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An Introduction to Foreign Exchange
1.
1.
Why Trade Foreign
Exchange ?
Introduction
A brief history of the development of the markets………………
-
-Before
the First World War, central banks supported their
currencies with convertibility to gold, but often
did not have sufficient cover as this was not deemed
probable in reality. With supplies of paper money
booming, this often lead to inflation and political
instability, and foreign exchange controls were
often necessary
-
-In
July 1944 as the Second World War ended, The Bretton
Woods agreement set up the USD as the new world
reserve currency, along with the IMF and the World
Bank. The agreement fixed the USD to gold at
USD35/oz and other currencies to the dollar,
creating a system of fixed exchange rates
-
-As
national economies moved in different directions in
the sixties, a number of realignments were
necessary, and in 1971 US president Nixon suspended
the USD ‘s convertibility to gold at a time when the
USD was under pressure from increasing US budget and
trade deficits.
-
-Restrictions
on capital flows were removed by most countries,
leaving the market forces free to adjust the foreign
exchange rates according to their own perceived
values – floating exchange rates
-
-Banks
who wished to service their customers in the new
floating rate environment began to develop treasury
departments, and trade actively with each other in
what became the interbank market
-
-The
foreign exchange market now dwarfs any other
investment market, with over USD1,200 billion traded
every day, far more than the world’s stock and bond
markets combined
Interbank Market versus Retail
-
-The
interbank market is made up of a large number
of banks and institutions who trade actively with
each other on a daily basis. At this level
transaction sizes are in millions, and are done on a
settlement basis, with sums being exchanged
from bank to bank, from account to account on a
spot value date basis, i.e. all sums are settled
within 2 days – in the future the CLS system will
allow same day exchange to take place. Banks can
choose who they trade with, buying from one and
selling to another, and may deal with many others
during a day’s trading. Banks set up credit
limits with each other to allow them to deal any
number of times each day, up to preset amount
limits.
-
-The
retail market is made up of a vast number of
private individuals who trade with banks or margin
brokers on the internet or telephone. The ability to
trade is based on a margin deposit at a bank
or margin broker, and then to monitor the markets
and trade with that broker, but only that broker. As
retail investors, we cannot trade by buying from one
broker and selling to another, we must execute all
deals within the same environment of one broker- we
may have accounts at a number of brokers however if
we wish. In the retail market, amounts that we trade
in are not moved from account to account or settled,
we are merely trading an amount in the margin
brokers books, and closing it off at a different
rate to give a net profit or loss in our margin
account.
-
-The
major difference between the interbank and the
retail market is settlement and margin – it used to
be that interbank pricing of FX rates was much finer
than the wider retail pricing, but now the internet
has made pricing transparent, and what was once
interbank pricing is now available to the private
investor
Foreign
Exchange Training by
www.fxmoneymap.co.uk
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