global linkage of forex maket

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CHAPTER I -INTRODUCTION

The foreign exchange market is the biggest financial market in the world. Every day,

transactions worth about 3.98 trillion dollars are carried out within the market. The major aimof introducing the foreign exchange market is to facilitate international trade by enabling

businesses to erform transactions outside their local currency. The market oerates round the

clock from !onday through "riday. "oreign Exchange is the simultaneous #uying of one

currency and aying for it with another at an agreed rice $exchange rate% for settlement on

an agreed date. "&'E( is an acronym for "&'eign Exchange. )n the foreign exchange

market today, a trader can urchase some amount of international currencies by aying with a

different currency. This tye of foreign exchange market started to develo in the *9+s,

which was about thirty years after foreign exchange was introduced. -ome imortant features

about the "( market include the following

*. )t has a very large number of daily articiants. This makes its li/uidity one of the highest

in the world.

0. 1articiants come from several countries in the world.

3. The market is oen from 00 2!T on -unday to 0 2!T on "riday.

. Exchange rates are affected by a number of factors.

The foreign exchange market is a global henomenon with two main functions to convert the

currency of one country into the currency of another, and to minimi4e the risk of changes in

foreign exchange rates. These functions create three defining characteristics the foreign

exchange market is decentrali4ed, never ceases, and is constantly changing wealth. )nvolving

many billions of 5- dollars, the foreign exchange market involves agents as large as

multinational cororations to the very small, such as an international tourist trying to change

one currency into another.

The world relies on the foreign exchange market. 6hen buying foreign goods and services or

investing in other countries, individuals and comanies need to urchase the currency of the

country where they are transacting business. 7urrencies are traded everyday in the "( market

to be used for direct foreign investments, imort and exort needs of comanies and

individuals, urchases of foreign instruments, and managing existing ositions.

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Characteristics of the Foreign Exchange Market

The "orex !arket does not exist hysically. )t is a framework in which articiants are

connected by comuters, telehones and telex $-6)"T% and oerates in most financial

centers globally. !ost exchanges of currency are made through bank deosits that are

transferred electronically from one account to another. The volume of foreign exchange

transactions worldwide is assumed to be aroximately 5- trillion er day in &ctober

0:. The "orex !arket is an over;the;counter market that is trading in financial instruments

that are not listed or available on an officially recogni4ed exchange, but traded in direct

negotiation between buyers and sellers. Trading takes lace telehonically or electronically.

"oreign exchange markets oerate 0 hours er day. )t is said that the foreign exchange

market follows the sun around the earth. Twenty four hours market means that exchange rates

can change at any time due to change in market conditions or other events at anytime and

anywhere. This demands alertness on the art of dealers to the ossibility of a change in

exchange rate anywhere. "oreign exchange transactions do not take lace evenly throughout

the day. Transactions are heavy when markets in 5-< and Euroe are oen that is when it is

morning in =ew >ork and afternoon in ?ondon.

Why do we make use of the Foreign Exchange Market?

Trading in a domestic market is substantially different from doing business in an offshore

market. )n the comlex world of international trade, merchants face a number of risks that

need to be managed in order to ensure the success of their cross@border transactions. )n order

to rotect themselves, these cororations aly hedging techni/ues using various foreign

exchange instruments and roducts in order to negate the imacts of exchange rate

fluctuations. -uccessful comanies emloy effective risk management techni/ues when

making business decisions, and evaluate commercial risk in an exlicit and logical manner inorder to offset financial loss occasioned by the volatility in exchange rates $currency risk%.

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History of Foreign Exchange Market

The foreign exchange market as we know it today originated in *9+3. Aowever, money has

been around in one form or another since the time of 1haraohs. The #abylonians are credited

with the first use of aer bills and receits, but !iddle Eastern moneychangers were the first

currency traders who exchanged coins from one culture to another. uring the middle ages,

the need for another form of currency besides coins emerged as the method of choice. These

aer bills reresented transferable third;arty ayments of funds, making foreign currency

exchange trading much easier for merchants and traders and causing these regional

economies to flourish. "rom the infantile stages of forex during the !iddle <ges to 66), the

forex markets were relatively stable and without much seculative activity. <fter 66), the

forex markets became very volatile and seculative activity increased tenfold. -eculation in

the forex market was not looked on as favorable by most institutions and the ublic in

general. The 2reat eression and the removal of the gold standard in *93* created a serious

lull in forex market activity. "rom *93* until *9+3, the forex market went through a series of

changes. These changes greatly affected the global economies at the time and seculation in

the forex markets during these times was little, if any.

The Bretton Woods Accord

The first major transformation, the #retton 6oods <ccord, occurred toward the end of 6orld

6ar )). The 5nited -tates, 2reat #ritain and "rance met at the 5nited =ations !onetary and

"inancial 7onference in #retton 6oods, =.A. to design a new global economic order. The

location was chosen because, at the time, the 5.-. was the only country unscathed by war.

!ost of the major Euroean countries were in shambles. 5 until 66)), 2reat #ritainBs

currency, the 2reat #ritish 1ound, was the major currency by which most currencies were

comared. This changed when the =a4i camaign against #ritain included a major

counterfeiting effort against its currency. )n fact, 66)) vaulted the 5.-. dollar from a failed

currency after the stock market crash of *909 to benchmark currency by which most other

international currencies were comared. The #retton 6oods <ccord was established to create

a stable environment by which global economies could restore themselves. The #retton

6oods <ccord established the egging of currencies and the )nternational !onetary "und

$)!"% in hoe of stabili4ing the global economic situation. The #retton 6oods <ccord lasted

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until *9+*. 5ltimately, it failed, but did accomlish what its charter set out to do, which was

to re;establish economic stability in Euroe and Caan.

The Beginning of the free-foating system

<fter the #retton 6oods <ccord came the -mithsonian <greement in ecember of *9+*.

This agreement was similar to the #retton 6oods <ccord, but allowed for a greater

fluctuation band for the currencies. )n *9+0, the Euroean community tried to move away

from its deendency on the dollar. The Euroean Coint "loat was established by 6est

2ermany, "rance, )taly, the =etherlands, #elgium and ?uxemburg. The agreement was

similar to the #retton 6oods <ccord, but allowed a greater range of fluctuation in the

currency values. #oth agreements made mistakes similar to the #retton 6oods <ccord and in*9+3 collased. The collase of the -mithsonian agreement and the Euroean Coint "loat in

*9+3 signified the official switch to the free;floating system. )n *9+8, the free;floating system

was officially mandated. )n a final effort to gain indeendence from the dollar, Euroe

created the Euroean !onetary -ystem in Culy of *9+8. ?ike all of the revious agreements,

it failed in *993.

Market !i"e and #i$uidity

?i/uidity in the forex market is the highest among other financial markets in the world. The

market comrises central banks, currency seculators, organi4ations, governments, retail

investors and international investors. &ver the years, the si4e of the "( market has been

constantly increasing. )n 0*, The Triennial -urvey by the #ank of )nternational -ettlements

reorted that the average daily transaction in the 5- for the month of <ril was D3.98 trillion.

