Types of Foreign Exchange Markets

T.L. Chancellor
T.L Chancellor has more than 12 years of newspaper reporting and editing experience. She has written extensively about education, business and city government. She has also worked at a public relations firm, focusing on environmental issues with clients.
By T.L. Chancellor, eHow Contributor

Foreign exchange markets exist to allow business owners to purchase currency in another country so they can do business in that country. The "FX" market, also called the Forex market, is a worldwide network of currency traders who work around the clock to complete these transactions, and their work drives the exchange rate for currencies around the world.

1. Spot Market
These are the quickest transactions involving currency in foreign markets. These transactions involve immediate payment at the current exchange rate, which is also called the spot rate. The Federal Reserve says the spot market accounts for one-third of all currency exchange, and trades usually take place within two days of the agreement. This does leave the traders open to the volatility of the currency market, which can raise or lower the price between the agreement and the trade.

Futures Market
As the name implies, these transactions involve future payment and future delivery at an agreed exchange rate, also called the future rate. These contracts are standardized, which means the elements of the agreement are set and non-negotiable. It also takes the volatility of the currency market, specifically the spot market, out of the equation. These are popular among traders who make large currency transactions and are seeking a steady return on their investments.

Forward Market
These transactions are identical to the Futures Market except for one important difference---the terms are negotiable between the two parties. This way, the terms can be negotiated and tailored to the needs of the participants. It allows for more flexibility. In many instances, this type of market involves a currency swap, where two entities swap currency for an agreed-upon amount of time, and then return the currency at the end of the contract.

Participants
There are approximately five different types of entities that use the foreign exchange markets on a daily basis. Commercial banks are the leaders in this market and are the main source of currency transactions. Traditional users refer to entities that do business across national borders. Central banks are the official players in this market, and each country has a central bank to manage its money supply. Brokers work as go-betweens for banks, typically during large transactions. And, traders and speculators work to take advantage of short-term trends in the market.

Where This Happens

Unlike the New York Stock Exchange, which has a physical building, currency exchange takes place all over the world and has no central building. Most transactions are done by phone or computer. Estimates have the international currency exchange driving $180 billion in business per day. The majority of transactions take place in London, New York and Tokyo, with cities such as Singapore, Zurich, Frankfurt and Hong Kong handling transactions as well.

Who Are the Foreign Exchange Market Participants?

T.L. Chancellor
T.L Chancellor has more than 12 years of newspaper reporting and editing experience. She has written extensively about education, business and city government. She has also worked at a public relations firm, focusing on environmental issues with clients.

The Foreign Exchange Market is the best way to trade currency around the world. Known by the nickname Forex, more than 100 types of currency are traded each day and more than $3 trillion is exchanged daily. There are plenty of participants in the Forex, including those that serve investors, middle men for currency purchase and companies in need of international funds.

1. Banks

Banks participate in the Forex in order to manage the foreign exchange risks of their bank and their clients, according to Peter Pontikis, who writes for Forex Journal Magazine. They can also speculate in the market. Their main goal is to make profits through direct trade of currency and through managing their clients' trading positions. This gives the bank access to both the buying and selling interests of their clients.

Brokers

Brokers in the Forex are the middle men between banks who trade currency on a daily basis. Their role is no different than a trader on the floor of the stock market. Brokers spend their day matching buy and sell orders between clients. Many of their functions are computerized, which means deals are done fast. Banks pay a fee to have these brokers handle their transactions.

Central Banks

Pontikis writes that most developed countries have central banks, whose main role is to maintain the validity of the national currency. Central banks usually monitor and test prices on the Forex, and have a great deal of sway with banks, brokers and other players in the Forex market. The reason? Central banks print the money. For that reason alone, their opinions are always respected and rarely ignored.

Corporations

When a corporation in the United States makes a purchase in France, that company must find a way to make that purchase in foreign currency. That's where the Forex comes in. The U.S. corporation uses the market to purchase the foreign currency they need to complete the transaction.

Fund Managers

There are two types. The fund managers are money managers who deal in funds that amount to hundreds of millions of dollars. They invest that money across a range of investments and a diverse list of clients, including pensions, individuals and governments. Those who manage hedge funds take bigger risks, as they're seeking to realize leverage potential and will exploit the use of derivatives, according to Pontikis.

