The Foreign Exchange Market

The Foreign Exchange Market

What is the Foreign Exchange Market?

The foreign exchange market is an online marketplace where you can exchange currencies. In order for exchange of currencies to happen, each currency on the forex market has a currency rate. This value determines how much of one currency can be traded in terms of another currency. For example, 100 Australian dollars can be traded on the foreign exchange market for 77.5 US Dollars, 64.7 Euros, 8424 Japanese Yen and so on. Since this is a free market, the currency rates tend to fluctuate depending on the relative demand and supply for each currency.

The foreign exchange market is a decentralized market. This means that there is no one location where traders exchange currencies, but rather buyers and sellers can exchange amongst themselves without the supervision of a governing body. The decentralized nature of the foreign exchange market allows it to determine currency rates without any interference. 

The foreign exchange market is also the world’s largest financial market where trillions are traded daily. Trading in forex markets averaged $6.6 trillion every day in April, 2019. The forex market is also used for currency conversion of international trade settlements and investments. 

Types of Foreign Exchange Markets:

The foreign exchange market has two levels of operation. The major level of operation is called the interbank market. In the interbank market, a network of commercial banks from around the world exchange currencies with each other. The banks in this market are constantly in touch with other banks to ensure uniformity in currency rates offered around the world.  Since commercial banks have a huge volume of international money transfers, the trades in this market are enormous. As a result, the interbank foreign exchange market dictates the market rates of most currencies.

INFO NUGGET: Deutsche Bank, Union Bank of Switzerland and Barclays Capital, also known as ‘The Big Three’ dominate the foreign exchange market.

The second level of operation of the foreign exchange market is called OTC (over-the-counter) market. Private companies and individuals trade in this market and although trade volume is limited, this market is starting to grow since online international money transfer companies are going global like Wise, Western Union and Rapid Remit and people around the world are shifting from banks to money transfer operators for their international exchange needs. 

The foreign exchange markets are open 24 hours a day from Sunday evening till Friday evening. Foreign exchange transactions occur in the major financial centers of London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris and Sydney. This means that when the trading day ends in United States, the foreign exchange market is about to open in Tokyo and Hong Kong, due to differences in time zones. Due to this reason, the foreign exchange market is active 24 hours a day and different financial centers keep causing fluctuations in currency rates.

INFO NUGGET: London is the most important forex trading center in the world. 

The impact of Coronavirus on Foreign Exchange Markets:

The Coronavirus pandemic has also left its impact on the largest financial market of the world. The foreign exchange market experienced a shock in 2019 when the coronavirus pandemic hit the world. Uncertain about what the future holds, all countries took measures to keep their currency rates afloat and avoiding them from over-depreciating in early 2019. 

According to a study in 2020, the state of impact on each currency in the forex market depended on three factors namely the “currency’s market standing, risk sensitivities and the nature of policy response the government has been putting in place”. For example, the Australian Dollar (AUD) and the New Zealand Dollar (NZD) plummeted to their lowest level in more than a decade. Whereas some currencies like the Japanese Yen (JPY) and the Swiss Franc (CHY) rose in value. 

Despite the detrimental effects of coronavirus on the foreign exchange market, it still remains the largest financial market in the world and continues its hegemony on deciding currency rates around the world.

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