Who Is Involved In Forex?
There are in excess of one hundred different official currencies globally. Most international trades and payments use the U.S. dollar, Euro or Yen and there are several players in this market. Currency trades can be done via spot transactions, swaps, option contracts and forwards.
The central banks form a very important part of the foreign exchange market. Interest rate policies and open market operations of the central banks play a huge role in currency rates. Central banks make decisions regarding the regime that will be used to trade their currency in the open market. The different types of regimes are pegged, fixed and floating types.
The actions of the central banks are done mainly to increase the value of the currency or to stabilize the rate. Central banks along with governments often intervene in currency trade to boost or limit their currencies. For example, a central bank may decide to weaken its currency during prolonged deflationary periods. To do this, the bank will create an additional supply and use it to buy foreign currency. This causes a weakening of the local currency which makes exports in the global trading market more competitive. Central banks utilize these different strategies in an attempt to abate inflation, but forex traders can use this to their advantage if they keep abreast of developments.
The interbank market handles the largest volume of currency. The interbank market is the place where all banks trade currency. Banks undertake foreign exchange transactions on behalf of their clients and do speculative trades as well. Banks who undertake speculative dealings on behalf of their clients normally make a profit based on the bid-ask spread.
Businesses that are involved in importing and exporting require foreign currency to pay for services and goods. An example of this is a European company who imports parts and components from an American company and sells their finished product to South Africa. Once the sale of finished goods has been finalized, the South African Rand has to be converted to Euros. The European company will need to exchange those Euros to Dollars to pay for the components bought from the American company.
To limit their risk of currency fluctuations, the European company may choose the option to buy U.S. dollars via the spot market, or it may enter into a swap agreement. If it enters into a swap agreement it will obtain the U.S. dollars in advance to reduce the risk attached to fluctuation.
Hedge Funds and Investment Managers
Portfolio managers, hedge funds and pooled accounts are the second largest players in this financial market, second only to the banks. The managers of investment funds usually trade currencies on behalf of large accounts such as endowments and pension funds. Investment management firms who handle large international portfolios need to sell and buy currencies to trade with foreign securities. Investment managers often undertake speculative trades as well, as do hedge funds.
The main players in the foreign exchange market are banks, investment management firms and hedge funds. Central banks play a huge role and individual investors are the smaller players.