01. Foreign Exchange Market & Structure - Introduction

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Foreign Exchange Market

& Structure - Introduction

IBA - RAVI


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A foreign exchange transaction is anagreement between a buer and ase!!er that a gi"en amount of onecurrenc is to be de!i"ered at as#eci$ed rate for some other currenc%

he foreign exchange market 'forex(

F)( or currenc market* is a form ofexchange for the g!oba! decentra!i+edtrading of internationa! currencies%

Foreign Exchange


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Foreign ExchangeDefnition

Forexransacti

on

Im#ort&

Ex#ort

Interbank

Sett!ement

In"estment

A"enues

Abroad

ourism(Educatio

n( etc


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Features

,argest $nancia! marketin the wor!d with

a"erage dai! turno"erof a##roximate! .

tri!!ion

/ominated b !argeMu!tinationa! banks(0entra! banks( 1edge

funds & 0urrencBrokers

Round the c!ock market

starting from Sdne(oko( 1onk 2ong(Singa#ore( Bahrain(,ondon( 3ew 4ork%

A!most o#en 56hours x. das

he forex market is

greater than the stockmarket% It is 7. timesgreater than the

combined "o!umes at3ew 4ork Stock

Exchange


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FEX Market -Defnition

he foreign exchange market( a!soknown as the forex( F)( or currencmarket( in"o!"es the trading of onecurrenc for another%

8rior to 9::; the market wascon$ned to !arge cor#orate banks

and internationa! cor#orations%


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FEX Market -Defnition

1owe"er it has since o#ened u# toinc!ude a!! traders and s#ecu!ators%

he a"erage dai! turno"er in forex

markets is o"er sriennia! Sur"e from 5=9=%

he market is growing ra#id! asin"estors gain more information andde"e!o# more interest%


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Forex market contd.

he foreign exchange market is adecentra!ised( o"er-the-counter '?0* g!oba!market%

he dai! "o!ume of the Forex market sur#asses6 tri!!ion as da wor!dwide% o #ut this in#ers#ecti"e the dai! "o!ume traded on the3ew 4ork stock exchange is 5. bi!!ion makingit the !argest $nancia! market in the wor!d%

he tota! Forex "o!ume is we!! o"er three timesthe tota! amount of the stocks and futuresmarkets combined%


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Forex Market contd.

he #artici#ants of the Forex market inc!ude banks,corporations, institutional investors, hedgeunds and individuals.In sim#!e terms Forextrading is where ou can bu and se!! currencies(

simu!taneous!% he wa it works is much !ike the #rocess of

currenc exchange at air#orts or hote!s where oucan exchange the currenc ou dea! with for the

!oca! currenc% he Forex market is o#en 56 hours a da . das a

week( enab!ing traders to bu and se!! around thec!ock acting on g!oba! news e"ents as the ha##en%


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In trading foreign exchange( in"estorsbet that one currenc wi!! a##reciateo"er another@ the #ro$t when the

bet correct! and co!!ect the #ro$t inthe form of an interest rate s#readwhen the return to the origina!

currenc% he #ro$t margins are !ow com#ared

with other $xed-income markets%


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,arge trading "o!umes can( howe"er(resu!t in "er high #ro$ts% ?"er ha!f of a!!forex trading takes #!ace in ,ondon and

3ew 4ork( with ,ondon dominating themarket at 7 of a!! transactions%

3ew 4ork>s market share is 9C( withoko ranked third at ;% Singa#ore(

Swit+er!and( and 1ong 2ong are the next-!argest forex markets g!oba!! witha##roximate! . market share each%


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FE) t#es

?ne t#e of "er short-term transaction is the spottransactionbetween two currencies( de!i"ering o"er twodas and using cash as o##osed to a contract%

In a forward transaction( the mone is not exchanged unti!

an arranged date and an exchange rate is agreed inad"ance% he time #eriod ranges from das to ears%Currency swapsare a #o#u!ar t#e of forwardtransaction@ these in"o!"e the exchange of currenc b two#arties for an agreed !ength of time and an arrangement to

swa# currencies at an agreed !ater date% Another t#e is a foreign currenc future( which is inc!usi"e

of interest% A standard contract is drawn u# and a maturitdate arranged% he time schedu!e is about three months%


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In a foreign exchange option (FX option), themost liquid and biggest options market inthe world,the owner ma e!ect to exchange

mone in a designated currenc for anothercurrenc at an agreed date in the future%

his t#e of transaction de#ends on thea"ai!abi!it of o#tion contracts on an

organi+ed exchange% ?therwise( such forexdea!s ma be carried out using an over-the-counter (OTC) contract.


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Forex Market tructure

For most retai! traders understandingthe structure of the Forex market issomething that is often o"er!ooked%

his is a critica! e!ement that needs tobe considered when designing andim#!ementing an trading #!an%

he forex market diers from otherg!oba! markets due to the wa it isstructured%


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Forex Market tructure

he main factors aecting the structure of theForex market are the was Forex #roducts aretraded( the #artici#ants and their moti"ation(

regu!ation and the sheer si+e of the market% Since transactions in the Forex market are

done o"er-the-counter '?0* and not througha centra! exchange !ike futures or shares(

#rices beha"e dierent!%


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!ver "he #ounter

he $rst thing to understand about thestructure of the forex market is the wa inwhich #roducts are traded% Forex is for themost part, an over the counter (

OTC) market%

This means that there is no central exchangethrough which instruments are traded.

hen we refer to instruments( we are

referring to the dierent forex #roducts#artici#ants use to conduct transactions(whether the be cor#orate( s#ecu!ati"e orhedging%


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!ver "he #ounter

hese #roducts inc!udeG Spot forex, outrightforwards, forex swaps, forex options. hen a#roduct is traded ?0 it is done so through a marketmaker%

market maker in forex is e!ectivel" a bank orbroker that facilitates currenc" trades b" providing

bu" and sell quotes and then taking orders.

