Chapter 3: The Foreign Exchange Market
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
worldwide trade at $3,200,000,000,000. It is also one of the most efficient. It is characterized
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.
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
Numbers in parentheses represent the percentage shares of average daily turnover in April 2007. The numbers
sum to more than 100 because two currencies are always involved in each transaction.