This was much greater than the D*.+ trillion recorded in *998. The 5 had about 3:.+F of

the traders in the market to make it the highest contributor in foreign exchange trading.-econd on the list was 5-<, which had about *+.9F traders while Caan was third with :.0F

of the total exchangers from the country. Turnover of exchange;traded foreign exchange

futures and otions have grown raidly in recent years, reaching D*:: billion in <ril 0*

$double the turnover recorded in <ril 0+%. Exchange;traded currency derivatives reresent

F of &T7 foreign exchange turnover. "oreign exchange futures contracts were introduced

in *9+0 at the 7hicago !ercantile Exchange and are actively traded relative to most other

futures contracts. !ost develoed countries ermit the trading of derivative roducts $like

futures and otions on futures% on their exchanges. <ll these develoed countries already

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have fully convertible caital accounts. -ome governments of emerging economies do not

allow foreign exchange derivative roducts on their exchanges because they have caital

controls. The use of derivatives is growing in many emerging economies. 7ountries such as

orea, -outh <frica, and )ndia have established currency futures exchanges, desite having

some caital controls. "oreign exchange trading increased by 0F between <ril 0+ and

<ril 0* and has more than doubled since 0. The increase in turnover is due to a

number of factors the growing imortance of foreign exchange as an asset class, the

increased trading activity of high;fre/uency traders, and the emergence of retail investors as

an imortant market segment. The growth of electronic execution and the diverse selection of

execution venues have lowered transaction costs, increased market li/uidity, and attracted

greater articiation from many customer tyes.

Market %artici&ants

There are three tyes of articiants in the foreign exchange market. These are central banks,

global funds, retail clients $or individual retailers% and cororations. The commercial and

investment banks belong to the grou known as G)nterbank market. The interbank market is‖

the largest market that oerates in the foreign exchange market. 7ororations, central banks

and global funds also oerate at this level. #eing the highest traders in the market,

articiants in the interbank level are given the best rates. This level constitutes about seventy

five ercent of the total volume available each day. The foreign exchange market consists of

two tiers the interbank or wholesale market, and the client or retail market. )ndividual

transactions in the interbank market usually involve large sums that are multiles of a million

5- or the e/uivalent value in other currencies. #y contrast, contracts between a bank and

its client are usually for secific amounts, sometimes down to the last enny.

Foreign Exchange 'eaers(

#anks, and a few nonbank foreign exchange dealers, oerate in both the interbank and client

markets. They rofit from buying foreign exchange at a bid rice and reselling it at a slightly

higher ask rice. 6orldwide cometitions among dealers narrows the sread between bid and

ask and so contributes to making the foreign exchange market efficient in the same sense as

securities markets.

%artici&ants in Commercia and )n*estment Transactions(

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)morters and exorters, international ortfolio investors, multinational firms, tourists, and

others use the foreign exchange market to facilitate execution of commercial or investment

transactions. -ome of these articiants use the foreign exchange market to hedge foreign

exchange risk.

!&ecuators and Ar+itragers(

-eculators and arbitragers seek to rofit from trading in the market. They oerate in their

own interest, without a need or obligation to serve clients or to ensure a continuous market.

-eculators seek all of their rofit from exchange rate changes. <rbitragers try to rofit from

simultaneous exchange rate differences in different markets.

Centra Banks and Treasuries(

7entral banks and treasuries use the market to ac/uire or send their countryBs foreign

exchange reserves as well as to influence the rice at which their own currency is traded. )n

many instances they do best when they willingly take a loss on their foreign exchange

transactions. <s willing loss takers, central banks and treasuries differ in motive and behavior

form all other market articiants.

Foreign Exchange Brokers(

"oreign exchange brokers are agents who facilitate trading between dealers without

themselves becoming rincials in the transaction. "or this service, they charge a small

commission, and maintain access to hundreds of dealers worldwide via oen telehone lines.

)t is a brokerBs business to know at any moment exactly which dealers want to buy or sell any

currency. This knowledge enables the broker to find a counterart for a client /uickly without

revealing the identity of either arty until after an agreement has been reached.

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CHAPTER II - KINDS OF FOREIGN EXCHANGE

MARKETS

The foreign exchange currency markets allow buying and selling of various currencies all

over the world. #usiness houses and banks can urchase currency in another country in order

to do business in that articular comany. -ince the foreign exchange currency market is one

of the biggest markets of the world, the market is sub divided into different kinds of foreign

exchange market. The main three tyes of foreign exchange markets; the sot foreign

exchange market, the forward foreign exchange market and the future foreign exchange

market are discussed below.

!&ot Market

The term sot exchange refers to the class of foreign exchange transaction which re/uires the

immediate delivery or exchange of currencies on the sot. )n ractice the settlement takes

lace within two days in most markets. The rate of exchange effective for the sot transaction

is known as the sot rate and the market for such transactions is known as the sot market.

Forward Market

The forward transactions is an agreement between two arties, re/uiring the delivery at some

secified future date of a secified amount of foreign currency by one of the arties, against

ayment in domestic currency be the other arty, at the rice agreed uon in the contract. The

rate of exchange alicable to the forward contract is called the forward exchange rate and

the market for forward transactions is known as the forward market. The foreign exchange

regulations of various countries generally regulate the forward exchange transactions with a

view to curbing seculation in the foreign exchanges market. 6ith reference to its

relationshi with sot rate, the forward rate may be at ar, discount or remium. )f the

forward exchange rate /uoted is exact e/uivalent to the sot rate at the time of making the

contract the forward exchange rate is said to be at ar. The forward rate for a currency, say

the dollar, is said to be at remium with resect to the sot rate when one dollar buys more

units of another currency, say ruee, in the forward than in the sot rate on a er annum basis.The forward rate for a currency, say the dollar, is said to be at discount with resect to the

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sot rate when one dollar buys fewer ruees in the forward than in the sot market. The

discount is also usually exressed as a ercentage deviation from the sot rate on a er annum

basis.

Futures Market

"uture "orex currency markets tyes are secific tyes constitute the forward outright deals

which in general take u small art of the foreign exchange currency trading market. -ince

future contracts are derivatives of sot rice, they are also known as derivative instruments.

They are secific with regard to the exiration date and the si4e of the trade amount. )n

general, the forward outright deals which get mature ast the sot delivery date will mature

on any valid date in the two countries whose currencies are being traded, standardi4edamounts of foreign currency futures mature only on the third 6ednesday of !arch, Cune,

-etember, and ecember. "uture kinds of foreign exchange markets have many features,

which attracts traders to future markets. The first thing is that anyone can trade in future

market. )t is oen to all kind of traders in foreign exchange market including individual

traders. This is the difference between the future foreign exchange market and the sot

foreign exchange market, since sot market is closed to individuals traders excet in case

there are deals of high net worth. The future forex currency market tyes are central markets,

just as efficient as the cash market, and whereas the cash market is a much decentrali4ed

market, futures trading take lace under one roof. The futures market rovides various

benefits for currency traders because futures are secial tyes of forward outright contracts

which cororate firms can use for hedging uroses.

