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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 date.
Copyright 2004 Pearson Addison-Wesley. All rights reserved.
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Geography
The foreign exchange market spans the globe, with prices moving and currencies trading somewhere every hour of every business day.
As the next exhibit will illustrate, the volume of currency transactions ebbs and flows across the globe as the major currency trading centers open and close throughout the day.
Copyright 2004 Pearson Addison-Wesley. All rights reserved.
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Exhibit 4.1 Measuring Foreign Exchange Market Activity: Average Electronic Conversations Per Hour
25,000
20,000
15,000
10,000
5,000
Asia closing
Afternoon in America
6 pm In NY
Tokyo opens
Source: Federal Reserve Bank of New York, The Foreign Exchange Market in the United States, 2001, www.ny.frb.org.
Copyright 2004 Pearson Addison-Wesley. All rights reserved.
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Market Participants
The foreign exchange market consists of two tiers:
The interbank or wholesale market (multiples of $1MM US or equivalent in transaction size) The client or retail market (specific, smaller amounts)
Five broad categories of participants operate within these two tiers; bank and nonbank foreign exchange dealers, individuals and firms, speculators and arbitragers, central banks and treasuries, and foreign exchange brokers.
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Their use of the foreign exchange market is necessary but nevertheless incidental to their underlying commercial or investment purpose. Some of the participants use the market to hedge foreign exchange risk.
Copyright 2004 Pearson Addison-Wesley. All rights reserved.
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Market Size
In April 2001, a survey conducted by the Bank for International Settlements (BIS) estimated the daily global net turnover in traditional foreign exchange market activity to be $1,210 billion. This was the first decline observed by the BIS since it began surveying banks on foreign currency trading in the 1980s.
Copyright 2004 Pearson Addison-Wesley. All rights reserved.
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Exhibit 4.2 Global Foreign Exchange Market Turnover (daily averages in April, billions of US dollars)
800 700 600 500 400 300 200 100 0 1989 1992 1995 1998 2001
Source: Bank for International Settlements, Central Bank Survey of Foreign Exchange and Derivatives Market Activity in April 2001, October 2001, www.bis.org.
Copyright 2004 Pearson Addison-Wesley. All rights reserved.
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Exhibit 4.3 Geographic Distribution of Foreign Exchange Market Turnover (daily averages in April, billions of US dollars)
700 600 500 400 300 200 100 0 1989 1992 1995 1998 2001
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Source: Bank for International Settlements, Central Bank Survey of Foreign Exchange and Derivatives Market Activity in April 2001, October 2001, www.bis.org.
Exhibit 4.4 Currency Distribution of Global Foreign Exchange Market Turnover (percentage shares of average daily turnover in April)
Because all exchange transactions involve two currencies, percentage shares total to 200%
90 80 70 60 50 40 30 20 10 0
1989 1992 1995 1998
US dollar euro Deutshemark French franc EMS currencies Japanese yen Pound sterling Swiss franc
2001
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Source: Bank for International Settlements, Central Bank Survey of Foreign Exchange and Derivatives Market Activity in April 2001, October 2001, www.bis.org.
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Most foreign currencies in the world are stated in terms of the number of units of foreign currency needed to buy one dollar.
Copyright 2004 Pearson Addison-Wesley. All rights reserved.
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Excluding two important exceptions, most interbank quotations around the world are stated in European terms.
Copyright 2004 Pearson Addison-Wesley. All rights reserved.
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For quotations expressed in home currency terms (Direct quotations) the formula becomes:
f = Forward Spot x 360 x 100 Spot n
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Dresdner Bank
(5) Sell 1,121,651 to Citibank at $0.9045/ (4) Receive 1,121,651
Barclays Bank
(2) Receive 692,377 (3) Sell 692,377 to Dresnder Bank at 1.6200/ 4-31
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