1. Global Forex markets
By A.V. Vedpuriswar
February 28, 2009

2. Introduction International Trade - Barter Gold Standard (1879 - 1934)
Bretton Woods ( )
1960s: Decline of U.S Economy
1971: Devaluation of Dollar
Managed / Dirty float
America, Germany first to free capital flows
Britain, 1979, Japan, 1980 (mostly)
France, Italy remove restrictions in 1990
Currency Board in Hongkong, Argentina
Dollarisation

3. Overview of market
Players : Individuals, corporate banks, central banks  and securities firms
More than 97 % or trading is speculative.
Trading almost around the clock.

4. Major forex trading centres
Auckland
Sydney
Tokyo
Singapore
Frankfurt
Zurich
Paris
London
New York

5. Daily trading pattern Peak trading during European waking hours.
New York most active when Europe is open.
During afternoon, New York becomes more volatile.
Worst time to trade - after New York closes but Sydney has not opened.

6. Unique features of forex markets
The foreign exchange market is unique because of
its trading volumes
the extreme liquidity of the market
the large number of, and variety of, traders in the market
its geographical dispersion
its long trading hours: 24 hours a day (except on weekends)
the variety of factors that affect exchange rates
the low margins of profit compared with other markets of fixed income
the large amount of profits due to very large trading volumes
As such, it has been referred to as the market closest to the ideal of perfect competition.

7. Bid Ask Spreads
Unlike a stock market, where all participants have access to the same prices, the forex market is divided into levels of access.
At the top is the inter-bank market, which is made up of the largest investment banking firms.
Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and usually unavailable, and not known to players outside the inner circle.
As we move to the next level of access, the difference between the bid and ask prices widens.
This is due to volume.
Traders who can guarantee large numbers of transactions for large amounts of currencies, can demand a smaller difference between the bid and ask price.

8. Below the top-tier, are usually smaller investment banks, followed by large MNCs (which need to hedge risk and pay employees in different countries), large hedge funds, and some retail forex market makers.
Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in in FX markets, since the early 2000s.
Hedge funds grew markedly over the 2001–2004 period in terms of both number and overall size.
Central banks also participate in the forex market to align currencies to their economic needs.

9. Country’s choice of exchange rates
Openness
Size
Export dependence on a few commodities
Capital A/C Convertibility
                   

10. Openness
Relatively closed economies may find it difficult to correct external imbalances   using domestic policies.
They would prefer flexible exchange rates.
On the other  hand, open economies would prefer fixed exchange rates.

11. Size Small countries tend to prefer fixed exchange rates.
Economic policy can be   tailored to  meet the needs of the economy as a whole.
In a diversified large   economy, flexible rates are preferable.

12. Export dependence on a few commodities
Fixed exchange rate is preferable.
Otherwise there may be disruptive effect on economy.

13. Capital A/C Convertibility
Heavy inflows and outflows of capital create considerable difficulties in  maintaining fixed exchange rates.
So countries which allow free flows of capital may prefer floating exchange rates.
    
              

14. How Currency Boards operate
A currency board's foreign currency reserves must be sufficient to ensure that all notes and coins holders can convert them into the reserve currency.
A currency board maintains absolute, unlimited convertibility between its notes and coins and the currency against which they are pegged, at a fixed rate of exchange, with no restrictions on current-account or capital- account transactions.
A currency board only earns profit from interest on reserves (less the expense of note-issuing), and does not engage in forward-exchange transactions.

15. How Currency Boards operate.
A currency board has no discretionary powers to effect monetary policy and does not lend to the government. Governments cannot print money, and can only tax or borrow to meet their spending commitments.
A currency board does not act as a lender of last resort to commercial banks, and does not regulate reserve requirements.
A currency board does not attempt to manipulate interest rates by establishing a discount rate like a central bank.
The peg with the foreign currency tends to keep interest rates and inflation very closely aligned to those in the country against whose currency the peg is fixed.

16. Global currency crises
1994- Mexican Peso crisis
1997- Asian currency crisis
1998- Brazil/Russia
What were the causes?
Weak financial systems
 Poor supervision and regulation
 Too much short term borrowing
 False security of stable exchange rates
 Once crisis struck, contagion effects because of interconnected financial markets.

17. Key points to note
Floating exchange rates can overshoot but allow country to retain independence as far   as monetary policies are concerned .
This freedom is however more limited than it  looks prima facie.
For example, Indian interest rates cannot be set completely independent of the Fed.
Fixed rates mean subservience to monetary policies of another country.