Unlike a stock market, the foreign exchange market is divided into levels of access. At the top is the interbank market, which is made up of the largest commercial banks and securities dealers.
Within the interbank market, spreads, which are the difference between
the bid and ask prices, are razor sharp and not known to players outside
the inner circle. The difference between the bid and ask prices widens
(for example from 0 to 1 pip
to 1–2 pips for currencies such as the EUR) as you go down the levels
of access. This is due to volume. If a trader can guarantee large
numbers of transactions for large amounts, they can demand a smaller
difference between the bid and ask price, which is referred to as a
better spread. The levels of access that make up the foreign exchange
market are determined by the size of the "line" (the amount of money
with which they are trading). The top-tier interbank market accounts for 39% of all transactions.[60]
From there, smaller banks, followed by large multi-national
corporations (which need to hedge risk and pay employees in different
countries), large hedge funds, and even some of the retail market makers. According to Galati and Melvin, “Pension funds, insurance companies, mutual funds,
and other institutional investors have played an increasingly important
role in financial markets in general, and in FX markets in particular,
since the early 2000s.” (2004) In addition, he notes, “Hedge funds have
grown markedly over the 2001–2004 period in terms of both number and
overall size”.[65] Central banks also participate in the foreign exchange market to align currencies to their economic needs.
Commercial companies
An important part of the foreign exchange market comes from the
financial activities of companies seeking foreign exchange to pay for
goods or services. Commercial companies often trade fairly small amounts
compared to those of banks or speculators, and their trades often have
little short-term impact on market rates. Nevertheless, trade flows are
an important factor in the long-term direction of a currency's exchange
rate. Some multinational corporations
(MNCs) can have an unpredictable impact when very large positions are
covered due to exposures that are not widely known by other market
participants.
Central banks
National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates
and often have official or unofficial target rates for their
currencies. They can use their often substantial foreign exchange
reserves to stabilize the market. Nevertheless, the effectiveness of
central bank "stabilizing speculation" is doubtful because central banks
do not go bankrupt if they make large losses, like other traders would,
and there is no convincing evidence that they do make a profit trading.
Foreign exchange fixing
Foreign exchange fixing
is the daily monetary exchange rate fixed by the national bank of each
country. The idea is that central banks use the fixing time and exchange
rate to evaluate behavior of their currency. Fixing exchange rates
reflects the real value of equilibrium in the market. Banks, dealers and
traders use fixing rates as a market trend indicator.
The mere expectation or rumor of a central bank foreign exchange
intervention might be enough to stabilize a currency, but aggressive
intervention might be used several times each year in countries with a dirty float
currency regime. Central banks do not always achieve their objectives.
The combined resources of the market can easily overwhelm any central
bank.[66] Several scenarios of this nature were seen in the 1992–93 European Exchange Rate Mechanism collapse, and in more recent times in Asia.
Hedge funds as speculators
About 70% to 90%[citation needed]
of the foreign exchange transactions conducted are speculative. This
means the person or institution that bought or sold the currency has no
plan to actually take delivery of the currency in the end; rather, they
were solely speculating on the movement of that particular currency.
Since 1996, hedge funds have gained a reputation for aggressive currency speculation. They control billions of dollars of equity
and may borrow billions more, and thus may overwhelm intervention by
central banks to support almost any currency, if the economic
fundamentals are in the hedge funds' favor.
Investment management firms
Investment management
firms (who typically manage large accounts on behalf of customers such
as pension funds and endowments) use the foreign exchange market to
facilitate transactions in foreign securities. For example, an
investment manager bearing an international equity portfolio needs to
purchase and sell several pairs of foreign currencies to pay for foreign
securities purchases.
Some investment management firms also have more speculative specialist currency overlay
operations, which manage clients' currency exposures with the aim of
generating profits as well as limiting risk. While the number of this
type of specialist firms is quite small, many have a large value of assets under management and, hence, can generate large trades.
Retail foreign exchange traders
Individual retail speculative traders constitute a growing segment of this market with the advent of retail foreign exchange trading, both in size and importance. Currently, they participate indirectly through brokers or banks. Retail brokers, while largely controlled and regulated in the USA by the Commodity Futures Trading Commission and National Futures Association, have in the past been subjected to periodic foreign exchange fraud.[67][68]
To deal with the issue, in 2010 the NFA required its members that deal
in the Forex markets to register as such (I.e., Forex CTA instead of a
CTA). Those NFA members that would traditionally be subject to minimum
net capital requirements, FCMs and IBs, are subject to greater minimum
net capital requirements if they deal in Forex. A number of the foreign
exchange brokers operate from the UK under Financial Services Authority regulations where foreign exchange trading using margin is part of the wider over-the-counter derivatives trading industry that includes Contract for differences and financial spread betting.
There are two main types of retail FX brokers offering the opportunity for speculative currency trading: brokers and dealers or market makers. Brokers
serve as an agent of the customer in the broader FX market, by seeking
the best price in the market for a retail order and dealing on behalf of
the retail customer. They charge a commission or mark-up in addition to
the price obtained in the market. Dealers or market makers,
by contrast, typically act as principal in the transaction versus the
retail customer, and quote a price they are willing to deal at.
Non-bank foreign exchange companies
Non-bank foreign exchange companies
offer currency exchange and international payments to private
individuals and companies. These are also known as foreign exchange
brokers but are distinct in that they do not offer speculative trading
but rather currency exchange with payments (i.e., there is usually a
physical delivery of currency to a bank account).
It is estimated that in the UK, 14% of currency transfers/payments are made via Foreign Exchange Companies.[69]
These companies' selling point is usually that they will offer better
exchange rates or cheaper payments than the customer's bank.[70] These companies differ from Money Transfer/Remittance Companies in that they generally offer higher-value services.
Money transfer/remittance companies and bureaux de change
Money transfer companies/remittance
companies perform high-volume low-value transfers generally by economic
migrants back to their home country. In 2007, the Aite Group estimated that there were $369 billion of remittances (an increase of 8% on the previous year). The four largest markets (India, China, Mexico and the Philippines) receive $95 billion. The largest and best known provider is Western Union with 345,000 agents globally followed by UAE Exchange.[citation needed]
Bureaux de change
or currency transfer companies provide low value foreign exchange
services for travelers. These are typically located at airports and
stations or at tourist locations and allow physical notes to be
exchanged from one currency to another. They access the foreign exchange
markets via banks or non bank foreign exchange companies.
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