Foreign exchange market - What is it? characteristics, instruments, and more

foreign exchange market

The global market in which currencies from different countries, known as currencies, are exchanged.

 

What is the foreign exchange market?

The foreign exchange market, also known as FOREX, is a global market in which currencies from different countries, known as currencies, are exchanged.

In this market, there are buyers and sellers who agree to carry out a certain transaction at an established exchange price, called the exchange rate.

The foreign exchange market is the base market for all other international financial markets because it establishes the exchange value of the currencies in which international monetary flows are going to be carried out.

This market is not limited to a specific geographical area but operates in all places where this purchase sale is carried out.

Characteristics of the forex market

The main characteristics of the foreign exchange market are the following:

• Currency operations are carried out throughout the length and breadth of the planet, so they handle large amounts of money.
• There is a great facility to make or receive payments derived from international economic transactions, in any convertible currency and with a high degree of efficiency and convenience.
• The currency exchange rate is double since there is a price for the buyer and another for the seller. The purchase price is always less than the sale price since the difference makes it possible for the intermediary to benefit.
• The values ​​of all currencies are Buy-sell operations are carried out very quickly and in large volumes. Entities of recognized solvency participate in them, which allows the intervention of arbitrageurs, actors who benefit from the difference in prices or currency quotes.
• Exposure to exchange risk appears linked to a large number of operations, for example, exports, imports, loans, foreign currency loans, direct investments abroad, foreign currency investments, among others.
• It is in operation 24 hours a day for 5.5 days a week. It operates from Sunday afternoon to Friday when it ends with the close of the New York Stock Exchange. (US time).

Forex market instruments

The main instruments of the foreign exchange market are the following:

• Cash transactions (spot): these are agreements to exchange one currency for another, at a certain exchange rate. The exchange of these currencies must occur within 48 hours or less following the transaction date.
• Term operations (forward): are those carried out through a currency exchange agreement, at a certain moment and to materialize in a future period of 1, 2, 3, or 6 months. The currency purchase-sale forward contract is a firm contract and its fulfillment is not optional, but mandatory. Two classes of participants attend this type of contract: those who seek security and speculators.
• Currency Options – An option is a contract that gives the option holder the right to buy or sell a certain amount of a currency at an agreed price, called the strike price or exercise price, at the time the option is exercised.
• Currency swaps: it is a contract to buy or sell an amount of a currency at a future date, at a certain value, and at an agreed exchange rate; simultaneously to sell or buy that same amount of currency at a later date and also at an agreed exchange rate.

Forex market participants

The main foreign exchange participants are companies, individuals, commercial banks, central banks, and operators ( brokers ):

• Companies: international corporations, for example, participate in foreign currency purchase-sale operations when subsidiaries pay dividends to the parent company, or when canceling imports of merchandise made in a currency other than their own currency of the account.
• Individuals: they may need foreign currency to conduct business, travel abroad, protect themselves, or speculate financially.
• Commercial banks: they supply foreign currency to companies and individuals through their network of exchange offices. Commercial banks carry out arbitrage operations that make it possible to ensure that prices in different centers tend towards the same price.
• Central Banks: These institutions participate in the foreign exchange market for two fundamental reasons. In the first place, the central banks have to acquire various types of foreign currency in order to pay for imports and capital debts of their corresponding countries. Second, they participate in the foreign exchange market to fix the composition of their international reserves.
• Brokers: foreign currency operators are responsible for carrying out transactions between buyers, sellers, and banks, for which they receive a commission.