An Introduction to Spot Foreign Exchange

Abstract

The foreign exchange market is by far the largest market in the world, and although the world's currency markets are generally thought of as the exclusive domain of the largest banks and multinational corporations, nothing could be further from the truth. Even though major currencies are traded like commodities, it is distinguished from both the commodity or equity markets by having no fixed base. In other words, the foreign exchange market exists through communications and information systems consisting of telephones, the Internet or other means of instant communications, for example, Reuters and Bloomberg. The foreign exchange market is not located in a building, nor is it limited by fixed trading hours, but is truly a 24-hour global trading system. It knows no barriers and trading activity in general moves with the sun from one major financial center to the next—so that around the clock a foreign exchange market is active somewhere in the world. Because of this decentralization, the total size of the foreign exchange market can only be guessed at. The foreign exchange market is an over-the-counter market where buyers and sellers conduct business. Many of the traders in the markets have all started with this simplest of products: just buy low and sell high, or sell high and buy low. Thus, the foreign exchange market is a global network of buyers and sellers of currencies with a foreign exchange transaction being a contract to exchange one currency for another currency at an agreed rate on an agreed date. Today, what began as a way of facilitating trade across country borders has grown into one of the most liquid, hectic, and volatile financial markets in the world—where banks (and many hedge funds) are the major players and have the potential of generating huge profits or losses. Keywords: foreign exchange; spot rate; spot value; reciprocal rate; indirect terms; European terms; fixed currency; variable currency; American terms; bid; offer; spread; market maker; price taker; market user; big figure; direct dealing; brokered dealing; cross rates; price determinants; market/price risk; country risk; credit risk; dealing room; dealers; back office; two-way price; quote; pips; risk; hit; foreign exchange exposure