2010 Chapter 3

2010 Chapter 3 - Chapter 3: The Foreign Exchange Market 3.1...

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Chapter 3: The Foreign Exchange Market 3.1 Introduction The foreign exchange market is the market where domestic money can be exchanged for foreign, and hence it is where the prices of many currencies are set. The price of foreign money is known as the exchange rate, denoted below by the letter E. Unlike the New York Stock Exchange, the foreign exchange market is not located in any one location. Rather, it is best thought of as a worldwide network of commercial banks linked together by sophisticated communications technology. Without doubt, it is the world's largest market; current estimates place the volume of daily worldwide trade at $3,200,000,000,000. It is also one of the most efficient. It is characterized 1 by low barriers to entry, a homogeneous commodity (money), many buyers and sellers none of whom has significant market power, and almost perfect information. Thus, it possesses all of the characteristics of a perfectly competitive market. And, because of its overall size and international dimensions, it is totally unregulated by any national or international government. Most of the trading takes place in a small set of currencies including the U.S. dollar (86.3), the euro (37.0), the Japanese yen (16.5), the British pound (15.0), the Swiss franc (6.8), the Australian dollar (6.7), the Canadian dollar (4.2), the Swedish krona (2.8), the Hong Kong dollar (2.8), and the Norwegian krone (2.2). Of these, the U.S. dollar is most often involved in trades. 2 This is because it serves as a vehicle currency in the market. Exchange rates, the prices of currencies, are quoted in dollars around the world, and trades of two non-dollar currencies are often handled via an intermediate purchase of dollars with one currency and then a sale of those dollars This is based on a 2007 BIS survey. See 1 http://www.bis.org/publ/rpfxf07t.htm for details. Numbers in parentheses represent the percentage shares of average daily turnover in April 2007. The numbers 2 sum to more than 100 because two currencies are always involved in each transaction.
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for the other. The foreign exchange market is almost always open. Business hours overlap around the world. The major foreign exchange trading centers are in London, New York, and Tokyo, with London accounting for about a third of all worldwide activity. The market is busiest in the early morning London time, when European and Asian banks are open, and early morning New York time, when New York and London banks are simultaneously open. Other significant centers of trading activity include Zurich, Singapore, and Hong Kong. Major participants in the foreign exchange markets include commercial banks, investment banks, and other financial institutions. These institutions conduct transactions in a variety of 3 financial instruments. Major dealer banks have developed into an Interbank market, with more than 2000 registered dealer institutions world wide. Dealers trade with each other via the telephone or through electronic brokerage systems. Major dealers buy and sell all major currencies as well as a
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2010 Chapter 3 - Chapter 3: The Foreign Exchange Market 3.1...

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