What Are the Functions of Foreign Currency Exchange Markets?

Laura Acevedo
Laura Acevedo has been a professional writer for more than 15 years. With a background in business, international relations, psychology and technology, Acevedo writes from both experience and an educational foundation. She holds a Master of Business Administration from the University of North Florida and undergraduate degrees in business and psychology.

What Are the Functions of Foreign Currency Exchange Markets?

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The foreign currency exchange markets are where money from different countries are bought and sold. The focus of foreign currency exchange is the facilitation of international commerce. Foreign currency exchange markets can also function as a method of making investments, can be used by governments to impact the value of their currency and can help companies reduce losses due to changes in exchange rates.

1. Primary Function
The primary function of foreign currency exchange markets is to convert the currency of one country into another currency. For example, the U.S. dollar may be changed into Mexican Pesos or English Pounds. The amount of currency converted depends on the exchange rate, which can be fixed or can fluctuate. The U.S. dollar is a currency that has a fluctuating exchange rate that is based on market demand. Some countries, like China, have a fixed exchange rate determined by their central bank.

International Transactions

Foreign currency exchange markets serve to facilitate international financial transactions. These transactions may be the purchasing and selling of goods, direct investment in buildings and equipment in a foreign country or the purchase of investment vehicles like foreign bonds. For example, a U.S.-based company may want to purchase goods manufactured in China. The foreign currency exchange market allows them to exchange U.S. dollars and make the purchase in Chinese RMB (renminbi, the currency of the People's Republic of China).

Currency Value
The value of a country's currency can influence international trade, consumers' purchasing power and inflation. Central banks of a county or region, like the U.S. Federal Reserve, seek to minimize the impact of currency fluctuations. The foreign currency exchange market functions as a tool for central banks to control the value of their currency by buying or selling currency, which influences the total amount in worldwide circulation.

Investment
Fund managers and investment professionals use the foreign currency exchange market to help diversify their portfolios and potentially increase their returns. Through calculated risks, investors can bet on a change in the price or exchange rate of a currency. Just like with the stocks, if currency is purchased at a low price and sold at a higher price, the investor makes money.

Loss Protection

International companies that work in multiple countries are subject to gains and losses based on exchange rate fluctuations. To help prevent losses, companies can make forward transactions where they make a binding agreement to exchange currency for another currency at a fixed rate. This function of the foreign currency exchange market helps a company minimize the risk of foreign exchange on future expenses. For example, if a U.S.-based company places an order with a firm in Taiwan that will be ready in five months, the company can enter a forward transaction agreement that fixes the price based on the current exchange rate at the time of order. The company knows the value and cost of the purchase and will not be hit with a future loss based on a change in exchange rates

The Basic Functions of Foreign Exchange Market

The foreign exchange market fosters international commerce and financial liquidity.
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The foreign exchange market broadly defines the global infrastructure of currency broker-dealers that facilitates the purchase and sale of currencies from around the world. Prices of individual currencies are quoted as ratios of one currency's value to that of another. These prices, or exchange rates, fluctuate in response to changes in market supply and demand. Widely regarded as the world's most solvent financial market, the foreign exchange market has two fundamental functions: It's a catalyst for the flow of goods and service between countries and it's a lucrative source of income among speculative investors.

1. The Foreign Exchange Market

The foreign exchange, or Forex, market is a virtual venue in which currencies from around the world are exchanged to meet the needs of industry and investors. The foreign exchange market is represented at physical venues such as airport money change kiosks and banks as well as virtual venues, such as the websites of webbased currency brokers. Participants in the foreign exchange market exchange one given currency for another at the applicable market exchange rate.

Exchange Rates

In the foreign exchange market, exchange rates are an expression of the relative value of two currencies, called a currency pair. For instance, if one U.K. pound sterling, GBP, is valued at 1.650 U.S. dollars, USD, the exchange rate would be stated as 1.650 USD/GBP (1.650 USD per one GBP). Since such an exchange rate figure reflects currency conversion in one direction (GBP exchanged for USD), the exchange rate for converting in the opposite direction (USD exchanged for GBP) can be found by simply dividing one (1) by the given exchange rate (1 / 1.650 = 0.606 GBP/USD). Any change in the market value of either currency results in a commensurate change in the exchange rate.

