CHAPTER I -INTRODUCTION

The foreign exchange market is the biggest financial market in the world. Every day,
transactions worth about 3.98 trillion dollars are carried out within the market. The major aim
of introducing the foreign exchange market is to facilitate international trade by enabling
businesses to perform transactions outside their local currency. The market operates round the
clock from Monday through Friday. Foreign Exchange is the simultaneous Buying of one
currency and paying for it with another at an agreed price (exchange rate) for settlement on
an agreed date. FOREX is an acronym for FOReign Exchange. In the foreign exchange
market today, a trader can purchase some amount of international currencies by paying with a
different currency. This type of foreign exchange market started to develop in the 1970s,
which was about thirty years after foreign exchange was introduced. Some important features
about the FX market include the following:
1. It has a very large number of daily participants. This makes its liquidity one of the highest
in the world.
2. Participants come from several countries in the world.
3. The market is open from 22:00 GMT on Sunday to 20:00 GMT on Friday.
4. Exchange rates are affected by a number of factors.
The foreign exchange market is a global phenomenon with two main functions: to convert the
currency of one country into the currency of another, and to minimize the risk of changes in
foreign exchange rates. These functions create three defining characteristics: the foreign
exchange market is decentralized, never ceases, and is constantly changing wealth. Involving
many billions of US dollars, the foreign exchange market involves agents as large as
multinational corporations to the very small, such as an international tourist trying to change
one currency into another.
The world relies on the foreign exchange market. When buying foreign goods and services or
investing in other countries, individuals and companies need to purchase the currency of the
country where they are transacting business. Currencies are traded everyday in the FX market
to be used for direct foreign investments, import and export needs of companies and
individuals, purchases of foreign instruments, and managing existing positions.
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Characteristics of the Foreign Exchange Market

The Forex Market does not exist physically. It is a framework in which participants are
connected by computers, telephones and telex (SWIFT) and operates in most financial
centers globally. Most exchanges of currency are made through bank deposits that are
transferred electronically from one account to another. The volume of foreign exchange
transactions worldwide is assumed to be approximately USD 5 trillion per day in October
2006. The Forex Market is an over-the-counter market that is trading in financial instruments
that are not listed or available on an officially recognized exchange, but traded in direct
negotiation between buyers and sellers. Trading takes place telephonically or electronically.
Foreign exchange markets operate 24 hours per day. It is said that the foreign exchange
market follows the sun around the earth. Twenty four hours market means that exchange rates
can change at any time due to change in market conditions or other events at anytime and
anywhere. This demands alertness on the part of dealers to the possibility of a change in
exchange rate anywhere. Foreign exchange transactions do not take place evenly throughout
the day. Transactions are heavy when markets in USA and Europe are open that is when it is
morning in New York and afternoon in London.
Why do we make use of the Foreign Exchange Market?
Trading in a domestic market is substantially different from doing business in an offshore
market. In the complex world of international trade, merchants face a number of risks that
need to be managed in order to ensure the success of their crossborder transactions. In order
to protect themselves, these corporations apply hedging techniques using various foreign
exchange instruments and products in order to negate the impacts of exchange rate
fluctuations. Successful companies employ effective risk management techniques when
making business decisions, and evaluate commercial risk in an explicit and logical manner in
order to offset financial loss occasioned by the volatility in exchange rates (currency risk).

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History of Foreign Exchange Market

The foreign exchange market as we know it today originated in 1973. However, money has
been around in one form or another since the time of Pharaohs. The Babylonians are credited
with the first use of paper bills and receipts, but Middle Eastern moneychangers were the first
currency traders who exchanged coins from one culture to another. During the middle ages,
the need for another form of currency besides coins emerged as the method of choice. These
paper bills represented transferable third-party payments of funds, making foreign currency
exchange trading much easier for merchants and traders and causing these regional
economies to flourish. From the infantile stages of forex during the Middle Ages to WWI, the
forex markets were relatively stable and without much speculative activity. After WWI, the
forex markets became very volatile and speculative activity increased tenfold. Speculation in
the forex market was not looked on as favorable by most institutions and the public in
general. The Great Depression and the removal of the gold standard in 1931 created a serious
lull in forex market activity. From 1931 until 1973, the forex market went through a series of
changes. These changes greatly affected the global economies at the time and speculation in
the forex markets during these times was little, if any.

