The foreign exchange market is the market which is concerned with the purchase and sale of foreign exchange. It is a major and highly liquid financial market in the world. The increase in the volume of the foreign exchange turnover indicates the continuing growth of international trade and expansion in global finance and investment.

The London Exchange is the largest global foreign exchange market, well ahead of the US and Japan. Bulk of the trading is accounted for by a small number of currencies such as the US Dollar, Euro, Yen, Pound Sterling, Swiss Franc, Canadian Dollar and Australian Dollar.

Characteristics of foreign exchange market:

Size of the Market:

The size of the average daily global turnover in traditional foreign exchange market totaled $2.7 trillion in April 2006 according to the IFSL estimates of London, New York, Tokyo and Singapores semi-annual - Foreign Exchange Committee data. Overall turnover, including non-traditional foreign exchange derivatives and products traded on exchanges, averaged around $2.9 trillion a day. It is ten times the size of the combined daily turnover of the global equity market. Foreign exchange turnover enhanced by 37% between the time period of April 2005 and April 2006 and has more than doubled since 2001.

Trading Locations:

The foreign exchange market is an OTC market. There is no single physical or electronic market place where brokers/dealers negotiate directly with one another. The foreign exchange market does not have any central exchange or clearing house.

The largest trading centre is the UK, primarily London, which according to IFSL estimates has increased its share of global turnover in traditional transactions from 31.3% in April 2004 to 32.4% in April 2006. Other major trading centres include the US (with 18.2% global share), Japan (7.6%) and Singapore (5.7%). Rest of the trading is accounted by Germany, Switzerland, Australia, Canada, France and Hong Kong.

International Network of Dealers:

The foreign exchange market is an international

network of inter-bank traders, who make an active participation in the foreign exchange trading with customers as well as with each other. There are around 2,000 dealer institutions where foreign exchange activities are carried on and make up the global foreign exchange market. These dealer institutions are widely dispersed and are located in numerous financial centers around the world. Wherever located, these institutions are linked to, and in close communication with, each other through latest electronic communication devices.

The foreign exchange market functions in a truly global manner. It links the trading centers from around the world, into a single, integrated, and cohesive world wide market. The Foreign exchange trading takes place among dealers and other market professionals in a large number of individual financial centers: New York, Chicago, Los Angeles, London, Tokyo, Singapore, Frankfurt etc.

Each nations market is governed by its own rules and legislations. It enforces its own laws, banking regulations, accounting rules, and tax code, and it operates its own payment and settlement systems. Thus, even in a global foreign exchange market with currencies traded on essentially the same terms simultaneously in many financial centers, there are different national financial systems and infrastructures through which transactions are executed, and within which currencies are held. With access to all of the foreign exchange markets generally open to participants from all countries, and with vast amounts of market.

Dollar - Highly Traded Currency:

Char The US Dollar is the most extensively traded currency. Dollar constitutes around 87% of the global foreign exchange transactions. During peak volume periods, this figure can reach upwards of US$1.6 trillion a day. Dollar has global acceptance because of its variety or roles as:

* investment currency - capital markets;

* reserve currency - central banks;

* transaction currency - international commodity markets;

* invoice currency - contracts; and

Vehicle currency - foreign exchange.

The extensive trading of the dollar indicates that it acts as a vehicle in the foreign exchange transactions which strengthens and is strengthened by its international role in the finance and commerce. In case of many currencies the trade practice is to buy/sell a pair of currency against a common third currency as the vehicle, rather than to trade the currency directly against each other, the Dollar is used which acts as a medium for the foreign exchange transaction.

For example a trader wanting to shift funds from one currency to another Swiss Franc to Italian Lira, will sell the Swiss Franc for US Dollars and then sell the US Dollars for Italian Lira. Hence the entire transaction involves two steps rather than one, but it is the most preferred way.

Structure of the foreign exchange market:

The entire structure of the Foreign Exchange Market can be described as two divisions:

* Inter-bank Market or Wholesale Market

* Retail Market

Inter Bank Market:

The inter-bank market is composed of participants such as commercial banks, investment institutions, non-financial corporations and central banks. The average transaction size is very large and constitutes the bulk of commercial turnover. Among the participants in this market, primary price makers make a two way market to each other and to their clients. They perform an important role in taking positions off the hands of another dealer or corporate customer and offsetting these by doing an opposite deal with another entity. Among the primary price makers, there is a kind of tiering:

* A few giant multinational banks deal in a large number of currencies in large amounts and often deal dirctly with each other without using brokers. These transactions have significant influence in the market.

* In the second tier are commercial companies who deal in a small number of currencies and use the services of the broker more often

* Lastly, there are small local institutions which make market in a very small number of major currencies against their home currencies.

Retail market:

In the retail market, the market players make foreign exchange prices but do not make a two way market to each other. Restaurants, Hotels, Shops catering to tourists buy the foreign currency in payment of bills; some specialise in retail business for travellers and buy and sell foreign currencies and travellers cheques. The bid-ask spread or margin is wider than those of the interbank market.

Brokers:

Brokers play the role of an intermediary between two market players. Their main function is to provide information about the prices at which there are firm buyers and sellers in a pair of currencies. If a party indicates its willingness to buy/sell, broker transmits the information to the other party and collects a commission on conclusion of the deal.

Central banks:

The central banks play a pivotal role in the foreign exchange markets. They step in to the market in periodic intervals and control the economic variables such as money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They take steps to stabilize the foreign exchange market by releasing the forex reserves also.

Conclusion:

The Foreign Exchange Market is the over the counter market with a vast network of interconnected traders, market places and different currency instruments. There does not exist a single dollar rate but a range of different rates, depending on what bank or market the party is trading. It is lucrative to the investors due to its liquidity, volatility, and low-cost per trade. Today, it is accessible to any investor enabling him to diversify his portfolio. Hence, one can fully appreciate the excellent opportunities to increase their profits.