C,M%,ET! ,F F,.E)/ E0CHA/E T.A')/

Trading Characteristics

7urrencies that are often traded include the 5nited -tates dollar, Euro, Caanese >en, 1ound

-terling, <ustralian dollar, -wiss franc, 7anadian dollar, Aong ong dollar, -wedish krona,

=ew Healand dollar, -outh orean won, -ingaore dollar, =orwegian krone, !exican eso

and )ndian ruee. There is no regulation for the traders on the kind of currencies to trade

since this is an over;the;counter market. Aowever, there are different market laces where the

articiants can trade on the different currencies. Exchange rates among currencies are

affected by the growth of 2ross omestic 1roduct $21%, inflation, interest rates and balance

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The JaskB is the rice at which one can buy the base currency $at the same time selling the

counter currency%. )n every /uote there are two currencies $known as the currency air%. "or

examle, <5I5- . means that * <ustralian dollar is worth . 5- dollars. )n

order to generate rofit from their business, forex brokers /uote one rate for buying a

currency $#id% and another rate for selling it $&ffer% The 5- dollar is the centeriece of the

"&'E( market and is normally considered the JbaseB currency for /uotes. "or examle, a

/uote of 5-IC1> **.* means that one 5.-. dollar is e/ual to **.* Caanese yen.

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CHAPTER III - FOREX PRODUCTS

Cross trades(

Trades that does not involve the 5-. The 'ate is calculated from the /uote rates of the

individual currencies against the 5-.

F0 !wa& trade(

The 7ombination of a sot and forward, where the sot is traded and reversed out in the

future. K =on;deliverable "orward $="% 5sually traded in less li/uid JexoticB currencies.

=1L is settled in the main currency $usually 5-, or E5'% based on agreed fixing, usually

by the 7entral #ank of the country in /uestion. K "( otion The right but not the obligation

to exchange currency at a re;determined rate $strike% at an agreed future date. "( &tion is

of two tyes @ 7alls and 1uts M Lanilla and Exotics. K 7urrency "uture -tandardi4ed

exchange;traded roduct in many ways similar to "( forward.

on-'ei*era+e Forwards 1'F2s3

There are some currencies that cannot be hysically delivered to the country of origin. "or examle, due to currency restrictions in that country we are not therefore able to make a

hysical ayment of that currency. Tyically, these tend to be ?atin <merican, <sian or

Eastern Euroean currencies. 7ustomers may still wish to hedgeIseculate against

movements in that =on;deliverable 7urrencyBs exchange rate against other currencies. E.g.

#'? $non;deliverable% I 5- $deliverable%. <ny rofit I loss are cash;settled $ayable% in

5- $the deliverable currency%. <n =" is a short;term, cash;settled currency forward

between two counterarties. &n the contracted settlement date, the rofit or loss is adjusted

between the two counterarties based on the difference between the contracted =" rate and

the revailing sot "( rates on an agreed notional amount.

Com&onents of an F0 Trade

7urrencies Aas to be two of these for the exchange to be ossible. <mount < numerical

figure that shows the value of the trade. Exchange rate The rice of one currency exressed

in another.

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4aue date

The day the trade will settle. ).e. the funds will be debited I credited from I to your account.

#ooked 'ight 6ay 'ound -hows which currency one is aying and receiving. #roker Aels

to arrange a trade on behalf of others.

7ounterarties The entities involved in the trade.

Trade ate The day the deal was agreed 'eceit )nstructions 6here are we receiving our

currencyN @ ?ocation and <ccount =o. 1ayment )nstructions 6here are we aying the

currencyN @ ?ocation and <ccount =o.

Financia )nstruments

"inancial instruments in the "( market include sot, forward, swa, future, otion and

exchange traded fund. -ot < sot transaction lasts for two days excet when currencies such

as the 5- dollar, 7anadian dollar, Euro, Turkish ?ira and 'ussian ruble are traded. )n these

cases, transactions are comleted on the next business day. =ormally, there is no interest

involved in this transaction since it is just a direct exchange. "orward "orward transaction is

an effective way of reducing risks in the "( market. 6ith this, traders do not exchange

money until when an agreed exchange rate between currencies is actuali4ed. This may

haen in one day, several months or years. -wa )n swa, two traders agree to make a

transaction that will be reversed in the future. -ince this is not a standard oeration, there is

no exchange created for this. "uture "utures are standardi4ed forward contracts and are

usually traded on an exchange created for this urose. The average contract length is

roughly 3 months. "utures contracts are usually inclusive of any interest amounts.

&tion < foreign exchange otion $commonly shortened to just "( otion% is a derivative

where the owner has the right but not the obligation to exchange money denominated in one

currency into another currency at a re;agreed exchange rate on a secified date. The otions

market is the deeest, largest and most li/uid market for otions of any kind in the world.

Exchange;Traded "und Exchange;traded are oen ended investment comanies. These

financial tools in online "x can be traded at any time throughout the duration of the day.

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Tyically, ET"s are seen to reeat a stock market index but recently they are now relicating

investments in the currency markets, with an increase in their value.

ostro5 4ostro and #oro Accounts

=ostro and vostro are accounting terms used to distinguish an account held for another entity

from an account another entity holds. The entities in /uestion are almost always, but need not

be, banks. -ome customers will kee their own records of their transactions, for instance, so

they can check for errors by the bank. That record ket by the customer is also an account, of

the money the bank is holding for them. 6hen that customer is another bank, since they also

kee other accounts $of the money they are holding for their customers% there is a need to

clearly differentiate between these two tyes of accounts. The terms nostro and vostroremove the otential ambiguity when referring to these two searate accounts of the same

balance and set of transactions. -eaking from the bankBs oint;ofview < nostro is our

account of our money, held by you < vostro is our account of your money, held by us

*% Lostro <ccount <ccount held by a foreign bank in a domestic bank is called Lostro

account. < Lostro is our account of your money, held by us. < Lostro account with a credit

balance $i.e. a deosit% is a liability, and a vostro with a debit balance $a loan% is an asset.

For exam&e #ank < $#arclays #ank of 5% oening an account in #ank #$)7)7) #ank of

)ndia%, this is Lostro account for #ank #$)7)7) #ank of )ndia%.

