Foreign Exchange Markets Summary

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Functions of the world's major foreign currency exchange markets:

The FOREX market provides the physical and institutional structure through which the money of one country is exchanged for that of another country.

The FOREX market is the mechanism by which participants transfer purchasing power between countries, obtains or provides credit for international trade, and minimizes exposure to exchange rate risk. Transferring of purchasing power is necessary because international trade and capital transactions normally involve parties in countries with different currencies yet each party wishes to transact in their own currency.
Because the movement of goods between countries takes time, inventory in transit must be financed. The FOREX market provides a source of credit via specialized instruments such as letters of credit . The FOREX market provides "hedging" facilities for transferring foreign exchange risk to someone else more willing to carry that risk.

The FOREX market consists of two tiers, the interbank or wholesale market, and the client or retail market
Five broad categories of participants operate within these two tiers
Bank and non bank foreign exchange dealers
Individuals and firms conducting commercial or investment transactions
Speculators and arbitragers
Central banks and treasuries
Foreign exchange brokers

source: http://www.businessfaculty.utoledo.edu/pkozlowski/FINA3500/ch06.ppt.

Advantages of a virtual foreign exchange market:

Automatic balance of payments adjustment - Any balance of payments disequilibrium will tend to be rectified by a change in the exchange rate. For example, if a country has a balance of payments deficit then the currency should depreciate. This is because imports will be greater than exports meaning the supply of sterling on the foreign exchanges will be increasing as importers sell pounds to pay for the imports. This will drive the value of the pound down. The effect of ...