The Foreign Exchange Market

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Overview

An exchange-rate system is the set of rules established by a nation to govern the value of its currency relative to other foreign currencies. The exchange-rate system evolves from the nation's monetary order, which is the set of laws and rules that establishes the monetary framework in which transactions are conducted. When one currency is traded for another, a foreign exchange market is established. The foreign exchange market or FX market is the largest market in the world. The amount of cash traded exceeds the world's stock markets. Participants in the FX market include large commercial banks, central banks, governments, multinational corporations and other financial markets and institutions. Small retail traders also play a very minor part in the foreign exchange market.

The characteristics of the FX market that make it so unique are: the volume of trading, liquidity of the market, geographical dispersion, the 24 hours trading day (except on the weekends), the number and variety of market traders, and the factors that affect the exchange rate. This market has a number of marketplaces where currencies are traded at different rates. To avoid exploitation by arbitragers, difference in rates are usually kept at a minimum. Banks all over the world are involved in foreign exchange trading, but the main trading centers are located in Tokyo, London and New York, allowing the market to remain open 24 hours a day; when Asian trading is ending, European trading is starting, and U.S. trading ends the daily session. Traders do not have to wait for the market to open. Monetary flows and economic changes such as GDP growth, interest rates, inflation, and budget and trade deficits or surpluses, cause fluctuations in the exchange rate. Because news affecting foreign exchange is well publicized, insider information is almost nonexistent in the FX market.

Issue 7/8: Winter 2006/Spring 2007

International Economics & Trade

Table of Contents

Introduction
World Economic History
International Trade
International Finance
Foreign Exchange Market
Trends in International Trade
Trade Policy, Treaties, & Law
International Organizations & Economic Development
Country Data
Economic Trade Data & Statistics
Government Resources
Online Periodicals
Encyclopedias & Dictionaries

The world relies on the foreign exchange market. When buying foreign goods and services or investing in other countries, individuals and companies need to purchase the currency of the country where they are transacting business. Currencies are traded everyday in the FX market to be used for direct foreign investments, import and export needs of companies and individuals, purchases of foreign instruments, and managing existing positions. In addition, the FX market is often used as a means to obtain profits from short-term fluctuations of exchange rates. The U.S. dollar, the euro and the Japanese yen dominate the foreign exchange market. These hard currencies, representing the world's largest industrialized economies, are always in demand and make up 80% of the FX market trades.

There are three popular forms of foreign exchange transactions: 1.) spot transactions, 2.) forward transactions and 3.) options. With spot transactions, there is an agreement between two parties regarding a rate of exchange, and the currencies are traded at that rate. In a forward transaction, money does not change hands until a future date. The buyer and seller agree on an exchange rate and the future date when the transaction will occur, regardless of what the market exchange rate is on that date. The future exchange can be a matter of days, months or years. An option is more flexible than a forward transaction. It allows the option owner the right to buy or sell a specific amount of foreign currency at a certain price before the chosen expiration date. Depending on the market, the option owner may exercise his option or allow the option to lapse and buy at the less expensive current market rate.

For years, foreign exchange rates were relatively stable or fixed, and were dependent upon the gold-exchange standard. The FX market in the past was slow to respond to changing events. Under the gold standard, the currencies were valued by their exchange worth in gold. This system was established in 1944 at the Bretton Woods, New Hampshire Conference. In planning for the end of World War II, the conference sought to establish stability in the world economic structure. The U.S. dollar was chosen as the base of the system. The values of all currencies were expressed in relation to the worth of the dollar. The dollar was valued at $35.00 per ounce of gold. Problems arose in the 1960's regarding the supply of gold owned by the U.S. government. There were concerns about whether the United States owned enough gold to redeem the dollars accumulated in other countries.

