CIA-1International Financial Management

Foreign Exchange Market Structure, Players and EvolutionPublished by:Michael R. King, Carol Osler and Dagfinn RimeNorges Bank (Research Department 2010-11)

Submitted To: T.S.RamachandranProfessorInstitute of Management,Christ University

Name: Sayon DasRoll. No.: 1421328MBA(Finance) LMN

IntroductionThe foreign exchange affects various economic factors as the output level, international capital flow through risks and return of different assets and inflation through cost of imports and commodity prices. The dollar value of trading activity in spot and forward foreign exchange markets has daily average turnover estimated significant times larger than the combined imports and exports for the worlds largest economies. Recently, there has been a shift in the global distribution of currency trading from London which constitutes of twenty percent trading to Asian regional centres as Hong Kong & Singapore. The USD is the dominant currency traded in the Forex market against minor currency as a vehicle currency. The spot trading in the foreign exchange is stable in nature and is highest with daily turnover of $1.5 trillion and other activities as futures, currency options, swaps, constitutes $0.4 trillion as on 2010. Lehman Brothers bankruptcy led to growth of central bank swap activity which was in order to stabilise the banking system. Yet still vast majority of the FX market remains unregulated but manipulation by single entity is difficult in the foreign exchange market for major currencies as it is very liquid. ObjectiveThe research article aims to review the agents which bring information into the foreign exchange market and how their information affects the market price and study the evolution of foreign exchange market.Research Methodology used in Research PaperResearch Methodology used in the research article is survey of multiple banks on foreign exchange platforms and conducted survey of 15 institutional and retail platforms and various reports from institutions.Findings All Financial institutions and other hedge fund managers concentrate on maximising expected returns to foreign assets measured in the home currency and hedging has become important after the financial crisis in order to mitigate risk. The private financial institutions dominate in the Foreign exchange trading but central bank also influences exchange rates by trading in the economy. Corporate customers avoid involving in foreign exchange forecasting and speculation and use the market for supporting treasury operation related to their business activity. During hedging of foreign cash flow is also avoid future exchange rate movements and favour maturity below 6 months. Foreign exchange dealers earn income by speculating and providing liquidity to their customers and in order to align interests of shareholders they receive bonus on profits. It has been observed that foreign exchange interdealer are highest during short overnight when volatility are low and narrow spreads for larger trades. Global custodian banks trade with their custodians and they charge a mark-up over the prices which they have to pay in the inter-bank market. Electronic trading has helped in enabling direct processing of trade. Technological advancement has led to narrower spreads and has improved the efficiency of trading but also led to high concentration of dealers. Learning The market reacts from the information given by customers to their dealers and interdealer prices. Thus, there are two types of agents in the market namely pull agents who are informed and push agents who are uninformed financial customers. The trading pattern in the foreign exchange market is different for various entities as the objective for trading varies. Due to change in structure of foreign exchange market the fluctuations in liquidity are higher and earning of profit is possible through narrow margins. Electronic trading and algorithm trading has led to high frequency trading which helps to trade with a narrow margin and increase in arbitrage practices. The players in the foreign exchange market depend upon various forms of information from customers, dealers and the events in the economy.ConclusionThe foreign exchange market and structure is changing due to changes in objectives of entity involved in the market and technological enhancements. This has led to increase in information flow to different institutions and increase in foreign exchange trading and expansion of market centres around the globe.Reference: http://www.norges-bank.no/en/Published/Papers/Working-Papers/2011/WP-201110/