Foreign Exchange Markets

The currency system in the world economy has been forming for a long time. In 1867 a “gold standard” was introduced ”“ a monetary system, the basic calculation unit of which was a certain standardized quantity of gold.

In the economy based on the gold standard it is guaranteed that each monetary item issued can be exchanged into the corresponding amount of gold. In the calculations between the countries using the gold standard, the fixed exchange rate is set on the basis of correlation of currencies to the unit of weight of gold. The supporters of gold standard claim that it made the economy more stable, less exposed to inflation, as it prevented an uncontrolled money emission. But the gold standard did not solve all the currency problems. The lack of media of exchange caused a decline in the production because of the liquidity crisis (Eichengreen & Flandreau, 1997).

After the WW2 till 1971 the known Bretton-Woods Agreement was enacted according to which the national currencies were exchanged to dollar on the fixed rate, and dollar was pegged to gold. However, in time, the fixed exchange rate started to slow down the post-war development of economy and commodity exchange between the countries (Eichengreen & Flandreau, 1997).

In the 60s inflation overflowed the USA. The market price of gold started to exceed the fixed one. In 1971 the US President R. Nixon canceled dollar’s pegging to gold and its devaluation was made. Since 1973 the flexible exchange-rate regime has been prevailing.

FOREX appeared on January 8, 1976 when at the meeting of member countries of the IMF in Kingston a new agreement was signed about the structure of the international monetary system. Since then floating rates became the only method of currency exchange (Sadar, 2008).

In the new monetary system the principle of the gold standard based purchasing power determination was rejected. Currencies of member countries of the agreement no longer had an official gold content. The exchange began to take place at the open market with the free prices. This principle led to the term “freely convertible exchange”.

Presently, the amount of daily auctions at FOREX market makes $ 2-4 trillion. There is no exact data because there is no obligation to register and publish all the transactions at this market. Part of this volume is provided by margin trading. Regardless of the character and aims of transactions, such a large daily turnover is the guarantee of high liquidity of this market (Ishii, 2003).

Exchange market is a sum-total of all conversion and credit-deposit operations in foreign currencies, carried out between contractors-participants of the exchange market.

The primary task of the exchange market is providing its participants with foreign currency and regulating exchange rate (Coyle, 2004).

Exchange market is a great number of large commercial banks and other financial institutions connected by the difficult network of modern communication means through which currency trading is carried out (Sadar, 2008).

Exchange market consists of a number of officially not defined markets united by the international bank connection system. At exchange markets there are no written rules controlling their activity, however all the transactions must be conducted in accordance with the customary unspoken procedural and ethic norms. In practice, every country to a certain degree is a participant of the exchange market (Coyle, 2004).

Foreign exchange markets deal with the cash flows mediating the international goods and services flow, redistribution of capitals. Currency and financial resources flow is carried out through exchange operations; exchange credit and settlement services of purchase and sale of goods and services; foreign investments; securities trading; redistribution of national incomes as an aid to developing countries and contributions into international organizations.

The major functions of exchange market are: punctual conduction of international settlements; exchange rates regulation; currency diversification; exchange risks insurance; profit making in a form of an exchange rate difference; implementing monetary policy directed on government control of national economy, and concerted policy within the framework of world economy (Ishii, 2003).

Currency transaction is an exchange of money of one country to money of the other. For the conduction of operations at the exchange market a quotation is made, i.e. translation of currency of one country to currency of the other (Coyle, 2004).

There are two important types of currency markets distinguished depending on the temporal conditions of transactions conduction: spot and forward markets.

If operations are carried out at current prices and with immediate execution of subsequent obligations, such market is called sport or cash market. Spot markets’ approximate share is 60-70%. At forward market the transactions are carried out with the subsequent obligations execution at the set time in the future, which is longer, than at sport market (for example, in a month). Its stake is about 30-40% (Sadar, 2008).

As a result of long competition the world financial centers were formed, where the largest banks and exchange markets were concentrated. Such centers include London, Zurich, Paris, New York, Frankfurt am Main, Singapore, Hong Kong (Coyle, 2004).

London exchange market is the largest in the world ”“ the average daily currency turnover makes about $ 500 billion. It comprises more than 500 banks. The average New York market daily currency turnover reaches $ 200 billion. The Tokyo exchange market is also characterized by a high daily foreign currency turnover up to $ 130 billion. Singapore is the largest financial center in the South-East Asia.

Its currency turnover in 2007 made $ 186 million London, New York and Tokyo conduct more than a half of the world’s currency trading.

Moreover, London performs 1/3 and this share is growing. (Ishii, 2003).