Currency Market, Forex Market

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The currency market or forex market is a place where banks and other authorized establishments trade the currencies of various nations. This market is unique in the sense that it allows trading 24-hour a day, 5.5 days in a week. The currency market is highly liquid and is the world’s largest financial market, with more than $3 trillion being traded on a daily basis.

According to the Triennial Central Bank survey conducted end-2007, the daily trade in the forex market can be brokendown into:

  • Spot transactions – $1.005 trillion.

  • Forward contracts – $362 billion.

  • Foreign exchange swaps – $1.714 trillion.

Currency Market Participants

There are several types of participants in the currency market. The forex market is divided into various levels of access, the topmost being the interbank market. The interbank market consists of over a thousand banks that trade with each other andaccounts for the majority of the trading in the currency market. Other major participants in the currency market are:

  • Central banks: These banks play a crucial role in the forex market as they participate in the market to control inflation and the money supply with significant forex reserves, if needed. They also aim at protecting their country’s reserves.

  • Commercial Companies: These companies may trade in the forex market to pay for exported/imported goods and services and to pay wages and salaries to people working in their subsidiaries located in other countries. They usually trade in small amounts.

  • Hedging funds: These funds invest in various financial instruments, including foreign currencies. Most investment and hedgefunds speculate in the currency value, with an aim to generate profits for their customers and receive a percentage of the profits earned. These funds have been very actively involved in currency speculation.

  • Retail traders: They have been actively participating in the forex market. Retail traders use online trading platforms that provide real time data on currency prices, volumes traded and other related information.

  • Retail brokers: Retail forex brokers offer speculative trading opportunities and are regulated by the Commodity Futures Trading Commission (CFTC) and National Futures Association (NFA). They help retail traders in participating in the currency marketindirectly. Retail forex brokers earn by charging a spread, which is the difference between the ask and bid prices.

Common Financial Instruments Used in the Currency Market

Some of the common financial instruments used in the currency market are:

  • Spot: This is a direct exchange between two currencies within the shortest timeframe (takes two days for a transaction to conclude).

  • Forward: In forward transactions, a buyer and a seller set a date for a currency transaction. On this date, the transaction gets executed regardless of the prevailing forex rates.

  • Futures: These are contracts of forward transactions that mature at a pre-specified rate and date. Usually the length ofthese contracts is three months.

  • Swap: A currency swap is a transaction wherein two parties exchange currencies for a certain period of time and reverse thetransaction on a predetermined date.

  • Option: This instrument gives the owner the right to exchange currency at a pre-decided exchange rate on a pre-determineddate.

  • Exchange Traded Funds (ETFs): They are open-ended investment companies trading throughout the day. They track the price fluctuations in all currencies against the US dollar. ETFs rise in value when the US dollar loses its value against a specificcurrency.

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