0% =ostro <ccount <ccount held by a articular domestic bank in a foreign bank is called

=ostro account. < =ostro is our account of our money, held by you. < bank counts a =ostro

account with a credit balance as a cash asset in its balance sheet. Aere in the above examle

given in Lostro account the same account is a =ostro account for #ank <$#arclays #ank of

5%, or if #ank #$)7)7) #ank of )ndia% oens an account in #ank <$#arclays #ank of 5%

then that account is a =ostro account for #ank #$)7)7) #ank of )ndia%. =ostro accounts are

usually in the currency of the foreign country. This allows for easy cash management because

currency doesnBt need to be converted. 3% ?oro <ccount <n account held by a domestic bank

in itself on behalf of a foreign bank. The latter in turn would view this account as a =ostro

account. < ?oro is our account of their money, held by you. ?oro account is a record of an

account held by a second bank on behalf of a third artyO i.e, my record of their account with

you. )n ractice this is rarely used, the main excetion being comlex syndicated financing. )f

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any other bank for the urose of a transaction refer to an account maintained by yet another

bank in some other countries it is known as loro account. <n exression used, for examle,

by one bank when telling another bank to transfer money to the account of a third bank. )n

corresondent banking, an account held by one bank on behalf of another bank $the

Gcustomer bank %O the customer bank regards this account as its G=ostro account . The‖ ‖

?oro account is an account wherein a bank remits funds in foreign currency to another bank

for credit to an account of a third bank.

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CHAPTER IV - GLOBAL LINKAGE OF FOREIGN

EXCHANGE MARKETS

The Conce&t of ,ffshore Banking

escribing an institution, esecially a bank that exists in a foreign country. 7ollo/uially, the

term refers to institutions that exist in known tax havens. )ndividuals and comanies use

offshore accounts to avoid or evade taxes in their home countries. <s a result, some emerging

financial centers have objected to being called Poffshore,P asking for arity with the

develoed financial world. There are currently aroximately 30 recogni4ed &ffshore

"inancial 7enters, $&"7s% or Jlow tax jurisdictionsQ across the world. These jurisdictionscommonly have low tax and are lightly regulated aving the way for offshore comanies to

benefit from roserous infrastructures. !any &ffshore financial centers are current or

former #ritish 7olonies or 7rown eendencies, and often refer to themselves as offshore

jurisdictions. There has been much debate into what makes a country an offshore financial

jurisdiction. <s such, the generally acceted characteristics include the following

The country has a number of financial businesses that redominantly do business with

non;residents The business will have an infrastructure, external assets and liabilities which are out of

roortion with the domestic economy -ignificantly lower cororation tax rates

?enient financial regulation <n offshore bank is a bank located outside the country of

residence of the deositor, tyically in a low tax jurisdiction $or tax haven% that rovides

financial and legal advantages.

These advantages tyically include greater rivacy $see also bank secrecy, a rincile bornwith the *93 -wiss #anking <ct% low or no taxation $i.e. tax havens% easy access to deosits

$at least in terms of regulation% rotection against local, olitical, or financial instability

6hile the term originates from the 7hannel )slands being PoffshoreP from the 5nited

ingdom, and most offshore banks are located in island nations to this day, the term is used

figuratively to refer to such banks regardless of location, including -wiss banks and those of

other landlocked nations such as ?uxembourg and <ndorra. &ffshore banking has often been

associated with the underground economy and organi4ed crime, via tax evasion and money

launderingO however, legally, offshore banking does not revent assets from being subject to

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ersonal income tax on interest. Excet for certain ersons who meet fairly comlex

re/uirements, the ersonal income tax of many countries makes no distinction between

interest earned in local banks and those earned abroad. 1ersons subject to 5- income tax, for

examle, are re/uired to declare on enalty of erjury, any offshore bank accountsR which

may or may not be numbered bank accountsRthey may have. <lthough offshore banks may

decide not to reort income to other tax authorities, and have no legal obligation to do so as

they are rotected by bank secrecy, this does not make the non;declaration of the income by

the tax;ayer or the evasion of the tax on that income legal. "ollowing -etember **, 0*,

there have been many calls for more regulation on international finance, in articular

concerning offshore banks, tax havens, and clearing houses such as 7lear stream, based in

?uxembourg, being ossible crossroads for major illegal money flows.

Tax Ha*ens

< tax haven is a foreign country or deendency that has a series of uni/ue characteristics, the

rimary one being relatively lower tax rates in comarison with other countries. )n fact, many

tax havens imose no taxes at all on income earned by foreign individuals. #ank secrecy and

strict rivacy laws are other imortant characteristics of tax havens. )n fact, in some tax

havens there are rison sentences for anyone revealing rivate financial information. )n the

5-, the )'- agentsQ handbook defines tax haven as Pa term that generally connotes any

foreign country that has either a very low tax or no tax at all on certain categories of income.P

The )'- itself defines at least 3 jurisdictions around the world as tax havens, including

<ustria, the 7ayman )slands, Aong ong, ?iechtenstein, 1anama, -ingaore and -wit4erland

and lesse 2overnments of most industriali4ed nations, and esecially their tax collecting

agencies, would have everyone believe that the use of a tax haven is the same thing as tax

evasion. These governments frown on you relocating your money offshore. )f everyone

could invest abroad and in secrecy and never ay taxes these governments would go broke.

The 2overnments do everything in their ower to discourage citi4ens from moving funds

offshore because when you move your money offshore, the government loses control. )t is in

no way illegal to take your money offshore, even though the government has done its art to

try to ersuade you to not do so. To this end, the taxman would have the ublic believe that

tax havens are used exclusively for tax evasion, but that is just not the reality of the matter.

"or examle, in the 5- the )'- agentsQ handbook carefully notes that taxayers use havens to

avoid taxes, not evade them. Tax avoidance is the legal reduction of taxes, while evasion is

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any illegal means of reducing or eliminating taxes. "urthermore, the )'- guide concedes that

5- taxayers may also use tax havens for tax lanning reasons. This same guide also admits

that some transactions conducted through tax havens have a beneficial tax result that is

comletely within the letter of 5- tax law. )n fact, the 5- -ureme 7ourt stated in 2regory

vs. Aelvering $*93%, 093 5- : that taxayers can arrange their affairs so that they can

make their taxes as low as ossible. 2iven that admission, it becomes highly robable that

many <mericans are overlooking tax havens, rivate international banking and offshore

investing as a fully legal means of restructuring their income and reducing their tax liability r

known laces such as #ahrain, =auru, and Turks M 7aicos )slands.

.oe of Ar+itrage in Foreign Exchange Market

The foreign exchange market consists of many different markets and institutions. >et, at any

given oint in time, all markets tend to generate the same exchange rate for given currency

regardless of geograhical location. The uni/ueness of the foreign exchange rate regardless of

geograhical location occurs because of arbitrage. <s you recall, arbitrage refers to the

rocess by which an individual urchases a roduct $in the case foreign exchange% in a low;

riced market for resale in a high;riced market for the urose of making a rofit. )n the

rocess, the rice is driven u in the low;riced market for the urose of making a rofit. )n

the rocess, the rice is driven u in the low;riced market and down in the high;riced

market. This activity will continue until the rices in the two markets are e/uali4ed, or until

they differ only by the transaction costs involved. #ecause currency is going bought and sold

simultaneously, there is no risk in this activity and hence there are always many otential

arbitragers in the market. )n addition, because of the seed of communications and the

efficiency of transactions in foreign exchange, the sot market /uotations for a given

currency are remarkably similar worldwide, and any rofit sread on a given currency is

/uickly arbitraged away. )n world of many different currencies, there is also a ossibility for

arbitrage if exchange rates are not consistent between currencies. This is a situation of

multicurrency arbitrage, in this case called triangular arbitrage since it involves an

inconsistency between different currencies. The triangular arbitrage roduces cross;rate

e/uality, meaning that all three exchange rates are internally consistent. <rbitragers are

constantly watching the foreign exchange to take advantage of such a situation. The arbitrage

rocess is thus relied uon not only to maintain a similar individual currency value in

different foreign exchange markets but also to make certain that all the cross rates between

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currencies are consistent. <rbitrage is one of the fundamental illars of financial economics.

