From the contraction of the words Foreign Exchange, Forex is the nickname given to the universal exchange market, where currencies are traded against each other, exchange rates that vary continuously.

Economic Importance
This global market, which is essentially interchange is the second market of the world in terms of overall volume, behind the interest rates. It is nevertheless the most concentrated and the first for the liquidity of the most treaties, such as the euro / dollar.

To give an idea of liquidity in circulation, the daily volume of trade in 2004, 1 900 billion U.S. dollar, namely:
600 billion in spot transactions and 1 300 billion in futures almost solely in transactions over the counter, according to the three-year study of the Bank for International Settlements (BIS).

Transaction volume, were  53% between banks;
33% between a bank and a fund manager or a non-bank financial institutions;
and finally to 14% between a bank and a non-financial.
In every major bank, the operators (the traders) are the 3 × 8, though generally in different locations. A team based in Asia or Australia succeeds another located in Europe and a third located in North America, and so on.

However, despite the global nature and the release schedule between continents, a large (31% of total volume, according to the BIS) of market activity is still physically located in London.

In its latest triennial review, the BIS (Bank of International Settlements) has shown that an increasing number of individuals choose to invest in the Forex. Although they still represent a very small minority of transactions and volumes, a dedicated private investors has grown in parallel. Simply record the number of trading platform available to them on the internet as well as tools for real-time information once reserved for professional traders in the rooms. Now, the active trader of foreign exchange market can invest minimum amounts and due to the existence of leverage-trader in almost (!) Similar to those of the professional trader. Information tools in real-time broadcast news and information forex fundamental (economic indicators) and offer individuals the possibility of trading conditions in real time.

The foreign exchange market has existed in its present form, called floating exchange rate regime since March 1973 and the abandonment of fixed exchange rates of various currencies against the dollar standard Bretton Woods in 1944.

Treated products

Cash (called spot), the main parities were processed in 2004, according to BIS:

the euro / dollar – 28%
the dollar / yen – 17%
the sterling / dollar (cable said in English) – 14%
Despite the strong development of the euro, the dollar remains the dominant center, present in 89% of transactions (37% against the euro, 20% for the yen and 17% for the pound sterling, all on a total of 200% since each transaction involves two currencies). For a non-European currency XXX, a transaction between the euro and the currency is usually split into a EUR / USD and USD / XXX.

Change Term
The exchange term is divided into two products, both interbank term dry (it is said outright in English), rather little treaty, and foreign exchange swaps. Unlike other financial markets, futures held were never imposed on the foreign exchange market and remain marginal.

Options Exchange
Finally, the options market exchange is the most diverse and most inventive of the options markets. He is responsible for virtually all forms of so-called exotic options or second generation (barrier options, Asian options, options on options, etc..).

Trading and Foreign Exchange

Coverage (hedging)
The principle is to take opposite positions in order to cancel the risks.

This is to anticipate the movements of the market through a more or less advanced financial environment, economic and political. The advantage of anticipating the movements of foreign exchange speculation. For this, many information sources available to the forex trader (Reuters, Telerate, Bloomberg LP) to access to all quotes and financial information for trading. It also has access to economic indicators of major countries and global financial information. It is capable of forming an opinion on prices or rates and to anticipate future movements.

It is to try to take advantage of price discrepancies or occasional courses on the same medium, the same currency on 2 different markets. The diverter can perform these operations on a single market such as spot-on or several markets such as foreign exchange swaps. Powerful tools (called pricers) allowing it to calculate different prices or interest in a transaction arbitration. This strategy requires a response and stress management in real time from the trader.

Exchange Rates
Electronic exchange rate between monnaies.Le exchange rate of a currency (a currency) is the price (ie price) of that currency relative to another. Also referred to as the “parity of a currency.”

Exchange rates, listed on the exchange markets, vary continuously, they also vary depending on the place of listing.

For example, the exchange rate of the euro dollar will be noted: EUR / USD = 1.3120 and the dollar rate will be noted in yen USD / JPY = 89.4454.

(EUR = Euro, USD = U.S. dollar, yen JPY =, GBP = pound sterling by International Monetary coding, ISO 4217 distinguishing each currency by a three-letter abbreviation, cf. Complete list)

Exchange rate fixed or floating
This exchange rate of a currency is:
Either fixed, ie constant relative to a reference currency (usually the U.S. dollar or the euro), by decision of the State that issues that currency. The rate can not be amended by a decision of devaluation (or revaluation) of that State. A State may decide not to adopt any exchange rate of its currency. If the fixed exchange rate at a level too high or too low, the exchange rate could be “attacked” on the foreign exchange market. If monetary authorities are unable to cope (through their foreign exchange reserves), they should change their parity.