Exchange Rate Fluctuations

Currencies traded in the foreign exchange market experience rises and declines in value on an almost constant basis. As a result, exchange rates fluctuate each moment by varying amounts. The innumerable factors which contribute to exchange rate movements make it virtually impossible to explain a rate change up or down in a given moment. However, substantial exchange rate movements frequently result from international conflict, natural disasters or changes in a country's level of political and economic stability.

The Foreign Exchange Market and the Global Economy

One basic function of the foreign exchange market is practical. With the exception of the barter system, wherein two countries may agree on an exchange of mutually-desired goods or services, international commerce would not be possible without the foreign exchange market. At the industrial level, the foreign exchange market allows importers to pay exporters. At the individual level, it facilitates such activities as international travel and investment in offshore securities. It should be recognized, however, that any cross-border transaction assumes an element of risk due to the volatile nature of exchange rates.

The Profitability of the Foreign Exchange Market

The second more popular function of the foreign exchange market is currency speculation. Similar to speculative trading in a stock market, the foreign exchange market is replete with short-term trading activity aimed solely at profiting from changes in exchange rates. Using tools such as currency options, traders may make large profits in a short amount of time by leveraging large volumes of currency for only a small fraction of the value. The 2000s gradually witnessed an explosion in the number of Internet-based currency brokers. These enterprises allow ordinary individuals to learn, maintain accounts and place trades in the foreign exchange market from the convenience of a personal computer. For reason such as this, speculative trades now constitute the overwhelming majority of trades placed in the market.

Conclusion

Both the practical and speculative functions of the foreign exchange market play an important role as the world becomes economically and financially more interdependent. In a practical sense, the foreign exchange market fosters efficiency in international economic relations and activity. From a speculative standpoint, the volume of daytrading orders, and subsequent gains where successful, help maintain this efficiency by promoting the liquidity of the market.

Purpose of the Foreign Exchange Market

Kofi Bofah
Kofi Bofah has been writing Internet content since 2010, with articles appearing on various websites. He is the founder of ONYX INVESTMENTS, which is based out of Chicago. Bofah enjoys writing about business, finance, travel, transportation, sports and entertainment. He holds a Bachelor of Science in Business Management from the University of North Carolina at Chapel Hill.

Foreign exchange markets facilitate international business.

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Foreign exchange transactions are central to global commerce. The foreign exchange market is the network of private citizens, corporations and government officials who trade overseas currencies among each other. Beyond coordinating payments, foreign exchange rates and markets function as leading economic indicators. Investors and institutions analyze these foreign exchange market trends to create wealth and manage risks.

1. Identification
Consumers acquire foreign exchange so they can purchase overseas goods. Alternatively, businesses might receive foreign exchange and enter the market to convert that money back into domestic currency. The foreign exchange market also serves the purpose of attracting investors. Investors diversify and increase their asset holdings with currency reserves.

2. Features
Foreign exchange rates describe the amount of another currency that one unit of a certain currency can buy. Because of their association with specific nations, foreign exchange rates gauge economic and political sentiment. Low exchange rates translate into weak demand for a currency, as foreign investors liquidate that countrys stocks, bonds and real estate. At that point, foreigners might fear recession, or politics that are hostile to foreign investment. For example, high tax rates on foreign profits can cause foreigners to withdraw from a particular country. Conversely, high exchange rates define strong economies and effective political regimes. Investors are then encouraged to trade for that currency and to purchase its home nations assets. The increased demand for the currency supports elevated exchange rates.

3. Considerations

Government officials can manage their home economies through foreign exchange transactions. Low exchange rates for the domestic currency improve the export economy, because these goods become more affordable to foreign buyers. However, domestic consumers prefer higher exchange rates, which grants them more purchasing power for imported goods. Government leaders use foreign exchange reserves to influence currency exchange rates. Nations can buy large amounts of foreign exchange reserves to devalue the home currency. China owned $900 billion worth of U.S. treasuries as of April 2010, the U.S. Treasury reported. These holdings lower exchange rates for the Chinese yuan and support Chinas export economy.

