Foreign exchange markets comprise one of the largest markets in the world. It is also the most liquid market, given the huge diversity of stakeholders. Based on the aims, time horizons and risk appetite, agents in the market are divided into five main categories:
- Commercial banks: Commercial banks comprise 50% of the total market transactions and they typically make profits through market making.
- Multinationals: Multinational companies are major players in the forex market (representing 30% of total transactions) as they pay their foreign suppliers. They often enter the market to cover positions in their stocks and bonds portfolios.
- Central banks: Central banks influence exchange rates as they buy and sell currencies of their home country. Central bank transactions comprise 5 to 10% of total volumes in the market.
- Individual investors: Individual investors represent over 5% of the total transactions in the forex market. Their contribution has been steadily increasing, given the convenient availability of trading platforms and their leverage.
- Brokers: A forex broker offers traders access to the market. While some brokers only provide market access, others (such as market makers and banks) make profits through their customers’ operations (by offering bid price and a seller). The former only act as an intermediary between sellers and buyers and are typically paid the spread. Brokers also play an important role in market liquidity.
Foreign Exchange Markets: Functions
The main functions of foreign exchange markets include conversion of currencies and reducing risk in transactions. Different agents need foreign exchange for different reasons. For instance, companies need forex when they receive payments in foreign currency from foreign investments, profits, exports and licensing agreements. They need to convert foreign currency into their home country’s currency to be able to use them. Companies also need foreign currency to pay their foreign suppliers, to invest in a foreign country and so on. Besides, some companies also earn profits in foreign exchange markets by speculating on the forex rate movements.
Thus, foreign exchange markets help investors and traders swap currencies, in the process helping them make profits.
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