The Bretton Woods Accord

The first major transformation, the Bretton Woods Accord, occurred toward the end of World
War II. The United States, Great Britain and France met at the United Nations Monetary and
Financial Conference in Bretton Woods, N.H. to design a new global economic order. The
location was chosen because, at the time, the U.S. was the only country unscathed by war.
Most of the major European countries were in shambles. Up until WWII, Great Britains
currency, the Great British Pound, was the major currency by which most currencies were
compared. This changed when the Nazi campaign against Britain included a major
counterfeiting effort against its currency. In fact, WWII vaulted the U.S. dollar from a failed
currency after the stock market crash of 1929 to benchmark currency by which most other
international currencies were compared. The Bretton Woods Accord was established to create
a stable environment by which global economies could restore themselves. The Bretton
Woods Accord established the pegging of currencies and the International Monetary Fund
(IMF) in hope of stabilizing the global economic situation. The Bretton Woods Accord lasted

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until 1971. Ultimately, it failed, but did accomplish what its charter set out to do, which was
to re-establish economic stability in Europe and Japan.

The Beginning of the free-floating system

After the Bretton Woods Accord came the Smithsonian Agreement in December of 1971.
This agreement was similar to the Bretton Woods Accord, but allowed for a greater
fluctuation band for the currencies. In 1972, the European community tried to move away
from its dependency on the dollar. The European Joint Float was established by West
Germany, France, Italy, the Netherlands, Belgium and Luxemburg. The agreement was
similar to the Bretton Woods Accord, but allowed a greater range of fluctuation in the
currency values. Both agreements made mistakes similar to the Bretton Woods Accord and in
1973 collapsed. The collapse of the Smithsonian agreement and the European Joint Float in
1973 signified the official switch to the free-floating system. In 1978, the free-floating system
was officially mandated. In a final effort to gain independence from the dollar, Europe
created the European Monetary System in July of 1978. Like all of the previous agreements,
it failed in 1993.

Market Size and Liquidity

Liquidity in the forex market is the highest among other financial markets in the world. The
market comprises central banks, currency speculators, organizations, governments, retail
investors and international investors. Over the years, the size of the FX market has been
constantly increasing. In 2010, The Triennial Survey by the Bank of International Settlements
reported that the average daily transaction in the US for the month of April was $3.98 trillion.
This was much greater than the $1.7 trillion recorded in 1998. The UK had about 36.7% of
the traders in the market to make it the highest contributor in foreign exchange trading.
Second on the list was USA, which had about 17.9% traders while Japan was third with 6.2%
of the total exchangers from the country. Turnover of exchange-traded foreign exchange
futures and options have grown rapidly in recent years, reaching $166 billion in April 2010
(double the turnover recorded in April 2007). Exchange-traded currency derivatives represent
4% of OTC foreign exchange turnover. Foreign exchange futures contracts were introduced
in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other
futures contracts. Most developed countries permit the trading of derivative products (like
futures and options on futures) on their exchanges. All these developed countries already
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have fully convertible capital accounts. Some governments of emerging economies do not
allow foreign exchange derivative products on their exchanges because they have capital
controls. The use of derivatives is growing in many emerging economies. Countries such as
Korea, South Africa, and India have established currency futures exchanges, despite having
some capital controls. Foreign exchange trading increased by 20% between April 2007 and
April 2010 and has more than doubled since 2004. The increase in turnover is due to a
number of factors: the growing importance of foreign exchange as an asset class, the
increased trading activity of high-frequency traders, and the emergence of retail investors as
an important market segment. The growth of electronic execution and the diverse selection of
execution venues have lowered transaction costs, increased market liquidity, and attracted
greater participation from many customer types.