In 1971, U.S. dollars were no longer exchanged for gold; and in 1973, the floating exchange rate system that governs the FX market today was put into place. Now, all currencies are valued by the market forces of supply and demand. Since the abandonment of the gold standard, the FX market has become an important part of international economics. With the advent of floating exchange rates, the foreign exchange market has become unregulated. No institution sets rules for trading, and it is not under the supervision of any international organization. When necessary, governments and central banks often work together to restore stability to the FX market. Foreign exchange and international trade are closely connected. Together, they affect the economic situation of people throughout the world.

Selected Print Resources

Anthony, Steve. Foreign Exchange in Practice: The New Environment. New York: Palgrave Macmillan, 2003. 3rd edition, 392 p.
LC Call Number: HG3821 .A54 2003
LC Catalog Record: 2002042494
Table of Contents
Publisher's Description
Publisher-supplied Biographical Information

This text explains the concepts involved in foreign exchange and the application of these concepts to a number of day to day situations. Some of the chapter headings included in this book are: Exchange Rates, Interest Rates, Forward Exchange Rates, Applications of Forward Exchange, Currency Options - Pricing, Applications of Currency Options, Option Derivatives, and Factors Affecting Exchange Rates. Contains a glossary of terms and an index.

Beenhakker, Henri L. The Global Economy and International Financing. Westport, CT: Quorum Books,
2001. 274 p.
LC Call Number: HG3881.B42 2001
LC Catalog Record: 00037265

Includes chapters on: Foreign Exchange Markets, International Trade, International Capital Flows, Balance-of-Payments Policy, Determinants of Interest Rates, Financial Crises, Managing Foreign Exchange Exposure, and Financing from a Global Perspective. Has a number of figures and tables. The appendices have some sample case studies. Includes an index.

Daniels, Joseph P., and David D. Van Hoose. International Monetary and Financial Economics. Mason, OH: South-Western, 2005. 3rd edition, 600 p.
LC Call Number: HG3881 .D3264 2005
LC Catalog Record: 2004101631

This work is divided into five units - International Payments and Exchange; International Financial Instruments, Markets, and Institutions; Exchange Rate and Balance-of-Payments Determination; Open Economy Macroeconomics and Policy Analysis; and Domestic and Multinational Policymaking in a Global Economy. Contains many illustrative tables and figures. Includes chapter summaries, questions and problems, online applications, and selected references for further reading for each chapter. Has a glossary of terms and an index.

Dollar Overvaluation and the World Economy, edited by C. Fred Bergsten and John Williamson. Washington, DC: Institute for International Economics, 2003. Special Report 16, 310 p.
LC Call Number: HG540 .D65 2003
LC Catalog Record: 2002191274

This publication of the Institute for International Economics resulted from the Institute's conference on the dollar held in the fall of 2002. It is a collection of essays on the dollar and its usefulness, by a number of authors who attended the conference. The strength and decline of the dollar and its influence on exchange rates, trade, industries, and the economies of other countries are analyzed in these discussions. Includes biographical sketches of contributors and an index.

Exchange Arrangements and Foreign Exchange Markets: Developments and Issues, prepared by a staff team in the Monetary and Exchange Affairs Department. Washington, DC: International Monetary Fund,
2003. 81 p.
LC Call Number: HG3851 .E877 2003
LC Catalog Record: 2003475324

Report covers developments and issues relating to exchange arrangements, currency convertibility, foreign exchange market organization and foreign exchange volatility. The information source for this publication is the Annual Report on Exchange Arrangements and Exchange Restrictions (AREAER). This report is organized into five chapters. A list of reference resources is included at the end of each chapter.

Hinkelman, Edward G. A Short Course in International Payments: How to Use Letters of Credit, D/P and D/A Terms, Prepayment, Credit and Cyberpayments in International Transactions. Novato, CA: World Trade Press, 2003. 2nd edition, 182 p.
LC Call Number: HG3741 .H56 2003
LC Catalog Record: 2002193354

Designed to help both buyers and sellers learn about international payment. The relative merits of the four most common types of payment are explained, and the two most common options - documentary collections and documentary letters of credit - are featured. This book also contains chapters on Foreign Exchange Basics, Cyberpayments, Incoterms 2000, a comprehensive glossary, and a section devoted to documents used in international transactions.

