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The foreign exchange is an act through which currencies of different nations are traded. A currency assumes the value of the currency of the nation where it is used. Most of the assets that are traded in foreign exchange markets are bank deposits. The rates of change are considered in this concept as the price of the currency of a given currency in terms of a currency of a different nation. There exist two forms of exchange rates, firstly, in reference to time of exchange of the real currency; in this case, cash is regarded as the value for a transaction (time is in reference to a maximum of two days). The second case is where the exchange rate is the value that occurs after some times, between one and four months. The foreign exchange market is a forward market. In contrast to stock market, the foreign market is dominated by few financial organizations, which are not geographically positioned. This market has no boundaries (there is only one foreign exchange market in the world). The currency exchange is globally simultaneous. Considering its special feature of being global, the market is an economic organ that lacks proper regulations and rules; it becomes self regulatory by private and public intervention. Though global, the market is irregularly concentrated on financial markets of certain nations (Kriljenko, 2004).
The market is characterized by risky transactions such as risk of capital loss that is associated with the possible changes of exchange rate in future. The risk has been on the rise since 1970s, where there has been a large amount of floating currencies accompanied by the growth of international financial and commercial transactions. The exchange fluctuation rates create two types of attitudes on the market. The first market consists of traders unwilling to bet on the possible rate of exchange in future. Such traders are exposed to risk in their course of transactions. The other market consists of traders who take risk of the market to realize a gain. Practically, foreign exchange trader must have varying degrees of combination of the two attitudes.
Recently, the foreign exchange market has been attracted many traders; the market has become a priority for the international investors. The main characteristics of foreign exchange market are discussed below.
No trading field
The financial market in Europe and US is made up of two sets of structure: the centralism business operations where there is no any fixed field for this trade network and in contrast to it, stock trading, which is conducted in stock exchange, such as New York Stock Exchange in US, London Stock Market in UK, and the Tokyo Stock Exchange in Japan. In case of stock market, traders are able to sell and buy commodities via brokerage companies, giving this form of trade a trading ground and trading market. However, the foreign exchange trade is carried out without any business network or any unification operation-trading field; it lacks centralism-unified ground as in the case of stock exchange. The foreign exchange market is universal, with parties without formal organization. This market depends on advanced communication and information structure. Foreign exchange marketers do not entail any membership qualifications for individual or organizations, but it is based on participators approvals and trust amongst them. The form of foreign exchange market without trading field is known as “consist of market but no trading ground”. The brokers in the foreign exchange markets are not necessary regulated or certified by the governing bodies.
Given the differences in the geographical location of various financial centers and the differences in time relations, the trade in the foreign exchange has become 24 hours trade globally. Various markets close and open their trades at differing time due to their location in terms of GMT. Thus there is 24hours uninterrupted process, making the foreign exchange market 24 hours trade globally, closing only on given days such as weekends and during public holidays of respective nations. With this nature of continuity in operation, investors have a non-spatial or time barred outlets, while the traders in this market are free to trade in the best available opportunity. For example, a trader in the foreign exchange market may buy a Japanese currency in the morning at Nairobi market, and sell it in the New York market that is offering a better price in the evening. The participator in this market does not need to be a specific place to trade in the foreign exchange market. A trader can participate in different markets from the same geographical position. Given that he/she can trade simultaneously in different markets, the foreign market lacks time and spatial barriers (Ishii, 2006).
A Zero-Sum Game
In the case of stock market, any rise or drop of the stock market is a likely factor to influence the value of the given stock either upwards or downwards depending on the direction of change in the stock market. For example, the US new date gold stock price falls from 200 dollars to 150 dollars, the value of this stock has dropped by 50%. Nevertheless, in the case of foreign exchange market, the value of currency and that of stock are calculated differently. This is because the involved exchange rate is in reference to the exchange ratio for both currencies that are trading. The exchange rate will have influence on one kind of monetary value to drop while indirectly, the other currency monetary value rises. A case scenario is when some time ago, the Japanese Yen could trade at 360 for 1 US dollar, however, after Yen added value, 1 US dollar could buy only 110 Japanese Yen. This illustration is an indicator of a rise on the Japanese currency in the market at that time lapse, but at the same time, the US dollar had a drop in value in reference to Yen. Therefore, according to some scholars the market characteristic of rise on one currency and fall on the other currency value is referred to as “a zero-sum game”, as exactly viewed in the wealth change of hand.
The major purpose of the foreign exchange market is the transfer of the purchasing power. This transfer of power is done between the nations. Whenever there is a trade, partners are allowed to convert the currency revenues into their respective domestic currencies. The rise of purchasing power of one currency may transform to drop of the other currency that is trading with the rising currency. The foreign exchange market also provides credit for the international trades, avoiding exchange rate devastation. In regards to the international trade, the foreign exchange become helpful since it improves the movement of goods and services among countries offering credit for financing.
The Participant Characteristics
There are two major parts of the foreign exchange market, the interbank also known as wholesale market, and the client part, also called retail market. The non-bank and bank foreign exchange traders are those who buy at bid prices and later sell the currencies at the asking prices. This has helped the efficiency and effectiveness of the entire market. The thing to note is that, through these transactions the dealers can make up to 20% profits.
The client part consists of exporters, importers, and other portfolio investors. They use foreign market to invest, while others use the market to reduce their risk. A speculator operates to simply to make money from the market. They do not take any risk that is present in the rise and fall of the rates of currencies. The other group of participators in the foreign markets is brokers; their role is to facilitate the trade though they are not partners in the transaction. They usually earn from the fee they charge the participator.