?rders can be hedged or #assed on so there is no

ex#osureHrisk( matched within the interna! orderbook or he!d b the market maker( meaning thetake the other side of the order and take a #ositionagainst the c!ient


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?ther common! traded instruments suchas shares and futures are exchangetraded #roducts( this means that an

transaction in"o!"ing these instruments isdone through an exchange such as the3ew 4ork Stock Exchange '34SE* and,ondon Stock Exchange ',SE*%

he #oints be!ow high!ight some featuresof ?0 and exchange traded markets%


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,et>s ex#and on what ?0 means in thecase of the Forex market%

Since there is no centra! exchange through

which to #rocess orders and transactions( aso#histicated network has been estab!ishedin order to a!!ow #artici#ants tocommunicate and transact%

his network has dierent !e"e!s( each withits own institutions ser"ing dierentfunctions within the forex market%


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he interbank market is essentia!! a network between!arger banks% his network is made #ossib!e through EBS'e!ectronic broking ser"ices* and Reuters s#ot matchingsstems%

hese two a##!ications eecti"e! aggregate the orderbooks of the banks( showing the "arious bids( oers andamounts that each is wi!!ing to transact at% his a!!ows#ro#er market function to occur b #ro"iding sucient!iJuidit and ecient #rocessing%

he interbank market is on! accessib!e to !arger banks withthe highest of credit standings( this is to e!iminate ancounter#art risk and reduce com#etition% B restrictingaccess to the interbank market the big banks are continuingto maintain their share of forex turno"er and thus #ro$ts%


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"he $la%ers

At the to# of the food chain we ha"e theoreign exchange dealers% hese arethe dea!er banks which conduct foreign

exchange business for their c!ients orthemse!"es% he maKor banks inc!ude@/eutsche Bank(


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"he $la%ers

he dealer banks that form theinterbank market are eecti"e! themarket makers of the forex market(

the set the #rices and manage the"o!ume for the rest of the market tofeed o%


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"he $la%ers

hese banks hand!e a##roximate! 5H ofthe dai! forex "o!ume and a!ong withothers form what is known as the

interbank market% hese banks dea! with each other on

beha!f of c!ients or for themse!"es(#ro"iding much needed !iJuiditto the

market so !arge transactions whethercor#orate or s#ecu!ati"e can be faci!itatedand #ro#er market function can occur


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"he $la%ers

?n the next !e"e! of the forex market we ha"ethe market that exists for fnancial and non-fnancial participants.his ma inc!udesma!!er banks( businesses( hedgeHmutua!H#ension

funds( 0As and !arge in"estors%

raditiona!! the maKorit of foreign exchangeturno"er has been the resu!t of internationa!

trade Nows( this trend has changed in recent

ears with the maKorit of turno"er being theresu!t of ca#ita! Nows( s#ecu!ati"e and hedgingacti"ities%


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"he $la%ers

his shift reNects the increasingrecognition of foreign exchange as ameans of generating returns b a!!

market #artici#ants( and the need tomanage foreign exchange risksthrough hedging acti"ities%


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"he $la%ers

?n the next !e"e! we ha"e forex brokersand retai! E03s 'e!ectronic communicationsnetwork*%raditiona!! forex brokers were

the intermediar #art between buers andse!!ers( meaning the faci!itated thetransaction between the end user and their!iJuidit #ro"ider 'market maker bank*% For

the most #art this is sti!! the case toda(howe"er( some brokers wi!! run a book andtrade against their c!ients% %


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"he $la%ers

Brokers and E03s wi!! usua!! ha"ean agreement with one or more!iJuidit #ro"iders( through which

the can hedge #ositions on theirbook and manage an ex#osure themight ha"e% A !iJuidit #ro"ider cou!d

be an one of the abo"e mentionedmaKor banks( or e"en another retai!broker de#ending on their needs%


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"he $la%ers

In the background of a!! this we ha"e thecentral banks% he centra! banks fo!!owtheir res#ecti"e currenc( making sure it>s

#rice mo"ements aren>t to erratic and#romoting stabi!it% he are #artici#antsin the market to di"ersif their currencreser"es( inNuence the "a!ue of their

exchange rate '!ess common nowadas*and make internationa! #aments onbeha!f of the go"ernment


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"he $la%ers

o do a!! this the centra! bank has its owndea!ers who use a number of !arger banksto he!# faci!itate these Nows of funds%

0entra! bank inter"ention used to be farmore common and ha"e greater aectthan it has nowadas% Rather thanacti"e! #artici#ating in the market

buing and se!!ing their currenc( centra!banks instead use "erba! inter"ention toaect the "a!ue of their currenc%


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,iJuidit in FE) market


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Structure of Forex market


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01. Foreign Exchange Market & Structure - Introduction

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