Homaifar, Ghassem. Managing Global Financial and Foreign Exchange Rate Risk. Hoboken, NJ: J. Wiley, 2004. 380 p.
LC Call Number: HG3851 .H63 2004
LC Catalog Record: 2003015159

The focus of this work is on understanding various derivatives for managing exposure to foreign exchange, commodity price, interest rate, credit and weather risks. Presents an analysis of the various risks faced by a multinational firm in the global market. Considers active risk management approaches to commodity price, foreign exchange, equity price and interest rate changes. Contains a number of exhibits and examples. Has a list of references and an index.

Moffett, Michael H., Arthur I. Stonehill, and David K. Eiteman. Fundamentals of Multinational Finance. Boston: Pearson/Addison-Wesley, 2006. 2nd edition, 583 p.
LC Call Number: HG4027.5 .M64 2006
LC Catalog Record: 2004023647

This text is arranged in six parts - Global Finance Environment, Foreign Exchange Theory and Markets, Foreign Exchange Exposure, Financing the Global Firm, Foreign Investment Decisions, and Managing of Multinational Operations. Includes throughout the work a number of attractive exhibits. Has a glossary of terms related to the subject and a detailed index.

Moosa, Imad A. Exchange Rate Regimes: Fixed, Flexible or Something in Between? New York: Palgrave Macmillan, 2005. 267 p.
LC Call Number: HG3851 .M665 2005
LC Catalog Record: 2004060799

Chapters contained in this book include: The Role of the Exchange Rate in the Economy; Fixed Verses Flexible Exchange Rates; The Taxonomy of Exchange Rate Regimes; The History of Exchange Rate Arrangements; Macroeconomic Performance and Exchange Rate Regimes; and Modeling Exchange Rate Regime Choice. Includes case studies on the countries of Iraq, Kuwait, Peru, Sweden, the United Kingdom, and Argentina. Contains an extensive bibliography of references and an index.

Pugel, Thomas A. International Economics. Boston: McGraw-Hill/Irwin, 2004. 12th edition, 776 p.
LC Call Number: HF1411 .L536 2004
LC Catalog Record: 2002044914

The chapters in this text are arranged into four parts - The Theory of International Trade, Trade Policy, Understanding Foreign Exchange, and Macro Policies for Open Economies. Includes a number of mathematical examples, pertinent charts, chapter summaries and suggested readings for each chapter. Contains several appendices, a list of references and an index.

Steiner, Bob. Foreign Exchange and Money Markets: Theory, Practice and Risk Management. Boston: Butterworth-Heinemann, 2002. 330 p.
LC Call Number: HG3851 .S745 2002
LC Catalog Record: 2003389588

Provides an overview of Money Market Instruments, Deposit and Coupon-Bearing Instruments, and Discount Instruments. Also discusses: Spot Foreign Exchange, Forward Outrights and Swaps, and Currency Relationships. Includes a chapter on Essential Financial Arithmetic, a glossary of terms and an index.

Visser, Hans. A Guide to International Monetary Economics: Exchange Rate Theories, Systems and Policies. Northampton, MA: Edward Elgar, 2004. 3rd edition, 259 p.
LC Call Number: HG3851 .V57 2005
LC Catalog Record: 2004050644

Focuses on the economics behind exchange rate models. Discusses exchange rate policy, including capital controls, dollarisation, and monetary unions. Includes an extensive list of references and an index.

Selected Internet Resources

This section consists of foreign exchange resources that provide researchers with prices of foreign currencies, and information on foreign exchange markets. The resources available on this page also allow comparisons or reciprocal measurements of foreign currency prices to domestic currency prices. There are also resources that provide historical information on foreign exchange rates and historic data on past foreign currency prices.

