orders and also act on their own behalf;

  • monetary authorities, particularly central banks which are major participants in the foreign exchange market. They manage their foreign exchange reserves and intervene, if necessary, in the price of the currencies for which they are responsible.

  • international institutions (such as the IMF and the World Bank);

  • investment funds, some of which even specialize in currencies.

Some notable features in the foreign exchange market

The foreign exchange market is a market where almost all transactions are carried out over the counter. Brokers and banks trade directly with each other, without a stock exchange intermediary. Individuals and businesses alike must contact their bank to gain access to the foreign exchange market. Forex is therefore an unregulated market. However, there are regulated compartments in Forex – of very limited size – which offer derivative products (for example warrants) as hedging and speculation instruments.

Since trade liberalization in the 1990s, participants in the foreign exchange market have become highly concentrated, particularly at the banking level. They provide other market participants with instruments allowing them to hedge or speculate on variations in currency prices. They also play a role in setting a single exchange rate for each currency pair.

A market dominated by the dollar

Interestingly, the US dollar (USD) remains the reference currency in the foreign exchange market. The 2019 edition of the BIS survey showed that out of all transactions carried out on the foreign exchange market, 88.3 % were on the US dollar and 32.3 % on the euro.

Since two currencies are involved in each transaction, sIf one is bought, the other is necessarily sold. VSevery currency (dollar, euro, yen…) being counted twice, the sum of the percentagess of all currencies in exchanges reached 200%. On the other hand, when we consider currency pairs (euro/dollar, dollar/yen…) double counting disappears and the sum of the percentages of all pairs in the exchanges reaches 100%.

The EUR/USD pair is thus the one that is traded the most in the world: in 2019, it represented 24% of currency exchanges considered in pairs.

Spot transactions and futures transactions

The simplest transaction on the currency market is the spot transaction, known as the “transaction” spot“. It consists of buying one currency against another at the current market price with delivery on D+2 days. The spot market (market spot) represents 30.2% of daily transactions.

The majority of trading takes place in the futures market.

A futures transaction consists of setting the price, quantity and date of the future exchange from the day of the transaction. Its usefulness lies in the fact that it provides a hedge against exchange rate fluctuations. Indeed, whatever the price at maturity (i.e. on the date set for the currency exchange) the transaction will be carried out according to the terms of the contract set earlier.

Whatever the objective of a participant in the foreign exchange market, hedging or speculation, the different participants meet daily on this market as “counterparts” of transactions. So, for example, in order to hedge against a drop in the euro/US dollar exchange rate, the bank of a French company must find a person on the foreign exchange market who at the same time wishes to buy euros against US dollars.

A Eurozone industrialist buys oil in dollars, delivery of which will be made and paid for in three months. To hedge his exchange risk, he buys dollars at term has a guaranteed exchange rate.

This person can either be a speculator buying euros because he is betting on an increase in this currency, or a person wishing to hedge against an increase in the euro against the US dollar.

We therefore understand the interest of the forward transaction for companies or institutions whose activities are carried out internationally.

There are other types of derivative products to protect against the effects of exchange rate fluctuations: these are swaps, currency options and certain more complex structured products.

Of the 6,950 billion dollars of daily exchanges on the foreign exchange market, 3,310 billion dollars concern swaps, i.e. 50 % of volumes traded.

Access to the foreign exchange market allows most participants to to protect yourself against an exchange rate risk on their income and expenses, in particular by using the futures market as shown in the example above. But it also offers the possibility of speculate on the exchange rates of different currencies.

Hedging and Speculation

While many companies and commercial banks participate in the foreign exchange market primarily for hedging, other participants, including hedge funds and investment banks acting on their own account, participate in the foreign exchange market in order to profit. daily movements in exchange rates.

Indeed, since the 1970s and the end of fixed exchange rates, an explosion in the volume of currency transactions has been observed.although this increase has ended in recent years. Currencies are considered ordinary financial assets that allow profits or losses to be made by speculating on changes in exchange rates. Although the foreign exchange market is not in itself a leveraged market, the derivative products which have developed there on a large scale, such as options and swaps for example, have reinforced its attractiveness, particularly for speculators.

Speculation can have beneficial effects because it helps ensure the liquidity of a market. Indeed, if an investor wants to protect himself against the rise of a currency, he must buy this currency. This can only be possible if he finds a counterparty, that is to say an investor who bets on the fall of this currency, otherwise, the market is blocked.

But speculation can also cause violent upward or downward movements in certain currencies. When fluctuations get out of control, reading exchange rates becomes difficult and this can trigger serious economic crises requiring concerted interventions by Central Banks.

It is interesting to note that volatility (the speed and amplitude of price variations) in a market, such as that of foreign exchange, favors speculators because there is nothing to gain in a sluggish market while this volatility serves monetary authorities and those involved in foreign exchange hedging. That being said, exchange rate crises which adversely affect one or more currencies often only reveal a real weakness in the country(ies) in question.

You May Also Like

More From Author

+ There are no comments

Add yours