Question

3.Explain the role and importance of different market participants in the foreign exchange market.

Answer 1

Currency Exchange Market Participants

Foreign currency exchange trading is a fast growing business industry worldwide. The currency exchange takes place on a very large scale and this market has a global presence as currency exchange market participants are from all around the globe. There are various participating entities taking part in foreign exchange trading. The main players or the main market participants in currency exchange are Central Banks, largest investment firms, multinational commercial companies, hedge funds, mutual funds, insurance companies and retail foreign exchange brokers etc.

Central Banks

Central banks, which represent their nation's government, are extremely important players in the forex market. Open market operations and interest rate policies of central banks influence currency rates to a very large extent.

A central bank is responsible for fixing the price of its native currency on forex. This is the exchange rate regime by which its currency will trade in the open market. Exchange rate regimes are divided into floating, fixed and pegged types.

Any action taken by a central bank in the forex market is done to stabilize or increase the competitiveness of that nation's economy. Central banks (as well as speculators) may engage in currency interventions to make their currencies appreciate or depreciate. For example, a central bank may weaken its own currency by creating additional supply during periods of long deflationary trends, which is then used to purchase foreign currency. This effectively weakens the domestic currency, making exports more competitive in the global market.

Central banks use these strategies to calm inflation. Their doing so also serves as a long-term indicator for forex traders.

Banks

The inter bank market is the major currency exchange market participants playing an important role in currency trading market. This large market trades billions of dollars every single day and they have a great impact on inflation rates and the interest rates. The inter bank market is basically a controller in terms of the money supplied, inflation rates and the interest rates.

Multinational Corporations

Firms engaged in importing and exporting conduct forex transactions to pay for goods and services. Consider the example of a German solar panel producer that imports American components and sells its finished products in China. After the final sale is made, the Chinese yuan the producer received must be converted back to euros. The German firm must then exchange euros for dollars to purchase more American components.

Companies trade forex to hedge the risk associated with foreign currency translations. The same German firm might purchase American dollars in the spot market, or enter into a currency swap agreement to obtain dollars in advance of purchasing components from the American company in order to reduce foreign currency exposure risk.

Additionally, hedging against currency risk can add a level of safety to offshore investments.

Non-bank Foreign Exchange Companies

These non bank forex exchange companies market participants in currency exchange offer currency exchange and international payments to private individuals and companies. These are also called as forex brokers sometimes however, there is a little distinction as these non bank foreign exchange companies do not offer any kind of speculative trading. These Forex market participants exchange currencies with payments which mean there is physical delivery of currency to a bank account.

Money Transfer or Remittance Companies

Money transfer companies or remittance companies are market participants in currency exchange which are known for performing high-volume low-value transactions generally by migrants back to their home country. The largest markets of these kind of transactions are India, China, Mexico and Philippines and the biggest known currency exchange market participants in this category is largest and best Western Union which have about 345,000 agents globally.

Brokers

The Forex market is largely devoid of brokers. This is because a person need not deal with brokers necessarily. If they have sufficient knowledge, they can directly call the dealer and obtain a favorable rate. However, there are brokers in the Forex market. These brokers exist because they add value to their clients by helping them obtain the best quote. For instance, they may help their clients obtain the lowest buying price or the highest selling price by making available quotes from several dealers. Another major reason for using brokers is creating anonymity while trading. Many big investors and even Forex dealers use the services of brokers who act as henchmen for the trading operations of these big players.

Hedgers

There are many businesses which end up creating an asset or a liability priced in foreign currency in the regular course of their business. For instance, importers and exporters engaged in foreign trade may have open positions in several foreign currencies. They may therefore be impacted if there is a fluctuation in the value of foreign currency. As a result, to protect themselves against these losses, hedgers take opposite positions in the market. Therefore if there is an unfavorable movement in their original position, it is offset by an opposite movement in their hedged positions. Their profits and losses and therefore nullified and they get stability in the operations of their business.

Speculators

Speculators are a class of traders that have no genuine requirement for foreign currency. They only buy and sell these currencies with the hope of making a profit from it. The number of speculators increases a lot when the market sentiment is high and everyone seems to be making money in the Forex markets. Speculators usually do not maintain open positions in any currency for a very long time. Their positions are transient and are only meant to make a short term profit.

Arbitrageurs

Arbitrageurs are traders that take advantage of the price discrepancy in different markets to make a profit. Arbitrageurs serve an important function in the foreign exchange market. It is their operations that ensure that a market as large, as decentralized and as diffused as the Forex market functions efficiently and provides uniform price quotations all over the world. Whenever arbitrageurs find a price discrepancy in the market, they start buying in one place and selling in another till the discrepancy disappears.

Financial Investment Management Firms

The next important market participants in currency exchange are the financial investment management firms. The major work of these firms is the management of large accounts like pension funds and endowments. The management is done on customer’s behalf and these financial investment firms make use of currency trading market to facilitate money transactions in foreign securities.

Retail Market Participants

Retail market participants include tourists, students and even patients who are travelling abroad. Then there are also a variety of small businesses that indulge in foreign trade. Most of the retail participants participate in the spot market whereas people with long term interests operate in the futures market. This is because these participants only buy/sell currency when they have a personal/professional requirement and dealing with foreign currencies is not a part of their regular business.

The participants have been listed in descending order. This means that dealers are the most active traders in the Forex markets, followed by brokers and so on. It would also be fair to say that dealers have the maximum information about the market, followed by brokers and so on.