The financial system and trading of currencies among banks and financial institutions, excluding retail investors and smaller trading parties. While some interbank trading is performed by banks on behalf of large customers, most interbank trading takes place from the banks' own accounts. |||The interbank market for forex serves commercial turnover of currency investments as well as a large amount of speculative, short-term currency trading. According to data compiled in 2004 by the Bank for International Settlements, approximately 50% of all forex transactions are strictly interbank trades.
An agreement set forth by the Foreign Exchange Committee that reflects the best practices for transactions in the foreign exchange market. IFEMA was published in 1997 and sponsored by the British Bankers Association, Canadian Foreign Exchange Committee and the Tokyo Foreign Exchange Market Practices Committee. |||IFEMA is a standardized agreement between two parties for the exchange of currency. The agreement covers all facets of the transaction, providing detailed practices on the creation and settlement for a forex contract. In addition to the terms of a contract, IFEMA explains the consequences of default, force majeure or other unforeseen circumstances.
An economic theory that states that an expected change in the current exchange rate between any two currencies is approximately equivalent to the difference between the two countries' nominal interest rates for that time. Calculated as: Where:"E" represents the % change in the exchange rate"i1" represents country A's interest rate"i2" represents country B's interest rate |||For example, if country A's interest rate is 10% and country B's interest rate is 5%, country B's currency should appreciate roughly 5% compared to country A's currency.The rational for the IFE is that a country with a higher interest rate will also tend to have a higher inflation rate. This increased amount of inflation should cause the currency in the country with the high interest rate to depreciate against a country with lower interest rates.
The market in which participants from around the world are able to buy, sell, exchange and speculate on different currencies. International currency markets are made up of banks, commercial companies, central banks, investment management firms, hedge funds, retail forex brokers and investors. Watch: Forex Market Basics |||Because the international currency markets are large and liquid, it is thought that they are extremely efficient. International currency transactions do no occur on a single exchange, but in a global computer network of large banks and brokers from around the world.
The rate at which two currencies in the market can be exchanged. International currency exchange rates display how much of one unit of a currency can be exchanged for another currency. Currency exchange rates can be floating, in which case they change continually based on a multitude of factors. Alternatively, the exchange rates of some foreign currencies are pegged, or fixed, to other currencies, in which case they move in tandem with the currencies to which they are pegged. |||International currency exchange rates are important in today's global economy. Knowing the value of your home currency in relation to different foreign currencies helps investors to analyze investments priced in foreign dollars. For example, for a U.S. investor, knowing the dollar to euro exchange rate is valuable when choosing European investments. A declining U.S. dollar could increase the value of foreign investments, just as an increasing U.S. dollar value could hurt the value of foreign investments.
An electronic program that allows for the quick conversion of currencies. An international currency converter can convert the value of one currency to another, such as dollars to euros. Converters will typically use the most recent market prices in the foreign exchange market. |||Currency converters are usually free of charge when found online, and are useful when determining how much of your home currency (base currency) you will need to exchange when traveling to a foreign country. For example, if a U.S. resident travels to England, he or she will need to exchange U.S. dollars for Great Britain pounds. An online currency converter could be used to determine how much base currency would be required to buy a predetermined about of the foreign currency.
A theory that the interest rate differential between two countries is equal to the differential between the forward exchange rate and the spot exchange rate. Interest rate parity plays an essential role in foreign exchange markets, connecting interest rates, spot exchange rates and foreign exchange rates. |||The relationship can be seen when you follow the two methods an investor may take to convert foreign currency into U.S. dollars. Option A would be to invest the foreign currency locally at the foreign risk-free rate for a specific time period. The investor would then simultaneously enter into a forward rate agreement to convert the proceeds from the investment into U.S. dollars, using a forward exchange rate, at the end of the investing period. Option B would be to convert the foreign currency to U.S. dollars at the spot exchange rate, then invest the dollars for the same amount of time as in option A, at the local (U.S.) risk-free rate. When no arbitrage opportunities exist, the cash flows from both options are equal.
A differential measuring the gap in interest rates between two similar interest-bearing assets. Traders in the foreign exchange market use interest rate differentials (IRD) when pricing forward exchange rates. based on the interest rate parity, a trader can create an expectation of the future exchange rate between two currencies and set the premium (or discount) on the current market exchange rate futures contracts. |||The IRD is a key component of the carry trade. For example, say an investor borrows US$1,000 and converts the funds into British pounds, allowing the investor to purchase a British bond. If the purchased bond yields 7% while the equivalent U.S. bond yields 3%, then the IRD equals 4% (7-3%). The IRD is the amount the investor can expect to profit using a carry trade. This profit is ensured only if the exchange rate between dollars and pounds remains constant.
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