4. Warning
Foreign exchange markets do introduce distinct risks of financial losses and contagion. Institutions that hold a particular currency lose purchasing power when its exchange rates deteriorate. However, as a home currency strengthens, multinational corporations suffer sales declines because their wares become more expensive overseas. "Contagion" refers to the process of financial distress in one region growing into a global crisis. For example, Mexico might default on its sovereign debt, which causes the peso to collapse. From there, foreign businesspeople

with exposure to Mexico might be forced to sell off all assets to raise cash. The selling compounds, and it causes markets to crash globally.

5. Strategy
Foreign exchange markets offer currency derivatives to hedge against risks. Currency derivatives, such as futures, forwards and options establish predetermined exchange rates over set periods of time. Futures and options trade on major exchanges, such as the Chicago Mercantile Exchange. Forwards are private agreements between two parties to negotiate exchange rates at later points in time.

FX & Currency Option Definitions

Nicholas B. Sisson
Nicholas B. Sisson holds a B.A. in economics from Ithaca College and a certificate in technical communication from J.B.S. Technical Communications, Ltd. Working in investment operations, Sisson participated in an initiative to revise and rewrite his group's procedure manual. More recently, Sisson created definitions of financial terms for the glossary of a major financial website. He has been writing since 2008.

Currency options help to reduce the price risk in international transactions.

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The abbreviation FX stands for foreign exchange and is commonly used in connection with transactions made in the growing foreign exchange market. As the world becomes increasingly interdependent economically, the the role of the foreign exchange market becomes more crucial. The market for currency option contracts, or currency options, has proliferated greatly for the purposes of both risk hedging and pure speculation.

1. What is foreign exchange?

Foreign exchange, commonly abbreviated as "FX" or "FOREX," is a market for the purchase and sale of the world's currencies at prices called exchange rates, which are determined by the fluctuating levels of supply and demand for different currencies. Exchange rates express the cost of a given currency in terms of another. For instance, if the cost in U.S. dollars of purchasing 10 U.K. pounds sterling is $15.00, then the exchange rate is expressed as 1.5 USD/GBP (U.S. dollars per U.K. pound sterling).

What is the role of the foreign exchange market?

The widespread removal of trade barriers and tariffs since the latter half of the 20th century has resulted in what has been termed "globalization," which is to say a growing tendency toward a worldwide economy of interdependent national markets. Enhanced by networks like the World Wide Web, international trade and growth in offshore securities investing have brought the foreign exchange market to the fore. Without this market, trade and investment across international borders would not be possible.

What is an option?
An option is a financial derivative contract that gives the holder the non-obligatory option to buy or sell some quantity of a specific asset (underlying asset) at a predetermined price (strike price) on a particular date (expiration date). Despite the wide variety of options styles, all options are classified as "call" or "put." Call options hedge that the price of an asset will rise, while put options hedge that an asset's price will decline. If the holder's suspicion is correct in either case, he or she may exercise the option to purchase (call) or sell (put) some quantity of the asset in question. If the asset price does not move as expected, then the option expires, having no value.

What is a currency option?

A currency option is an option contract that uses a foreign currency as the underlying asset, giving the holder the option to buy or sell the currency at a specific exchange rate against another currency (usually the home, or base, currency of the holder). For instance, if an investor holds USD and believes that the exchange rate against GBP

will decline, he or she may purchase a call currency option. If the investor's forecast is correct, this will allow the investor to exchange USD for GBP at an advantageous rate.

Why currency options?

At a practical level, companies and all manner of investors have incorporated currency options into their portfolios. The foreign exchange market now operates on a near continual basis, and individual exchange rates fluctuate from moment to moment. Consequently, foreign exchange has become increasingly risky, and currency options have become an affordable method for hedging losses associated with unfavorable currency price movements. As a speculative tool, currency options offer investors with strong convictions about price movements the opportunity to capitalize and make potentially astronomical profits from favorable changes in exchange rates.