The purpose of the foreign exchange market is to assist international trade and investment. The foreign exchange market allows businesses to convert one currency to another. For example, it permits a U.S. business to import European goods and pay Euros, even though the business's income is in U.S. dollars. Some experts, however, believe that the unchecked speculative movement of currencies by large financial institutions such as hedge funds impedes the markets from correcting global current account imbalances. This carry trade may also lead to loss of competitiveness in some countries. [1]
In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.
The foreign exchange market is unique because of
- trading volume resulting in market liquidity
- geographical dispersion
- continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 UTC on Sunday until 22:00 UTC Friday
- the variety of factors that affect exchange rates
- the low margins of relative profit compared with other markets of fixed income
- the use of leverage to enhance profit margins with respect to account size
- $1.005 trillion in spot transactions
- $362 billion in outright forwards
- $1.714 trillion in foreign exchange swaps
- $129 billion estimated gaps in reporting
Market size and liquidity
Of the $3.98 trillion daily global turnover, trading in London accounted for around $1.36 trillion, or 34.1% of the total, making London by far the global center for foreign exchange. In second and third places respectively, trading in New York accounted for 16.6%, and Tokyo accounted for 6.0%.[4] In addition to "traditional" turnover, $2.1 trillion was traded in derivatives.
Exchange-traded FX futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts.
Several other developed countries also permit the trading of FX derivative products (like currency futures and options on currency futures) on their exchanges. All these developed countries already have fully convertible capital accounts. Most emerging countries do not permit FX derivative products on their exchanges in view of prevalent controls on the capital accounts. However, a few select emerging countries (e.g., Korea, South Africa, India—[1]; [2]) have already successfully experimented with the currency futures exchanges, despite having some controls on the capital account.
FX futures volume has grown rapidly in recent years, and accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20).
| Rank | Name | Market Share |
|---|---|---|
| 1 |  Deutsche Bank | 20.96% |
| 2 |  UBS AG | 14.58% |
| 3 |  Barclays Capital | 10.45% |
| 4 | Royal Bank of Scotland | 8.19% |
| 5 |  Citi | 7.32% |
| 6 | JPMorgan | 5.43% |
| 7 | HSBC | 4.09% |
| 8 | Goldman Sachs | 3.35% |
| 9 | Credit Suisse | 3.05% |
| 10 |  BNP Paribas | 2.26% |
These spreads might not apply to retail customers at banks, which will routinely mark up the difference to say 1.2100/1.2300 for transfers, or say 1.2000/1.2400 for banknotes or travelers' checks. Spot prices at market makers vary, but on EURUSD are usually no more than 3 pips wide (i.e., 0.0003). Competition is greatly increased with larger transactions, and pip spreads shrink on the major pairs to as little as 1 to 2 pips.
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