Is floating and determined for each transaction by the balance between supply and demand in the foreign exchange market. This is a global interbank currency, less centralized places specific quotation and trade, as based on links between banks.

The exchange rate:
is an “spot”, ie “spot” for immediate purchases and sales of currencies. Generally the deadline for delivery of foreign currency is less than 2 days.
is a course forward, “ie” forward “for foreign exchange transactions due to future, more than 2 days. The mission is to manage the risk. It is an agreement today to set the price at which we buy / sell the currency.

Factors affecting the exchange rate:
The exchange rate is determined by supply and demand of both currencies: if demand exceeds supply, the price increases.

Since the currency of a country is essentially a claim held on the central bank of this country, detention of a foreign currency can be seen as holding a claim to “view” on the country that has issued.

In the short term
The exchange rates vary widely during a single day, these variations can not be explained by the theory of Purchasing Power Parity (PPP) previously described. Within this framework of short-term analysis, it is necessary to refer to other explanations.

These daily changes based on the concept of early return of deposits in foreign currencies. Economic agents will determine their demand for different currencies depending on the return they expect deposits in these currencies.

In the long term
Recovery rate of euro-dollar exchange rate from January 1972 to January 1999 from the exchange rate of the franc french or Deutschemark. In the long term, currencies should theoretically be closer to equilibrium parities obtained from structural parameters. Imbalances and, more rarely, the balances in the valuation of currencies, are measured on the basis of purchasing power parities (PPP). It is a complex statistical exercise, which is to compare over time the purchasing power of a consumer model in a country and a range of consumer products up with another consumer-type in a different country and for a range of consumer goods desired close, but correspond to other local practices in terms of lifestyle and cost structure. In practice, generally the U.S. dollar as currency of the joint index and true each time compare the purchasing power of a consumer-type of country X and that of a typical American consumer.

The purchasing power parity, if it is useful for international comparisons of living standards, where margins of error of a few percent are not significant, its use in analysis of the foreign exchange market should be done with the utmost caution.

Currency crisis
A country will suffer a currency crisis when the capacity to repay external debt (public and private) denominated in foreign currency of the country is highly in doubt (crisis of confidence). The outflow of capital in the short term then drop the exchange rate of the currency, making repayment even more difficult.

Economic role of exchange rates
Exchange rates (and interest rates, which are closely related) are of course on import prices and export. They have an influence on the direction of capital flows between economic areas.

As a result, countries and economic areas may be tempted to influence exchange rates, often under the pretext of preventing speculation (in fact these manipulations tend to encourage), and in order to improve (lower rate).

Operation of foreign exchange markets

Case of the euro / dollar
The exchange rate says euro / dollar is the euro figures in U.S. dollars, hence the slash (not to be confused with Eurodollars).

Financial instrument
is the most active and most addressed the world: 27% of total spot transactions. Its value is an indicator monitored not only by economic and financial circles, but also by the media, both specialized and general, throughout the world.

This definition is in fact, the external value of the euro against the U.S. dollar.

Profession (FX)
Those who conduct foreign exchange transactions are called professional traders.

Banks in particular have teams of traders, both to do the clean of these institutions on the market to meet the changing needs of their clients, for example on business, for their international trade. They act as market makers, ie that they “are prices” for a quantity is specified as standard, and provide both when they buy (bid, in English) and to whom they sell (ask in English), for example: 1 EUR = 1.2343 / 1.2346 USD.

Round lots
The traders expressed the unity of listing an exchange rate on a currency pair in dots called pips. Pip stands for “price interest point” or a “swap” in french. At the outset, as its name suggests, it meant the unit “off” or “report” of the exchange term, but eventually be applied to the unity of the market. It refers to the last decimal used: in the case of the euro, the fourth decimal place. A listing on three “pips,” which is standard on the interbank market of the euro / dollar, will in the first example (EUR / USD = 1.3120) of paragraph 1 above: EUR / USD = 1.3120 (bid ) / 1.3123 (ask). Is a spread of 3 pips in the case of the yen, it will be the second decimal, and a listing four “pips” will be, again to the above example, USD / JPY = 89.4454 (bid) / 89.4654 (ask ).

