The foreign exchange market enables companies, fund managers and banks to buy and sell foreign currencies, if necessary in large amounts. The motivations behind this demand for foreign currency include capital flows arising from trade in goods and services, cross-border investment and loans and speculation on the future level of exchange rates. The sums involved are very large: estimated global turnover in all currencies in April 1998 was $1,490 billion, an increase of 26 percent over the past three years. Deals are typically for amounts between $3 million and $10 million, though much larger transactions are often done.
Foreign exchange trading may be for spot or forward delivery. Generally, spot transactions are undertaken for an actual exchange of currencies (delivery or settlement) two business days later (the value date). Forward transactions involve a delivery date further into the future, possibly as far as a year or more ahead. By buying or selling in the forward market a bank can, on its own behalf or that of a customer, protect the value of anticipated flows of foreign currency, in terms of its domestic currency, from exchange rate volatility.
Unlike some financial markets, the foreign exchange market has no single location - foreign exchange is not dealt across a trading floor. Instead, trading is via telephone and computer links between dealers in different centres and, indeed, different continents. London is the world?s largest foreign exchange centre: average daily turnover is $637 billion. This is approximately the same as the combined level of trading in the United States, Japan and Singapore.
London?s leading position arises partly from the large volume of international financial business generated here - insurance, bonds, shipping, equities, commodities and banking. London also benefits from its geographical location which enables firms located here to trade not only with each other and with firms based in Europe throughout the day, but also with the US and the Far East, whereas their time difference makes it difficult for firms in those two centres to trade with each other. When banks in London begin trading at 8 am they can deal with banks in Tokyo, Hong Kong or Singapore whose trading day is just ending. From about 1 pm onwards, London banks can trade with banks in New York; before they close at 4 pm their counterparties may be in Los Angeles or San Francisco. This is important because the foreign exchange market trades 24 hours a day: 66 percent of trades involving a firm in London are transacted with a counterparty located abroad.
Source: Bank of England
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