Market Participants
There are three types of participants in the foreign exchange market. These are: central banks,
global funds, retail clients (or individual retailers) and corporations. The commercial and
investment banks belong to the group known as Interbank market. The interbank market is
the largest market that operates in the foreign exchange market. Corporations, central banks
and global funds also operate at this level. Being the highest traders in the market,
participants in the interbank level are given the best rates. This level constitutes about seventy
five percent of the total volume available each day. The foreign exchange market consists of
two tiers: the interbank or wholesale market, and the client or retail market. Individual
transactions in the interbank market usually involve large sums that are multiples of a million
USD or the equivalent value in other currencies. By contrast, contracts between a bank and
its client are usually for specific amounts, sometimes down to the last penny.

Foreign Exchange Dealers:

Banks, and a few nonbank foreign exchange dealers, operate in both the interbank and client
markets. They profit from buying foreign exchange at a bid price and reselling it at a slightly
higher ask price. Worldwide competitions among dealers narrows the spread between bid and
ask and so contributes to making the foreign exchange market efficient in the same sense as
securities markets.

Participants in Commercial and Investment Transactions:

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Importers and exporters, international portfolio investors, multinational firms, tourists, and
others use the foreign exchange market to facilitate execution of commercial or investment
transactions. Some of these participants use the foreign exchange market to hedge foreign
exchange risk.

Speculators and Arbitragers:

Speculators and arbitragers seek to profit from trading in the market. They operate in their
own interest, without a need or obligation to serve clients or to ensure a continuous market.
Speculators seek all of their profit from exchange rate changes. Arbitragers try to profit from
simultaneous exchange rate differences in different markets.

Central Banks and Treasuries:

Central banks and treasuries use the market to acquire or spend their countrys foreign
exchange reserves as well as to influence the price at which their own currency is traded. In
many instances they do best when they willingly take a loss on their foreign exchange
transactions. As willing loss takers, central banks and treasuries differ in motive and behavior
form all other market participants.

Foreign Exchange Brokers:

Foreign exchange brokers are agents who facilitate trading between dealers without
themselves becoming principals in the transaction. For this service, they charge a small
commission, and maintain access to hundreds of dealers worldwide via open telephone lines.
It is a brokers business to know at any moment exactly which dealers want to buy or sell any
currency. This knowledge enables the broker to find a counterpart for a client quickly without
revealing the identity of either party until after an agreement has been reached.

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CHAPTER II - KINDS OF FOREIGN EXCHANGE

MARKETS
The foreign exchange currency markets allow buying and selling of various currencies all
over the world. Business houses and banks can purchase currency in another country in order
to do business in that particular company. Since the foreign exchange currency market is one
of the biggest markets of the world, the market is sub divided into different kinds of foreign
exchange market. The main three types of foreign exchange markets- the spot foreign
exchange market, the forward foreign exchange market and the future foreign exchange
market are discussed below.

Spot Market
The term spot exchange refers to the class of foreign exchange transaction which requires the
immediate delivery or exchange of currencies on the spot. In practice the settlement takes
place within two days in most markets. The rate of exchange effective for the spot transaction
is known as the spot rate and the market for such transactions is known as the spot market.