The pip represents a different percentage and not fixed for each parity. This difference depends on the currency in which we choose by convention to express the exchange rate (the “uncertain” of the comparison), the other being taken for unit of goods (the “certain”), the number of decimal listing.
These differences between the current “buyer” and “seller” of a currency against another are much less of an individual can see when they wish to conduct a foreign exchange transaction in a pharmacy exchange (or his bank) for a modest amount.

In the first instance, the percentage (minimum) to a foreign exchange on Forex of 100 000 euros (the standard transaction is not in the tens of millions), it should be noted that for such a pip amount exchanged is 10 dollars. In the second example, the percentage of a foreign exchange of 100 000 dollars a pip for that quantity is 1 000 yen (about $ 9).

Exchange rate mechanism European
The exchange rate mechanism in Europe, or ERM, is an exchange rate mechanism introduced by the European Community in 1979 to statibiliser prices of European currencies, to prevent risks and increase confidence in the currency in the medium and long term inflation and promote trade and activity in the intra-EU trade.

Originally named “European Monetary System,” it was considerably revised in its operation by the Maastricht Treaty was ratified in 1992 establishing the European Union, in preparation for its economic and monetary union and single currency.

Since the introduction of the euro on 1 January 1999, was revised and replaced by the ERM II and is an agreement between the ECOFIN Council, bringing together all member countries of the European Union, the European Central Bank and banks central banks of the Member States of the European Union outside the euro area.

For Member States not participating in the European single currency, a second exchange rate mechanism in Europe, said ERM II, was put in place. During the negotiation of the Maastricht Treaty by the 12 EU members, and 3 new buyers (Finland, Sweden and Austria), it was expected that all members of the previous ERM and all new members join the Union must be in EMU (if eligible) or in ERM II. ERM has ended, but Sweden (despite his signing of the Treaty) and the United Kingdom (which has chosen to retire but was not allowed to do so) have not joined the ERM II. Such exemptions are no longer permitted for new candidate countries, who must first accept the convergence of their economies and participation in ERM II (and the EMU as soon as conditions are met) with a timetable set out in the Accession Treaty.

ERM II is based on the euro only, ie on the common unit of the only countries which joined the euro (and not on the ECU which was calculated on all currencies the European Union) and tolerates a difference of 15% around an initial exchange rate between the currency and the euro. This reduction of basis for determining rates of exchange from outside also should help stabilize and distribute the budget on a more equitable. However, this reduction of the base included a risk to the fixing of this budget, if insufficiently European countries joining the euro. This was not the case, and almost all countries of the European Union have all joined since the launch of the euro, which helped to end at the same time to the ECU and therefore also in ERM (at least formally, some financial institutions have continued to calculate until approximately 2001, as a index, but considering the weight of the euro in the old basket of currencies, although the composition of the euro has changed since then, and the methods of calculating contributions to the EU budget).

Since the introduction of the euro on 1 January 1999, the parity between the euro and the former national currencies of member countries joining the euro became fixed and irrevocable. Other countries have ratified the Treaty of Maastricht (or its successor) are committed to converge their economies in order to avoid economic distortions related to their exchange rate, not to resort to devaluation, let the market set the price of their currency in terms of their economic performance. To achieve to keep exchange rates stable around a pivot defined by membership in ERM II, the maximum fluctuation of ± 15%, they pursue a common policy of economic convergence criteria, and a healthy managing their public finances in the short and long term.

These criteria are assessed by the Council of Finance Ministers of the Union, ECOFIN, in collaboration with the European Central Bank and national central banks of EMU members. If the economic convergence criteria are met for a minimum period of 2 years, the participants receive the approval of the ECOFIN Council to enter the euro, and their national central banks (NCBs) can adhere to the ECB, and finally, when this integration is achieved (by the filing of the signatures of instruments of ratification and financial conditions, the approval of representatives of the NCBs and the money to convert, and the revenue guarantee funds deposited at the ECB), ECB fixed in accordance with the ECOFIN Council, the irrevocable conversion rate between their currency and the euro, taking into account the recent fixations official foreign exchange markets and adjustments based on the assets and international financial commitments of the NCB adhering to the day of closing.

All the countries aspiring to join the euro must first subscribe to the ERM II. This was the case for Greece in 2000 and 2001 before joining the euro. This is already the case of Estonia, Lithuania, Latvia, Malta and Cyprus, as well as in Slovakia since November 2005. By integrating the euro zone, Slovenia left the ERM II on 1 January 2007.

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Source by Anil Kumar Raju Addipalli