The international exchange of goods, services and capital requires the implementation of appropriate calculations, the implementation of which requires the exchange of one currency for another. As a result, importers, exporters, investors, trade intermediaries, other businessmen, tourists are forced to convert both national and foreign currency for the final settlement of foreign trade relations. Currency trading is carried out in the markets of its exchange.
The foreign exchange market is a system of economic and organizational-legal relations for the purchase and sale of foreign currencies and payment documents in foreign currencies .
The vast majority of monetary assets sold in the foreign exchange markets have the form of a demand deposit in the largest banks that trade with each other. Only a small part of the market falls on the exchange of cash. It is in the interbank foreign exchange market that the main quotations of exchange rates are carried out.
Depending on the timing of foreign exchange operations, foreign exchange markets are divided into:
spot market (the market of cash, current or cash currency transactions); derivatives foreign exchange market.
The spot market is a market for the immediate supply of currency. The traditional deadline for the delivery of currency in the spot market is 2 working days. Transactions, the execution of which goes beyond 2 working days, are made on the derivative (forward) foreign exchange market.
The global foreign exchange market covers the entire globe. Around the clock in this market, prices change, currency is traded all the time. The leading centers of currency trading in Europe are Zurich, Frankfurt am Main, Paris, London. In the USA – New York, in Asia – Tokyo, Singapore, Bahrain, Abu Dhabi, Qatar.
World currency trading begins in the morning in Tokyo and Sydney, moves west to Hong Kong and Singapore, passes through Bahrain, shifts to the main European markets in Frankfurt, Zurich and London, “jumps” across the Atlantic Ocean to New York and ends in San Francisco and Los Angeles. The market is most intense and liquid in the first hours of afternoon European time, when centers in Europe and on the east coast of the United States are simultaneously open.
At the end of the day in California, when stockbrokers in Tokyo and Hong Kong begin their activities, the market is characterized by the least intensity.
National foreign exchange markets, which serve the movement of cash flows within the country, are integrated into the world foreign exchange market, in which foreign exchange transactions and settlements related to the international movement of goods, services and capital are carried out. The world foreign exchange market, which operates around the clock from Monday to Friday, connects the national currency markets together with the help of modern means of communication, such as telephone, telefax, computer networks.
Quotation between banks in different parts of the world is always possible due to the existence of an electronic system. Therefore, most banks, in addition to operations in the domestic market, also participate in the work of foreign markets.
Large banks have branches in several major markets engaged in foreign exchange trading:
European banks – in other European countries, USA, Asia; American banks in Europe and Asia; Asian banks – in Europe and the United States.
In some countries, such as France, part of the foreign exchange operations is carried out in the official operating room by means of an open price offer. The prices prevailing at the time of closing are published as official prices for that day.
Currency markets perform the following functions:
1. Transfer of purchasing power (settlement service of export-import operations, as well as foreign exchange operations related to the investment of capital outside the national economy).
The need for such a transfer is due to the fact that international trade and capital transactions are usually carried out between business entities located in states that, as a rule, have different national currencies.
Each party would like to eventually get their own currency, although trading or capital transactions can be conducted in any convenient currency.
For example, a Japanese exporter sells a Toyota car to a Brazilian importer. The former can bill the latter in Japanese yen, Brazilian cruzeiros and U.S. dollars, with the currency type agreement being negotiated well in advance.
Whatever currency is used, one party must transfer purchasing power either to its national currency or to a foreign currency. If yen is used, then the Brazilian importer, in order to pay for the transaction, must transfer its purchasing power from cruzeiro to yen. If cruzeiros are used, the Japanese exporter must convert the yen to cruzeiro. If U.S. dollars are used, the Brazilian importer must convert the cruzeiro into dollars, and the Japanese exporter must convert dollars into yen.
2. Collateral for credit
Since the transport of goods from one country to another takes time, a mechanism is needed to finance the valuables in transit.
In the case of a Toyota transaction, someone must finance the goods while they are on their way either to Brazil or to a Brazilian store before they are sold. Usually it is from 5 weeks to 6 months. A Japanese exporter may agree to provide a loan, treating the Brazilian importer as a debtor of loans with or without interest.
The foreign exchange market can be a source of credit.
To finance trade, there are specialized obligations – bank lending and credit letters.
3. Hedging
The active mobility of exchange rates, the complexity and gigantic size of currency markets lead to the emergence of the risk of currency losses as a result of fluctuations in exchange rates, which is offset by hedging, i.e. a system of measures aimed at minimizing currency risk, by acquiring positions of equal content, but opposite in form (for example, swap operations involving the purchase of currency at the spot rate with its simultaneous sale at the forward rate and vice versa). Since, for example, the cruzeiro is an unstable currency, neither the Brazilian importer nor the Japanese exporter will want to be exposed to the risk associated with exchange rates. They would rather prefer normal profits from car transactions than speculation about financial losses or gains associated with exchange rates.
4. Currency speculation
The behavior of foreign exchange market participants who want to get the maximum benefit from a currency transaction depends on the difference between interest rates in the national and foreign money market, as well as on the expected changes in the exchange rate.
So, if an exporter from Germany, who received foreign exchange earnings in the amount of 100 thousand US dollars, which he will need in 6 months, does not expect any changes in the level of the exchange rate, then he will invest the resulting amount in an American bank if the interest rate in the US is higher than in Germany, and exchange US dollars for stamps after a 6-month period. If the interest rate is higher in Germany, the exporter will immediately exchange the amount received for stamps and invest them in German assets.
If we assume that the level of interest rates in the US and Germany is the same (for example, 4% for a 6-month deposit), but the depreciation of the German mark is expected from 1.5 marks per dollar to 1.6 marks per dollar, then it is more profitable for the exporter to put money in an American bank and exchange them for stamps in 6 months, which will allow him to receive a larger amount – 166.4 thousand marks (1.6 x 1.04 x 100 thousand), instead of 156 thousand marks (1.5 x 1.04 x 100 thousand).
Thus, the general rule for speculative transactions in foreign currency is that their profitability depends on how much the currency falls in value beyond the difference in interest rates on deposits in national and foreign currency. However, speculative operations will be profitable only if market participants correctly manage to predict the expected changes in the exchange rate.