The foreign exchange market involves the purchasing and selling of currencies. Individuals and institutions participate in the foreign exchange market. Licensed commercial banks are the main players in the market. Its role is to manage the foreign exchange liquidity within the banking system and helps to minimize risk by converting currencies and using derivative products. In Nigeria, the foreign exchange market is organized through a wholesale Dutch auction system. However, this method of selling does not guarantee a profit.
The foreign exchange market is made up of two types of currency. First, a country’s currency is supplied by a country’s citizens in order to receive foreign currency. For example, if an American tourist were to visit China, he would supply U.S. dollars into the foreign exchange market and demand Chinese yuan. These two types of transactions can cause fluctuations in the exchange rate of a currency. Hence, when the price of one currency rises, the value of the other currency declines.
Another type of foreign exchange market is the spot market. This type of trading involves an agreement to buy or sell currencies at a specific rate in the future. Hence, it is an excellent option for individuals and businesses who want to invest in foreign countries without buying them. The spot and forward transactions are both beneficial for investors in different ways. The former involves selling or buying a particular currency and taking advantage of a favorable exchange rate. The latter type involves a large amount of risk but allows for the flexibility of hedging.
The forex market consists of two markets: the over-the-counter and the interbank market. Individuals and firms can open a forex account with as little as $100. The forex market is not centralized and operates around the world through a global network of brokers and computers. Many of these brokers act as market makers and post bids at a difference to the most competitive bid. The exchange rate fluctuates, making foreign exchange risk unpredictable.
The foreign exchange market is dominated by several key geographic regions. London, for example, is the biggest trading hub, accounting for 41% of all global foreign exchange trading. Brexit may change this, but the United States (New York) accounts for 17% of total volume. Hong Kong and Singapore make up another seven percent of global trading. The United States and France make up the rest of the global trading industry. These markets do not meet the needs of Main Street companies.
There are two main types of foreign exchange transactions. Spot exchange rates are the rates for immediate exchange between two currencies, such as when a traveler exchanges Japanese yen for US dollars upon landing at the airport in Tokyo. A forward exchange rate, on the other hand, is the rate that two parties agree to exchange currencies at a later date. The main purpose of a forward exchange rate is to manage foreign exchange risk by enabling companies to buy and sell currencies based on a future date.