Types Of Foreign Exchange Markets
Being the world’s largest market, wholesale FX, otherwise known as forex exchange market or forex market, has a direct impact on local and national economies. Meanwhile, the government, central banks, corporations and traders engage in daily currency exchanges.
In addition to operating 24 hours a day, except on weekends, the market has high liquidity. Due to its decentralized nature, it is not controlled by governments or institutions. Traders also negotiate directly with one another.
Exchange rates can fluctuate based on factors such as interest rates, capital flows, money supply, inflation and others. Fluctuations in these markets have a direct effect on cross-border investments and on buying power.
Foreign Exchange Market As A Concept
A foreign exchange market, which is also called the forex market, is a global marketplace where currencies are traded. This is a decentralized market where foreign exchange can be bought and sold. In an over-the-counter market, foreign exchange rates are determined by their activity. This involves buying, selling, and exchanging currencies at market rates.
In that regard, here are 5 types of foreign exchange markets:
- The Spot Market: It refers to the wholesale FX market used by banks, governments, and investment funds to buy and sell foreign currency. It is mostly used for currency pairs. A transaction requires instant payment at the current exchange rate, also known as the spot rate. The traders on the spot market are not exposed to the uncertainties of the market, which can affect the price between an agreement and trade.
- Futures Market: Futures market operations are based on a previously agreed-upon exchange rate, referred to as the future rate. In a formal transaction, the terms of the agreement are set in stone and cannot be changed. A consistent return on assets can be relied upon by the traders who conduct the majority of the transactions. The majority of regular traders prefer to transact on the future market.
- Forward Market: The third type of foreign exchange market is the forward market, in which transactions are similar to those on future markets. In this case, the parties have the opportunity to negotiate the terms of the transaction, which can be amended as needed to suit the concerns of the parties involved. Forward markets are, however, more flexible as opposed to futures markets.
- Swap Market: A swap transaction occurs when two investors borrow and lend two different types of currencies simultaneously. One investor borrows a currency from the second investor and pays it back in a second currency. In this transaction, they are paying off their debts without having to deal with foreign exchange risk.
- Option Market: The investor in the options market agrees on the currency exchange rate and the date on which one denomination will be exchanged for another. If the investor wants to convert the currency at a later date, they are not obliged to do so.
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