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| Forex Structure |
The purpose of the foreign exchange market is to
facilitate the trading of various currencies
around the world. Although many different types of
currency are exchanged, the majority of trades
involve only a small number of them, including the
U.S. Dollar, Yen, Euro, Swiss Franc, Pound
Sterling, Australian Dollar, and Canadian Dollar.
The U.S. Dollar is involved in over 90% of all
exchanges on the forex markets. Contrary to
popular belief, there is no one centralized market
in which all currency trading occurs; rather, the
foreign exchange is a loose conglomerate of
several different markets, each of which has its
own rules and regulations. Major markets are
located in the U.S., London, and Tokyo, and each
is open during different hours according to their
time zones. Naturally, trading is heaviest when
the market hours overlap, and almost two thirds of
the trading activity at the New York market takes
place during the morning while the European
markets are still open.
Because there is no centralized market, a single
exchange rate for a given currency does not exist.
Because of the over-the-counter (OTC) nature of
the markets, the bid and ask rates for a currency
can vary among different geographic markets and
market makers, although they are usually fairly
close to each other. Since the price of a currency
must be given in relation to another currency, it
is expressed in the form XXX/YYY, where each trio
of letters represents the international currency
code. For example, the price of Euros in U.S.
Dollars is written as EUR/USD. Traditionally, the
first currency in the pair, called the base
currency, is always the one that was strongest
when the pair was created, and the other currency
is known as the counter currency. The actual
prices themselves are in decimal form, typically
rounded to the nearest ten-thousandth of a unit.
One type of very short-term transaction is the
spot transaction between two currencies,
delivering over two days and using cash as opposed
to a contract.
In a forward transaction, the money is not
exchanged until an arranged date and an exchange
rate is agreed in advance. The time period ranges
from days to years. Currency swaps are a popular
type of forward transaction; these involve the
exchange of currency by two parties for an agreed
length of time and an arrangement to swap
currencies at an agreed later date. Another type
is a foreign currency future, which is inclusive
of interest. A standard contract is drawn up and a
maturity date arranged. The time schedule is about
three months. |
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