)t seems to be generally acceted that financial markets do not offer risk;free arbitrage

oortunities, at least when allowance is made for transaction costs. This notion is directly

related to the law of one rice, which ostulates that in well;functioning, efficient financial

markets identical securities must have the same rice, no matter how they are created. "or

examle, if a derivative instrument can be created using two different sets of underlying

securities, then the total rice for each derivative instrument would be the same or else an

arbitrage oortunity would exist. <rbitrage is the mechanism that should ensure the validity

of the law of one rice. 6hile the assumtion of no arbitrage is likely to be reasonably mild

or valid in several contexts in finance, violations of the law of one rice can be rationali4ed

on several grounds. )n general terms, the absence of arbitrage oortunities gives rise to the

so;called arbitrage aradox, first ointed out by 2rossman and -tiglit4 $*9+:, *98%. That is,

if arbitrage is never observed, market articiants may not have sufficient incentives to watch

the market, in which case arbitrage oortunities could arise. < ossible resolution to this

aradox is for very short;term arbitrage oortunities to arise, inviting traders to exloit

them, and hence be /uickly eliminated. <lso, microstructure theory shows how rice

differences may occur for identical assets in markets that are less than fully centrali4ed or

with an imerfect degree of transarency. Emirical studies have, however, been unable to

detect short;term arbitrage oortunities in a variety of financial markets. 2iven the high

activity level in major financial markets, such shortterm arbitrage oortunities can only be

ade/uately studied using real;time /uotations on all asset rices involved, which are

notoriously difficult to obtain. "urthermore, one must take into account all relevant asects of

the microstructure of the markets in order to cature the oortunities and transaction costs

that market articiants face. >et, if resent, the existence and roerties of risk less arbitrage

oortunities are of great interest to both academics and articiants in financial markets,

given the central role of no;arbitrage conditions in the theory and ractice of financial

economics.

.iskess Ar+itrage in the F0 Market

'ound;tri, 7overed <rbitrage 7overed interest rate arity $7)1% ostulates that it is not

ossible to earn ositive returns by borrowing domestic assets for lending abroad $or vice

versa% while covering the exchange rate risk through a forward contract of e/ual maturity.

omestic and foreign interest;bearing assets can be considered similar if they are of e/ual

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maturity and share the same characteristics, such as li/uidity and olitical and default risk.

7ommonly, 7)1 is exressed as $* S id% *I- $* S if% "O $*%

where id and if denote domestic and foreign interest rates on similar assets, resectivelyO - is

the sot nominal exchange rateO and " is the forward exchange rate of maturity e/ual to that

of the interest;bearing assets. The sot exchange rate is exressed in units of domestic

currency er unit of foreign currency. The common exression of 7)1 in e/uation $*% neglects

transaction costs, however. -uch costs may be largely catured by market /uotes of interest

rates and exchange rates which are exressed in terms of ask and bid /uotes. The sread

between ask and bid ratesI/uotes for an asset is assumed to take into account inventory,

information and rocessing costs associated with the trading of the asset. ≠way <rbitrage

'ecognition of the fact that funds are borrowed and lent at different rates makes it imortant

to consider the behavior of traders that are looking for the highest risk less returns on their

endowments and of those who are looking for the cheaest borrowing oortunities. )n the

following sub;sections we consider these cases and oint out their relationshis with the

conditions for rofitable round;tri arbitrage, i.e. the case of 7)1. &wner <rbitrage The

concet of owner arbitrage $&<% refers to the case where a trader has an endowment of funds

in some currency and wants to lend the funds to obtain the highest ossible risk less net

return. -uch traders weigh the otion of lending own funds at the market bid rate for theendowment currency, against the otion of converting the funds to another currency at the

sot exchange rate and lending them at the market bid rate for that currency, while

eliminating the exchange rate risk at the maturity of the lending contract through a forward

contract. #orrower <rbitrage The concet of borrower arbitrage $#<% refers to the case where

a trader is searching for the cheaest way to finance an investment. -uch traders face the

otion of borrowing funds in the desired currency directly, or to borrow funds in another

currency and convert them to the desired currency at the sot exchange rate, whileeliminating the exchange rate risk at the maturity of the borrowing contract through a forward

contract. )n this case, funding costs avoided by choosing the relatively cheaer borrowing

oortunity essentially reresent risk;free net return.

Conditions for ar+itrage

<rbitrage is ossible when one of three conditions is met The same asset does not trade at

the same rice on all markets $Pthe law of one riceP%. Two assets with identical cash flowsdo not trade at the same rice. <n asset with a known rice in the future does not today trade

of 33



at its future rice discounted at the risk;free interest rate $or, the asset does not have

negligible costs of storageO as such, for examle, this condition holds for grain but not for

securities%. <rbitrage is not simly the act of buying a roduct in one market and selling it in

another for a higher rice at some later time. The transactions must occur simultaneously to

avoid exosure to market risk, or the risk that rices may change on one market before both

transactions are comlete. )n ractical terms, this is generally ossible only with securities

and financial roducts that can be traded electronically, and even then, when each leg of the

trade is executed the rices in the market may have moved. !issing one of the legs of the

trade $and subse/uently having to trade it soon after at a lower rice% is called Qexecution riskQ

or more secifically Qleg riskQ. )n the simlest examle, any good sold in one market should

sell for the same rice in another. Traders may, for examle, find that the rice of wheat is

lower in agricultural regions than in cities, urchase the good, and transort it to another

region to sell at a higher rice. This tye of rice arbitrage is the most common, but this

simle examle ignores the cost of transort, storage, risk, and other factors. PTrueP arbitrage

re/uires that there be no market risk involved. 6here securities are traded on more than one

exchange, arbitrage occurs by simultaneously buying in one and selling on the other.

