The participants of the foreign exchange markets

The participants of the foreign exchange markets. The foreign exchange market is extremely competitive so there are many participants, none of whom is large relative to the market.

The central institution in modern foreign exchange markets is the commercial bank. Most transactions of any size in foreign currencies represent merely an exchange of the deposits of one bank for the deposits of another bank. If an individual or business firm needs foreign currency, it contacts a bank, which in turn secures a deposit denominated in foreign money or actually takes delivery of foreign currency if the customer requires it. If the bank is a large money center institution, it may hold inventories of foreign currency just to accommodate its customers.

Small banks typically do not, hold foreign currency or foreign currency-denominated deposits. Rather, they contact large correspondent banks, which in turn contact foreign exchange dealers.

The major international commercial banks act as both dealers and brokers. In their dealer role, banks maintain a net long or short position in a currency, and seek to profit from an anticipated change in the exchange rate. A long position means their holdings of assets denominated in one currency exceed their liabilities denominated in this same currency. In their broker function, banks compete to obtain buy and sell orders from commercial customers, such as the multinational oil companies, both to profit from the spread between the rates at which they buy foreign exchange from some customers and the rates at which they sell foreign exchange to other customers, and to sell other types of banking services to these customers.

Frequently, currency-trading banks do not deal directly with each other but rely on foreign exchange brokers. These firms are in constant communication with the exchange trading rooms of the worlds major banks.

Their principal function is to bring currency buyers and sellers together. Security brokerage firms, commodity traders, insurance companies, and scores of other nonbank companies have come to play a growing role in the foreign exchange markets today. These Nonbank Financial Institutions have entered in the wake of deregulation of the financial marketplace and the lifting of some foreign controls on international investment, especially by Japan and the United Kingdom.

Nonbank traders now offer a wide range of services to international investors and export-import firms, including assistance with foreign mergers, currency swaps and options, hedging foreign security offerings against exchange rate fluctuations, and providing currencies needed for purchases abroad. In main all participants of an exchange market are usually divided on two groups. The first group of participants is called speculators by definition, they seek to profit from anticipated changes in exchange rates.

The second group of participants is known as arbitragers. Arbitrage refers to the purchase of one currency in a certain market and the sale of that currency in another market in response to differences in price between the two markets. The force of arbitrage generally keeps foreign exchange rates from getting too far out of line in different markets. 3. Instruments of the foreign exchange markets Cable and Mail Transfers Several financial instruments are used to facilitate foreign exchange trading.

One of the most important is the cable transfer, an execute order sent by cable to a foreign bank holding a currency sellers account. The cable directs the bank to debit the sellers account and credit the account of a buyer or someone the buyer designates. The essential advantage of the cable transfer is speed because the transaction can be carried out the same day or within one or two business days. Business firms selling their goods in international markets can avoid tying up substantial sums of money in foreign exchange by using cable transfers.

When speed is not a critical factor, a mail transfer of foreign exchange may be used. Such transfers are written orders from the holder of a foreign exchange deposit to a bank to pay a designated individual or institution on presentation of a draft. A mail transfer may require days to execute, depending on the speed of mail deliveries. Bills of Exchange One of the most important of all international financial instruments is the Bill of Exchange.

Frequently today the word draft is used instead of bill. Either way, a draft or bill of exchange is a written order requiring a person, business firm, or bank to pay a specified sum of money to the bearer of the bill. We may distinguish sight bills, which are payable on demand, from time bills, which mature at a future date and are payable only at that time. There are also documentary hills, which typically accompany the international shipment of goods.

A documentary bill must be accompanied by shipping papers allowing importers to pick up their merchandise. In contrast, a clean hill has no accompanying documents and is simply an order to a bank to pay a certain sum of money. The most common example arises when an importer requests its bank to send a letter of credit to an exporter in another country. The letter authorizes the exporter to draw bills for payment, either against the importers bank or against one of its correspondent banks.

Foreign Currency and Coin Foreign currency and coin itself as opposed to bank deposits is an important instrument for payment in the foreign exchange markets. This is especially true for tourists who require pocket money to pay for lodging, meals, and transportation. Usually this money winds up in the hands of merchants accepting it in payment for purchases and is deposited in domestic banks. For example, U.S. banks operating along the Canadian and Mexican borders receive a substantial volume of Canadian dollars and Mexican pesos each day. These funds normally are routed through the banking system back to banks in the country of issue, and the U.S. banks receive credit in the form of a deposit denominated in a foreign currency.

This deposit may then be loaned to a customer or to another bank. Other Foreign Exchange Instruments A wide variety of other financial instruments are denominated in foreign currencies, most of this small in amount. For example, travelers checks denominated in dollars and other convertible currencies may be spent directly or converted into the currency of the country where purchases are being made. International investors frequently receive interest coupons or dividend warrants denominated in foreign currencies.

These documents normally are sold to a domestic bank at the current exchange rate. III. Foreign exchange rates 1.