subject: Forex : the nature and functioning of foreign exchange markets [print this page] Forex : the nature and functioning of foreign exchange markets
A. Volume growth and international operations
The latest figures on the volume of foreign exchange at the international level dating back to April 1998, the month for which the BIS has conducted a survey it published the results in May 1999. According to the survey, daily operations on the foreign exchange markets resulting from spot transactions, outright forwards to and currency swaps totaled 1,500 billion, against 1,190 billion in April 1995.
The survey reveals that, based on the exchange rate of April 1998, the volume of international transactions has progressed considerably during the last period. Indeed, between 1992 and 1995, the increase was set at 9 p. 100 on an annualized basis, while between 1995 and 1998 it was $ 14 per 100. According to the BIS, the globalization of investment has certainly contributed to this growth, but the rapid accumulation of debt financing operations until mid-1998 has undoubtedly played a large role.
The most important forex market is in London and represents 32 per 100 of the world volume of transactions, followed by those of the United States (18 per 100), Japan (8 p. 100), Singapore (7 per 100) and Germany (5 p. 100). Foreign exchange transactions conducted in the United States have risen by 44 per 100 between 1995 and 1998 and those conducted in the United Kingdom, 37 p. 100. In Japan, they fell by 8 per 100 and in Hong Kong, 13 p. 100, which allowed the United States and the United Kingdom (where a place half of all foreign exchange transactions) consolidate their respective positions.
B. Structure
The foreign exchange market is not centralized: it is the sum of all exchanges taking place in many financial markets around the world. But all these markets are linked to form a global network. Currency markets operate differently organized exchanges such as NYSE or the Toronto and they are driven by traders, cover OTC transactions and are not transparent.
Traders (mainly commercial banks, investment banks and brokerage houses) are what is called the wholesale market (or interbank market). Their role is to supply foreign retail investors. They set the bid and ask prices they are willing to exchange various currencies.For most large transactions, the difference between these two courses is well below 10 basis points, which means that even a very small levy could have a significant impact on transaction costs. Furthermore, operations are decentralized, the price (way) and the amount of currency exchanged is confidential. Often the profits of operators are based on their ability to hide this information to their colleagues. They are specialists, and they set prices according to their expectations. In this regard, the exchange rates are extremely sensitive to new information - news from the monetary authorities, natural disasters, rumors, etc.. - Which, according to recent studies, explain their episodic volatility (3) .
In April 1998, the wholesale market alone generated 63 per 100 of all foreign exchange transactions (see Table 4). According to some, this stems from the fact that traders base their decisions on a host of information and different interpretations of the news on fundamentals and other data influencing the exchange rates (4) .
According to another interpretation, the traders do not really want to take risky positions, which means that they are not speculation. They exchange currencies according to the wishes of their clientele. However, they generally seek to balance their positions after having entered into significant transactions with their customers. For example, there may be a broker sells a large amount of U.S. dollars to a major customer for an equivalent amount of Japanese yen, but only in order to satisfy this customer. Afterward, the broker may choose to diversify its foreign exchange portfolio, rather than maintaining its position in yen.
He might choose to sell the yen against the first Mexican pesos, then he will transfer to another trader cons of dollars. In this example, $ 1 traded on the retail market creates a trading volume more than double the wholesale market. This example illustrates how traders exchanged the currency several times in order to balance their positions once they have met the wishes of their customers. This tactic does not come from what they are speculators, but precisely because they are not. Moreover, in 1998, a currency transaction of $ 1 made for a client gave rise to an average $ 1.7 currency transactions in the interbank market.
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