Forex( !&ecuation

The oosite of hedging is called QseculationQ, the act of taking a net asset osition $Qlong

ositionQ% or a net liability osition $Qshort ositionQ% in some asset class, here a foreign

currencyO that being said, seculating means committing oneself to an uncertain future value

of oneQs net worth in terms of home currency. )t can therefore be assumed that anybody who

seculates is acting on the basis of something he or she exects about the future rice of the

foreign currency. <lthough seculation has indeed layed such a sinister role in the ast, it is

an oen emirical /uestion whether it does so fre/uently. !ore to the resent oint, we

should recogni4e that the only concrete way of defining seculation is the broad way just

offered. <nybody is a seculator who is willing to take a net osition in a foreign currency,

whatever his motives or exectations about the future of the exchange rate. The foreign

exchange market rovides the same bridge between currencies for seculators as for hedgers,

since there is no credentials check that can sort out the two grous in the marketlace. The

rofitability in seculating a foreign currency deends on whether or not one exects the

value of that currency to dro by as great a ercentage, as its interest rate exceeds the

domestic interest rate. The existence of a foreign exchange market does not guarantee that

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seculation will be rofitable. )t only makes seculation feasible for those willing to take the

chance. )f it is generally feared that a certain currency in some country will dro in value

soon, say, 5.-. imorters are likely to ress for romter ayment from its foreign customers,

who are allowed to reay in such currency. )f the 5.-. exorts haen to be in dollars, then it

is the foreign imorter who has an incentive to ay such currency to get dollars now, while

each currency still buys more dollars. )n order to avoid bad deals in fx world, seculation in

forex is necessary. "orex seculation hels you to determine which currencies should be

bought and which must be sold. )t is essential for you to seculate over the rices of different

currencies and make transaction on it. <s we all know forex trade is related to buying and

selling of two different currencies and can hel you to earn good rofit on it. -omehow

seculation in forex can destabili4e currencies and revent them from rojecting a countryQs

economic fundamentals. #ut one needs to understand that seculation in fx is not only reason

for destabili4ation of currencies. Aowever, most of the seculators urchase currencies whose

value they exect to increase and sell currencies whose value they exect to decrease. "x

seculation is necessary if you want to earn a desirable rofit from your forex trade.

!oreover, most of the seculator likely reverses their currency osition to earn rofits when

the currency value moves towards their exected direction. This reversing in buying and

selling leads to the fluctuation of the currency value. Trading strategies of seculators are

little different from the other fx market articiants. They do the buying and selling of

currencies when others traders arenBt actively articiating in fx market. !oreover,

seculating fx means committing oneself to an uncertain future value of oneQs net worth in

terms of home currency. -o, anybody can be a seculator who is willing to take a net osition

in a foreign currency, whatever his motives or exectations about the future of the exchange

rate.

Hedging

< hedge is a tye of derivative, or a financial instrument, that derives its value from an

underlying asset. This concet is imortant and will be discussed later. Aedging is a way for a

comany to minimi4e or eliminate foreign exchange risk. Two common hedges are forwards

and otions. < "orward contract will lock in an exchange rate at which the transaction will

occur in the future. <n otion sets a rate at which the comany may choose to exchange

currencies. )f the current exchange rate is more favorable, then the comany will not exercise

this otion.

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< foreign exchange hedge $"&'E( hedge% is a method used by comanies to eliminate or

hedge foreign exchange risk resulting from transactions in foreign currencies. This is done

using either the cash flow or the fair value method. The accounting rules for this are

addressed by both the )nternational "inancial 'eorting -tandards $)"'-% and by the 5-

2enerally <cceted <ccounting 1rinciles $5- 2<<1%. The roducers and users of

commodities who use the futures market are called hedgers. #uying and selling futures as a

risk management tool is called hedging.

What is hedging as it reates to forex trading?

Aedging is buying or selling futures contracts as a temorary substitute for buying or selling

the commodity at a later date in the cash market. 6hen a currency trader enters into a trade

with the intent of rotecting an existing or anticiated osition from an unwanted move in the

foreign currency exchange rates, they can be said to have entered into a forex hedge. #y

utili4ing a forex hedge roerly, a trader that is long a foreign currency air, can rotect

themselves from downside riskO while the trader that is short a foreign currency air, can

rotect against uside risk.

The rimary methods of hedging currency trades for the retail forex trader are through

-ot contracts, and "oreign currency otions. -ot contracts are essentially the regular tye

of trade that is made by a retail forex trader. #ecause sot contracts have a very short;term

delivery date $two days%, they are not the most effective currency hedging vehicle. 'egular

sot contracts are usually the reason that a hedge is needed, rather than used as the hedge

itself. "oreign currency otions, however are one of the most oular methods of currency

hedging. <s with otions on other tyes of securities, the foreign currency otion gives the

urchaser the right, but not the obligation, to buy or sell the currency air at a articular

exchange rate at some time in the future. 'egular otions strategies can be emloyed, such as

long straddles, long strangles and bull or bear sreads, to limit the loss otential of a given

trade.

.isk A*ersion

'isk aversion is a trading attern that results when unfavorable conditions are bound to occur.

This is caused by the li/uidation of risky assets and diverting the funds into safer assets. )n

the foreign exchange market, traders li/uidate the funds they envisage otential risks and

of 33



divert them into more secure ones like the 5- dollar. Aowever, it is being observed that most

traders use these more secure currencies because of fear rather than the results shown on

economic statistics. "or examle, during the global economic meltdown of 08, the 5-

dollar was unaffected while other currencies dereciated. The success of the 5- dollar was

achieved desite the similar negative results caused by the crisis in the 5nited -tates.

Carry Trade

7urrency carry trade refers to the act of borrowing one currency that has a low interest rate in

order to urchase another with a higher interest rate. < large difference in rates can be highly

rofitable for the trader, esecially if high leverage is used. Aowever, with all levered

investments this is a double edged sword, and large exchange rate fluctuations can suddenlyswing trades into huge losses.

CHAPTER V - EXCHANGE RATES & ITS USES

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Exchange rates reresent the linkage between one country and its artners in the global

economy. They affect the relative rice of goods being traded $exorts and imorts%, the

valuation of assets, and the yield on those assets. )n the eriod of fixed or constant exchange

rates these rices, values, and yields were redictable over time. Aowever, since *9+3 we

have been living in a world of flexible rates where foreign exchange markets determine these

rates based on trade flows, interest rate differentials, differing rates of inflation, and

seculation about future events. Exchange rates can be exressed as the foreign rice of a

domestic currency $i.e., the Euro rice of a 5.-. dollar% or its recirocal ;; the domestic rice

of foreign currency. The sot exchange rate refers to the current exchange rate. The forward

exchange rate refers to an exchange rate that is /uoted and traded today but for delivery and

ayment on a secific future date. "ixed Exchange 'ates < fixed exchange rate, sometimes

called a egged exchange rate, is also referred to as the Tag of articular 'ate, which is a tye

of exchange rate regime where a currencyQs value is fixed against the value of another single

currency or to a basket of other currencies, or to another measure of value, such as gold. <

fixed exchange rate is usually used to stabili4e the value of a currency against the currency it

is egged to. This makes trade and investments between the two countries easier and more

redictable and is esecially useful for small economies in which external trade forms a large

art of their 21. "loating Exchange 'ates < floating exchange rate or fluctuating exchange

rate is a tye of exchange rate regime wherein a currencyQs value is allowed to fluctuate

according to the foreign exchange market. < currency that uses a floating exchange rate is

known as a floating currency.

