Forex (Foreign Exchange FX) market
- Global marketplace for exchanging national currencies.
- Largest and most liquid asset markets.
- Currencies trade against each other as exchange rate pairs, like EUR/USD.
- Spot (Cash) markets as well as derivatives markets offering forwards, futures, options, and currency swaps.
- Sometimes hedge against international currency and interest rate risk, to speculate on geopolitical events, and to diversify portfolios, among several other reasons.
- Trade is conducted over-the-counter.
- Trader can earn the interest rate differential, and profit from changes in exchange rate.
- Spot Market is where currencies are bought and sold based on their trading price.
- Forward contract is a private agreement between two parties to buy a currency at a future date and at a pre-determined price in OTC.
- Future contract is a standardized agreement between two parties to take delivery of a currency at a future date and at a pre-determined price.
- Forward and Future Contracts do not trade actual currencies. INSTEAD they deal in contracts that represent claims to a certain currency type, a specific price per unit and a future date for settlement.
What Factors affect Foreign Exchange Rates
Inflation
It is the decline of purchasing power of a given currency over time.
sequenceDiagram
participant Market;
participant Trader;
participant FX;
Market->>Trader: Inflation causes difficulties to purchase products.;
Trader->>FX: Less exchange of that currency.;
loop
FX->>FX: Less demand of that currency.;
end
Consumer Price Index (CPI), basket of goods, Producer Price Index (PPI),
Interest Rate
sequenceDiagram
participant Market;
loop
Market->>Market: More economic activities need more cash flow;
end
participant Bank;
Market->>Bank: Lender can gain more money by increaing interest rate;
participant Trader;
participant FX;
Bank-->>Trader: ;
Trader->>FX: Wants to deposit in bank to get more interest;
Government Debt
Terms of Trade
The terms of trade is the ratio of export prices to import prices. Exports prices rise at a greater rate than its imports prices, resulting in higher demand for the country's currency and its value.
Political Stability & Performance
The currency can become unreliable and have less purchasing power. Trader would not like to keep that currency, demand goes down, and the exchange rate is lowered.
Recession
A period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.
References