Currency foreign tradingBy Verkha of Cashsee.com
A foreign exchange market is a market in which currencies are bought and sold.
It is to be distinguished from a financial market where currencies are borrowed and lent.
The term foreign exchange market is used to refer to the wholesale segment of the market,
where the dealings take place among the banks.
The retail segment refers to the dealings take
place between banks and their customers. The retail segment is situated at a large number of
places. They can be considered not as foreign exchange markets, but as the counters of such
markets.
Foreign exchange market is the largest financial market. Foreign exchange markets were primarily
developed to facilitate settlement of debts arising out of international trade. But these markets
have developed on their own. The largest foreign exchange market is London, followed by New York,
Tokyo, Zurich and Frankfurt.
Developments in communication have largely contributed to the efficiency of the market.
The participants keep abreast of current happenings by access to such services. Any significant
development in any market is almost instantaneously received by the other market situated at a
far off place and thus has global impact. This makes the foreign exchange market very efficient
as if the functioning under one roof.
In most markets, United State dollar is the vehicle currency, the currency used to denominate
international transactions. This is despite the fact that with currencies like Euro and yen
gaining larger share, the share of United States dollar in the total turnover is shrinking.
The business houses, international investors, and multinational corporations may operate in the
market to meet their genuine trade or investment requirements. They may also buy or sell
currencies with a view to speculate or trade in currencies to the extent permitted by the exchange control
regulations. They operate by placing orders with the commercial banks. The deals between banks
and their clients form the retail segment of foreign exchange market. Commercial banks are the
major players in the market. They buy and sell currencies for their clients.
They may also operate on their own.
The big banks in the market are known as market makers, as they are willing to buy or sell
foreign currencies at the rates quoted by them up to any extent. Depending upon its resources,
a bank may be a market maker in one or few major currencies. When a banker approaches the market
maker, it would not reveal its intention to buy or sell the currency. This is done in order to
get a fair price from the market maker.
The transaction where the exchange of currencies takes place two days after the date of the
contact is known as the spot transaction. It is also known as value today.
The transaction where the exchange of currencies takes place two days after the date of the
contact known as the spot transaction.The transaction in which the exchange of currencies takes place at a specified future date,
subsequent to the spot date, is known as forward transaction.
Interbank deals refer to purchase and sale of foreign exchange between the banks.
In other words, it refers to the foreign exchange dealings of a bank in the interbank market.
Purchase and sale of foreign currency in the market undertaken to acquire or dispose of foreign
exchange required or acquired as a consequence of its dealings with its bank against any
fluctuation in the exchange rates.
Since the foreign currency is a peculiar commodity with wide fluctuations in price, the bank
would like to sell immediately whatever it purchases and whenever it sells it goes to the market
and makes an immediate purchase to meet its commitment. The main reason for this is that the
bank wants to reduce the exchange risk it faces to the minimum. Otherwise, any adverse change in
the rates would affect its profits.
Trading refers to purchase and sale of foreign exchange in the market other than to cover banks
transactions with the customers. The purpose may be to gain on the expected changes in exchange
rates.
A swap deal is a transaction in which the bank buys and sells the specified foreign currency
simultaneously for different maturities. Thus a swap deal may involve:
*Simultaneous purchase of spot and sale of forward.
*Simultaneous purchase and sale, both forward but for different maturities.
The term swap will be used rather loosely on cancellation and extension of forward contracts.
To be precise, a deal should fulfill the following conditions to be called a swap deal.
*There should be simultaneous buying and selling of the same foreign currency of same value for
different maturities ; and
*The deal should have been concluded with the distinct understanding between the banks that it
is a swap deal.
A swap deal is done in the market at a difference from the ordinary deals. In the ordinary deals,
the following factors enter into the rates:
*The difference between the buying and selling rates ; and
*The forward margin, i.e., the premium or discount.
In a swap deal, the first factor is ignored and both buying and selling are done at the same
rate. Only the forward margin enters into the deal as the swap difference.
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