Exchange-rate regime(

<n exchange;rate regime is the way an authority manages its currency in relation to other

currencies and the foreign exchange market. )t is closely related to monetary olicy and the

two are generally deendent on many of the same factors.

The basic tyes are a floating exchange rate, where the market dictates movements in the

exchange rateO a egged float, where a central bank kees the rate from deviating too far from

a target band or valueO and a fixed exchange rate, which ties the currency to another currency,

mostly more widesread currencies such as the 5.-. dollar or the euro or a basket of

currencies.

Fuctuations in exchange rates

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< market;based exchange rate will change whenever the values of either of the two

comonent currencies change. < currency will tend to become more valuable whenever

demand for it is greater than the available suly. )t will become less valuable whenever

demand is less than available suly $this does not mean eole no longer want money, it just

means they refer holding their wealth in some other form, ossibly another currency%.

)ncreased demand for a currency can be due to either an increased transaction demand for

money or an increased seculative demand for money. The transaction demand is highly

correlated to a countryQs level of business activity, gross domestic roduct $21%, and

emloyment levels. The more eole that are unemloyed, the less the ublic as a whole will

send on goods and services. 7entral banks tyically have little difficulty adjusting the

available money suly to accommodate changes in the demand for money due to business

transactions. -eculative demand is much harder for central banks to accommodate, which

they influence by adjusting interest rates. < seculator may buy a currency if the return $that

is the interest rate% is high enough. )n general, the higher a countryQs interest rates, the greater

will be the demand for that currency.

What is a %)%?

)n the "orex market, rices are /uoted in 1is. 1i stands for Percentage in ointP and is the

fourth decimal oint, which is *I*th of *F. < i is a number value. )n the "orex market,

the value of currency is given in is. &ne i e/uals .*, two is e/uals .0, three

is e/uals .3 and so on. &ne i is the smallest rice change that an exchange rate can

make. !ost currencies are riced to four numbers after the oint. "or examle, a five i

sread for E5'I5- is *.03I*.03.

)n the major currencies, the rice of the Caanese yen does not have four numbers after the

oint. )n 5-IC1>, the rice is only given to two decimal oints @ so a /uote for 5-IC1>

looks like this **.I**.8. This /uote has a three i sread between the buy and sell

rice.

'eterminants of F0 rates

"or countries oerating on the floating exchange rate regime, the exchange rates of their

currencies can be determined by the following theories *. )nternational 1arity 7onditions

These include theories such as relative urchasing ower arity, interest rate arity, domestic

of 33



fisher effect and international fisher effect. <lthough these theories work to actually

determine "( rates, they can also falter because they are formed on assumtions that are not

always true. 0. #alance of ayment model This is concerned with the exchange of goods and

services without considering the effect of the flow of money between and among nations. 3.

<sset market model views currencies as an imortant asset class for constructing investment

ortfolios. <ssets rices are influenced mostly by eoleQs willingness to hold the existing

/uantities of assets, which in turn deends on their exectations on the future worth of these

assets. The asset market model of exchange rate determination states that Gthe exchange rate

between two currencies reresents the rice that just balances the relative sulies of, and

demand for, assets denominated in those currencies.‖

)t is not ossible to redict "( rates within long time frames with these theories. The best that

can be done with these is redicting future rices that can occur within a few days. "( rates

cannot be judged on a single factor but rather by combining several factors in economics,

olitics and market sychology.

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CHAPTER VI - FACTORS THAT AFFECT FOREIGN

EXCHANGE MARKET TRENDS

The "oreign Exchange or "orex is the largest marketlace today for stock buying and selling,

and it is continually growing with more and more eole investing in it. =evertheless, as

romising as this marketlace might be when it comes to rofit, like any other trade it can be

extremely volatile as well. )t is therefore imortant to be familiar with articular factors that

affect develoments within the "oreign exchange marketlace if you are made the decision in

joining this arena. <fter all, ac/uainting yourself using the many scenarios that can cause

currencies to go u or down can hel you a great deal in generating decisions for when to buy

or sell. There are basically 3 main factors that affect the "oreign Exchange, a countryBs

economic system, olitical conditions and marketlace sychology.

Economic system

"inancial factors are the most basic things that create changes inside a countryBs forex. 6hen

such financial circumstances as a budget deficit or surlus is resent inside a country, there

will surely be reactions in the marketlace and values will be reflected on currencies. &ther

conditions may also include inflation trends, and also the general financial growth of the

country. The much more roserous a countryBs economy is, the much more investors will be

able to adhere to doing trade in a more constructive ersective. -uch indicators as a

develoment inside a nationBs gross domestic roduct $21%, emloyment levels and retail

sales among others will basically attract much more investors and that nationBs forex value

will likely go u.

%oitica Circumstances

<nother extremely essential factor that affect develoments in "orex, are the conditions of a

countryBs olitical sector. This is simly because olitical instability or turmoil can generally

create negative fluctuations to an economic system. #ut if this kind of situations haens

wherein a country might rise above olitical obstacles, the oosite may haen and the

economic system might imrove. &ccasions inside a region can surely create damaging or

constructive interest among investors for a nationBs forex. <nd so, such circumstances surely

influence the develoments for demands and costs of a certain currency.

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Market&ace %sychoogy

The ercetion of traders and investors will significantly affect the )nternational Exchange

market in so several ways. <fter all, the marketlace is highly deendent on regardless of

whether or not individuals would want to make investments on a countryBs economic system

in order to determine whether forex rices will go u or down. "or instance, such conditions

wherein unsettling worldwide occasions might occur, then under the Gflight of /uality rule,‖

eole would generally want to search for a secure haven for their investments. 6henever

there is a higher demand to get a articular countryBs economy, then a higher rice will

robably be given to buyers and the currencyBs worth will go u and turn out to be stronger.

&ther occasions that contribute to tradersB ercetions may be long;term develoments where

eole invest based on what theyBve observed for a lengthy eriod and time, and even

economic numbers in which eole may base their investments deending on what numbers

show a higher value.

'ifferent Exchange !ystems which inks the Forex Market /o+ay

The foreign exchange currency trading market has various different foreign exchange systems

through which currencies can be traded. )t is beneficial to understand various exchange

systems in forex as it hels while trading in forex markets.

Trading with Brokers(

The "orex brokers are art of the one of the different exchange systems in forex. Their

rimary function is to bring closer the buyers and the sellers in the forex market from around

the world. <lso, the broker exchange systems in forex hels in the /uick, accurate and

efficient execution of orders of various forex traders. The majority of transactions which are

comleted through the brokers using different systems in forex are via hone. The hone

lines between brokers and banks are dedicated, or direct, and are usually in;stalled free of

charge by the broker. < foreign exchange brokerage firm has direct lines to banks around the

world. !ost foreign exchange is executed through an oen box systemRa microhone in

front of the broker that continuously transmits everything he or she says on the direct hone

lines to the seaker boxes in the banks. This way, all banks can hear all the deals being

executed. #rokers communicate through 'euter, 1hone or #loomberg. ifferent "oreign

exchange systems used by brokers in doing the analysis of market trends. The Electronic

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Trading system was introduced in *990. 'euters, the news comany introduced the screen

/uotations which created screen;based market. 5nder this system, rices are visible to all

market articiants. Traders enter buy and sell orders directly into their terminals on an

anonymous basis.