Bloomberg.com offers the ability to determine the rate of exchange between any two world currencies, spot rates of the top 10 countries, and regional currency rates. The web site also provides a brief listing of currencies arranged in alphabetical order.

An online news service providing, market data, portfolios, mutual funds, personal finance, business discussions, and online research tools. The Global Markets page includes exchange rates, global exchange information, in addition to foreign market news and information.

The WorldBiz page provides information on international financial markets. The content includes a currency converter, global stock exchange information, a world market snapshot, tracking trading activity on international markets, and international financial news.

This web site allows access to resources that provide information on the current value of money at prior times in history. The sources listed on this site attempt to address how much money is worth from a certain period of time and what would be its current value. Links include historical online sources, historical exchange rates, historical changes in GDP, and a bibliography to related subject matter.

The European Central Bank (ECB) site that provides a table of foreign exchange rates of European Union member country currencies and the U.S. dollar. All currencies are quoted against the euro (base currency). Note from the ECB: The reference exchange rates are published both by electronic market information providers and on the ECB's web site shortly after the daily concertation procedure, between central banks within and outside the European System of Central Banks has been completed.

This page from the U.S. Federal Reserve Board web site provides the foreign exchange rates for 23 individual economies, and the Euro, comprised of the European Monetary Union member country currencies. Also available: historical data on foreign exchange rates; daily updates; dollar indexes; summary measures; currency weights; and release dates of weekly published foreign exchange rates which are available online.

This web site provides Real Time Foreign Exchange Market Commentary and Analysis; Previews and Summaries of Asian and European Financial Markets; Special Market Reports and Trading Analysis; Unique Fundamental and Technical Commentary; Wave Analysis with Two and Five Day Outlook; In Depth Technical Analysis; Financial News; and Daily Charts of Foreign Exchange Rates. Some services on this web site will be limited to customer access only.

An online information service that presents Global Foreign Exchange rates, for the U.S. dollar, Asian currencies, Euro rates, and other European currencies. The web site also includes foreign exchange charts, quotes, international financial and foreign market news, and an online forum.

Pacific Exchange Rate Service provides access to current and historic daily exchange rates through an online database retrieval and plotting system. Also available is a list of all the world currencies with information on each country's exchange rate regime and ISO-4217 currency code.

Online foreign exchange service providing currency conversion information, real time currency rates, cross rate table, historical exchange rates, and daily exchange rate tables. Other features include OANDA FXTrade that allows online foreign exchange in the spot market, OANDA's FX TradeGame, a currency trading game, foreign currency trend and currency news.

A foreign exchange web site presented in a table format which provides basic rates and expanded rates of foreign currencies, exchange rates, and currency conversions. Also allows cross exchange rate conversions.

The Universal Currency Converter allows users to perform interactive foreign exchange rate calculations online, using real time, up-to-the-minute currency rates. The site converts any currency amount of the many foreign currencies that are available on the web site.

This web site is intended to serve as an online campus covering all elements for the foreign currency trader. The site provides updated, objective facts to assist its users; a resource library that provides foreign exchange information and events effecting the exchange market; and Foreign Exchange News, that lists foreign exchange rates, foreign currencies, and commodity rates, as well as foreign market and foreign exchange news.

A foreign exchange web site that provides currency conversions and calculations, exchange rate historical data, and daily listings of foreign exchange rates. Also available are tables and graphs of foreign exchange rates, and example photos of various foreign currencies. The site lists the currencies of over 40 countries and economies.

Library of Congress Catalog Searches

Additional resources on this topic in the Library of Congress may be identified by searching the Online Catalog under appropriate Library of Congress subject headings. Choose the topics you wish to search from the following list of Library of Congress subject headings to link directly to the Catalog and automatically execute a search for the subject selected. Please be aware that during periods of heavy use you may encounter delays in accessing the catalog. Please see the individual sections of this guide for catalog searches relating to those topics. For assistance in locating other subject headings which relate to this subject, please consult a reference librarian.