International Finance Theory and Policy
by Steven M. Suranovic

Finance 10-2

Participants in the FOREX

The foreign exchange market (FOREX) is not a market like the New York stock exchange, where daily trades of stock are conducted in a central location. Instead, a FOREX market refers to the activities of major international banks that engage in currency trading. These banks act as intermediaries between the true buyers and sellers of currencies, ie, governments, businesses, and individuals. These banks will hold foreign currency deposits and stand ready to exchange these for domestic currency upon demand. The exchange rate will be determined independently by each bank but will essentially be determined by supply and demand in the market. In other words, the banks set the exchange rate at each moment to equalize its supply of foreign currency with the market demand. Each bank makes money by collecting a transactions fee for its "exchange services."

It is useful to categorize two distinct groups of participants in the FOREX, those whose transactions are recorded on the current account (importers and exporters) and those whose transactions are recorded on the financial account. (investors)

1. Importers and Exporters

Anyone who either imports or exports goods and services will need to exchange currencies to make the transactions. This includes tourists who travel abroad since their transactions would appear as services in the current account. These businesses and individuals will engage in currency trades daily, however, these transactions are small in comparison to those made by investors.

2. International Investors, Banks, Arbitrageurs etc.

Most of the daily currencies transactions are made by investors. These investors, be they investment companies, insurance companies, banks or others, are making currency transactions to realize a greater return on their investments or holdings. Many of these companies are responsible to manage the savings of others. Pension plans and mutual funds buy and sell billions of dollars worth of assets daily. Banks, in the temporary possession of the deposits of others do the same. Insurance companies manage large portfolios which act as their capital to be used to pay off claims on accidents, casualties and deaths. More and more these companies look internationally to make the most of their investments.

It is estimated that over $1 trillion (or $1000 billion) worth of currency is traded every day. Only about $70-$100 billion of trade in goods and services takes place daily worldwide. This suggests that much of the currency exchanges are done by international investors rather than importers and exporters.

International Finance Theory and Policy - Chapter 10-2: Last Updated on 12/31/05