Foreign Exchange

Foreign exchange market is the largest market in the world in terms of cash value traded. Since it includes trading with other financial markets, it facilitates international trade and international investment of a country and helps to minimize domestic interest and inflation rates. (Levinson, 2006). According to Geisst (2006), foreign exchange market occurred in ancient times. From 1944 until 1971, most of the world’s major currencies were pegged to the US dollar, quoted $ 35 per ounce of gold under Bretton Woods System. (Geisst, 2006). UBS Investment Bank (n.d.) also stated that International Monerary Fund (IMF) was formed under Bretton Woods System and IMF’s members agreed to pegged their currencies in US dollar.

According to Tradersk (2012), daily turnover around US $ 3 billion of foreign exchange market make it become the most liquid financial market in the world. But a research carried by Mancini, Ronaldo, & Wrampelmeyer (2012) illustrated that foreign exchange market is not suitable in terms of liquidity. Currencies depreciated in value from the incident of Lehman Brothers caused exchange rates illiquid than before. (Mancini et al., 2012). “Commonality in Forex liquidity implies that the phenomenon of diminishing liquidity and the corresponding Forex illiquidity cost affect all exchange rates and thus Forex liquidity risks cannot be diversified away easily” (Mancini et al., 2012).

There are many features of foreign exchange market. Parikh (2011) pointed out that there are time and location flexibility in foreign exchange market. Ickes (2006) explained the foreign exchange market is essentially an over the counter (OTC) market whereby there is no central place between buyer and seller. It is a 24-hour market that opens daily and it located over numerous locations who transact via a network of sophisticated international dealing system. Furthermore, it is an electronic market where funds are transferred between the participants through SWIFT computer network. (Standard Bank, n.d.). There are many participants in the foreign exchange market. Chancellor (n.d.) stated that there are at least 5 major participants and classified them as banks, central banks, brokers, corporations and fund managers.

Exchange rate is the rate used in trading in foreign exchange market. It is the rate at which one currency can be exchange for another. Riley (2006) classified the exchange rate into 5 ways, such as spot exchange rate, forward exchange rate, bi-lateral exchange rate, effective exchange rate index (EER) and real exchange rate.

References

Chancellor, T. L. (n.d.). Who are the foreign exchange market participants?.

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