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The Foreign Exchange Market or Forex

Essay by   •  January 11, 2019  •  Course Note  •  5,430 Words (22 Pages)  •  40 Views

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The Foreign Exchange Market.                         Chap 1

FOREX is the short of FOReign
EXchange.

Definition:

It’s a market in which the money of one country is exchanged against the money of another country.
Foreign Exchange transaction :

A foreign exchange transaction is an agreement between a buyer and a seller that a fixed amount of one currency will be delivered for some other currency at a specified rate


Characteristics of the FOREX

FOREX does not exist physically (OverThe-Counter market): it is a network in which participants are connected by computers and telephones.

The four most liquid currency pairs traded
in the world are:
EUR/USD (euro/US dollar)
USD/JPY (US dollar/Japanese yen)
GBP/USD (British pound/US dollar)
USD/CHF (US dollar/Swiss franc)

Most exchanges of currency are made through bank deposits that are transferred electronically from one account to another.

Daily global value of FOREX trading averaged US$ 5100 billion in April 2016. (against US$ 5300 billion in April 2013 and US$ 4000 billion in April 2010)



Market participants :

Traders: commercial banks

Brokers:

Central banks:

Individuals and firms conducting
commercial or investment transactions:

Speculators and arbitragers:

They act as market makers who quote a buy
and sell price on a currency hoping to make a
profit on the spread which is the difference
between the buying and the selling price.

They act as middleman between
commercial banks: they inform banks about
the best buying and selling prices.
- They have very close contacts with both
commercial banks and customers.

They act to support the value of their
currency because of their government’s
policies or obligations.
- They may use the market to influence the
price at which their own currency trades.

Importers, exporters, portfolio investors,
tourists and others use the FOREX market to
execute commercial or investment
transactions.
- Some of these participants use the market
to hedge exchange rate risk.

Speculators and arbitragers seek to profit
from trading in the market.
- They operate for their own interest,
without need or obligation to serve
customers.

- Speculators seek all their profit from
exchange rate changes over time.
- Arbitragers try to profit from
simultaneous differences in exchange rates
in different markets.


There are 2 exchange rate systems:

-Fixed exchange rate system.
- Floating (or flexible) exchange rate system.

Fixed exchange rate system.

Floating (or flexible) exchange rate system.

-A fixed exchange rate system (also known
as
pegged exchange rate system) is a
system in which governments try to keep
the value of their currencies constant
against another one.

-The value of the particular currency that has been pegged to another one depends on the performance of the same, which is also known as the reference value.

In this system, the exchange rate is
determined exclusively by the supply and
demand for the currencies involved, with
no outside intervention.

No better system . each system has his own caracteristique .

Exchange Rates:

Each country has a currency in which the prices of goods and services are quoted.
An exchange rate is the price of one currency in terms of another. This is called the
nominal exchange rate.

An exchange rate can be quoted in two ways:
Difference between indirect quote and direct quote .

Direct quote ( american )

Indirect quote  (European )

Is a national currency price of a unit of
foreign currency.

How many units of national currency do
we need to buy a unit of foreign currency ?

Example US$/€ = 0.8602
i.e 1US$ = 0.8602 €

Is a foreign currency price of a unit of
national currency.
• How many units of foreign currency do we
need to buy a unit of national currency ?

Example €/US$= 1.1625
i.e 1€ = 1.1625 US$

[pic 1]

An appreciation of the euro against the dollar means that the price of a euro in terms of dollars has gone up
A depreciation of the euro against the dollar means that the price of a euro in terms of dollars has gone down.

If the euro appreciates against the dollar:
                                      The
dollar depreciates against the euro.                                                      If the euro depreciates against the dollar:
                                     The
dollar appreciates against the euro.


                                                 
Chap 2
Bid & Ask quotations.

Bank quotations are given as a bid and ask :

  • The Bid is the price at which banks (traders) buy currencies.
  • The Ask is the price at which banks (traders) sell currencies.

Banks buy at one price (Bid), and sell at a slightly higher price (Ask), making their profit from the spread between the buying and selling prices.

Spread = Ask – Bid 

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