'irect 'eaing(

<nother most common exchange system in forex is direct dealing. These exchange systems

in forex are based on the rincile of trading recirocity. The market maker and the bank

making or /uoting a rice exects the bank that is calling to recirocate with resect to

making a rice when called uon. irect dealing used to be conducted mostly on the hone.

ealing errors were difficult to rove and even more difficult to settle. )n order to increasedealing safety, most banks taed the hone lines on which trading were conducted. This

measure was helful in recording all the transaction details and enabling the dealers to

allocate the resonsibility for errors fairly. #ut tae recorders were unable to revent trading

errors. 6ith the introduction of dealing systems in *98s, the direct dealing exchange

systems in forex were changed forever.

'eaing !ystems(

These tyes of exchange systems in foreign exchange are actually online comuter systems

which are linked to the contributing banks around the world on a one on one basis. These

exchange systems in forex are highly reliable and most referred. The erformance of dealing

systems greatly deends uon the seed, reliability, and safety. <ccessing a bank through a

dealing system is much faster than making a hone call. There are continuous imrovements

in dealing foreign exchange in order to offer maximum suort to the dealerQs main function.

Matching !ystems(

This exchange system in forex is different from the other foreign exchange systems such as

the dealing systems. )n the dealing system the currency trading is done directly and on a one;

on;one basis, however in matching systems the currency trading is done anonymously and

individual traders deal against the rest of the market. This is similar with other different

systems in forex such as the trading the market with the hel of a broker. Aowever, unlike the

brokersQ market, there are no individuals to bring the rices to the market, and li/uidity may

be limited at times. !atching -ystems are well;suited for trading smaller amounts as well.

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The dealing systems characteristics of seed, reliability, and safety are relicated in the

matching systems. )n addition, credit lines are automatically managed by the systems. Traders

inut the total credit line for each counter arty. 6hen the credit line has been reached, the

system automatically disallows dealing with the articular arty by dislaying credit

restrictions, or shows the trader only the rice made by banks that have oen lines of credit.

<s soon as the credit line is restored, the system allows the bank to deal again. )n the

interbank market, traders deal directly with dealing systems, matching systems, and brokers

in a comlementary fashion.

Basis of Communication for internationa transfers

The raid imrovement in communication and technology has enabled the foreign exchangedealers worldwide to link together through telehone, telex and satellite communication

network called the -ociety for 6orldwide )nternational "inancial 7ommunication $-6)"T%.

The communication system based in #russels, in #elgium links banks and brokers in every

financial centre. )t enables the dealers to have the information of all the events that may have

an imact on the exchange rate thus making the worldwide foreign exchange centers to

function as efficient as one single market.

)n the 5nited -tates, all foreign exchange transactions involving dollars are cleared through

the 7learing Aouse )nterbank 1ayments -ystem $7A)1-%. )t is an electronic fund transfer

mechanism. )t is a system develoed by the =ew >ork 7learing Aouse <ssociation for

transfer of international dollar ayments. )t links about * deository institutions that have

offices in =ew >ork. )t handles more than *, , interbank transfers daily, valued about D

billion. )t reresents about 9 ercent of all interbank transfers relating to international

dollar ayments.

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CONCLUSION

The real and financial linkages between countries can exlain why movements in the worldQs

largest markets often have such large effects on other financial markets, and how these crossmarket linkages have changed over time. )t estimates a factor model in which a countryQs

market returns are determined by global, sectoral, and cross;country factors $returns in large

financial markets% and by country;secific effects. Then it uses a new data set on bilateral

linkages between the worldQs five largest economies and aroximately other markets to

decomose the cross;country factor loadings into direct trade flows, cometition in third

markets, bank lending, and foreign direct investment. )n the latter half of the *99s, bilateral

trade flows are large and significant determinants of how shocks are transmitted from large

economies to other stock and bond markets. #ilateral foreign investment is usually

insignificant. Therefore, desite the recent growth in global financial flows, direct trade still

aears to be the most imortant determinant of how movements in the worldQs largest

markets affect financial markets around the globe.

The trading of currencies takes lace in foreign exchange markets whose major functions, is

to facilitate international trade and investment. "oreign exchange markets, however, are

shrouded in mystery. &ne reason for it is that a considerable amount of foreign exchange

market activity does not aear to be related directly to the needs of international trade and

investment. Aighlighting the range of activities that take art in a foreign exchange market,

we may say that seculation exlains a vast amount of foreign exchange transactions

available through organi4ed markets. -eculation is the kind of activity of making rofits by

outguessing other market articiants as to what future exchange rates will be.

&ver the years, the foreign exchange market has emerged as the largest market in the world

and the breakdown of the #retton 6oods system in *9+* marked the beginning of floating

exchange rate regimes in several countries. The decade of the *99s witnessed a ercetible

olicy shift in many emerging markets towards reorientation of their financial markets and

these changing contours were mirrored in a raid exansion of foreign exchange market in

terms of articiants, transaction volumes, decline in transaction costs and more efficient

mechanisms of risk transfer.

The "&'E( markets have become the worldBs most li/uid and continuous markets withtrillions of dollars being traded daily. 6hether trading in the sot market, the futures markets,

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or the otions markets, seculators and hedgers can find an instrument and the leverage that

meet their needs. "rom comlex seculative strategies to everyday hedging techni/ues, the

"&'E( markets rovide the forum for dealing with currency fluctuations.

"oreign exchanges markets hel kee the system of floating exchange rates functioning. <s

international business increased, esecially during the last /uarter of the Twentieth 7entury,

comanies around the world needed a reliable means of trading their native currencies for

goods and services from across the globe. To do this, businesses had to be able to ay for

goods in services in a currency which businesses from outside their country that they would

accet. )n addition, business owners also wanted a way to store their rofits in currencies

which would retain their value, esecially if their national currencyBs value fluctuated wildly.

To meet the needs of all the market articiants that was when the foreign exchange markets

came into existence.

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BIBLIOGRAPHY

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erivative !arket $T>#"! -em L% @ Liul 1rakashan

"oreign Exchange !arket $T>#"! -em L% @ Liul 1rakashan

EW!%A%E.!

"inancial Exress The Economic Times

WEB!)TE!

www.goforex.net

www.financial;dictionary.thefreedictionary.com

www.investoedia.com www.forexcycle.com

www.actionforex.com

www.thinkforex.com

www.wikiedia.org

http://www.financial-dictionary.thefreedictionary.com/

http://www.investopedia.com/

http://www.forexcycle.com/

http://www.actionforex.com/

http://www.thinkforex.com/

http://www.investopedia.com/

http://www.forexcycle.com/

http://www.actionforex.com/

http://www.thinkforex.com/

http://www.financial-dictionary.thefreedictionary.com/

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