Forward Market
The forward transactions is an agreement between two parties, requiring the delivery at some
specified future date of a specified amount of foreign currency by one of the parties, against
payment in domestic currency be the other party, at the price agreed upon in the contract. The
rate of exchange applicable to the forward contract is called the forward exchange rate and
the market for forward transactions is known as the forward market. The foreign exchange
regulations of various countries generally regulate the forward exchange transactions with a
view to curbing speculation in the foreign exchanges market. With reference to its
relationship with spot rate, the forward rate may be at par, discount or premium. If the
forward exchange rate quoted is exact equivalent to the spot rate at the time of making the
contract the forward exchange rate is said to be at par. The forward rate for a currency, say
the dollar, is said to be at premium with respect to the spot rate when one dollar buys more
units of another currency, say rupee, in the forward than in the spot rate on a per annum basis.
The forward rate for a currency, say the dollar, is said to be at discount with respect to the
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spot rate when one dollar buys fewer rupees in the forward than in the spot market. The
discount is also usually expressed as a percentage deviation from the spot rate on a per annum
basis.

Futures Market
Future Forex currency markets types are specific types constitute the forward outright deals
which in general take up small part of the foreign exchange currency trading market. Since
future contracts are derivatives of spot price, they are also known as derivative instruments.
They are specific with regard to the expiration date and the size of the trade amount. In
general, the forward outright deals which get mature past the spot delivery date will mature
on any valid date in the two countries whose currencies are being traded, standardized
amounts of foreign currency futures mature only on the third Wednesday of March, June,
September, and December. Future kinds of foreign exchange markets have many features,
which attracts traders to future markets. The first thing is that anyone can trade in future
market. It is open to all kind of traders in foreign exchange market including individual
traders. This is the difference between the future foreign exchange market and the spot
foreign exchange market, since spot market is closed to individuals traders except in case
there are deals of high net worth. The future forex currency market types are central markets,
just as efficient as the cash market, and whereas the cash market is a much decentralized
market, futures trading take place under one roof. The futures market provides various
benefits for currency traders because futures are special types of forward outright contracts
which corporate firms can use for hedging purposes.

COMPONENTS OF FOREIGN EXCHANGE TRADING

Trading Characteristics
Currencies that are often traded include the United States dollar, Euro, Japanese Yen, Pound
Sterling, Australian dollar, Swiss franc, Canadian dollar, Hong Kong dollar, Swedish krona,
New Zealand dollar, South Korean won, Singapore dollar, Norwegian krone, Mexican peso
and Indian rupee. There is no regulation for the traders on the kind of currencies to trade
since this is an over-the-counter market. However, there are different market places where the
participants can trade on the different currencies. Exchange rates among currencies are
affected by the growth of Gross Domestic Product (GDP), inflation, interest rates and balance
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of trade. News about the foreign exchange market is given to the public on scheduled periods
so that every trader involved gets access to it at the same time. However, the big banks are
given higher priority by letting them see the operations of their customers.

Currencies Traded In FX Market

Currencies on the forex market are traded in pairs. A currency quote is made of these two
pairs of forex trading currencies, situated together and divided by a line (for example,
EUR/USD). The first currency is called as base currency and the second currency is known as
quote currency. The second currency shows your profits and losses for the forex trading
transactions. Many currencies are used all over the world, but there are only a few currencies
that are traded actively in the fx world. In forex trading, only the most economically stable
and liquid currencies are demanded in sufficient quantities. Get to know about the currencies
traded in fx world by reading through the article further. Forex currencies are divided into
major and minor currencies. The major currencies which are frequently traded in forex
market are USD, EUR, JPY, GBP, CHF, CAD, AUD and NZD. All the other currencies are
called minor currencies. However, there are about 18 currency pairs that are conventionally
quoted by forex market makers as a result of their overall liquidity.
These pairs include USD/CAD, EUR/JPY, EUR/USD, EUR/CHF, USD/CHF, EUR/GBP,
GBP/USD, AUD/CAD, NZD/USD, GBP/CHF, AUD/USD, GBP/JPY, USD/JPY, CHF/JPY,
EUR/CAD, AUD/JPY, EUR/AUD and AUD/NZD. These18 pairs represent the majority of
the trading volume in the forex world. You have a wide variety to choose from and this makes
fx trading less complicated.

Bid-Offer spread
The bidoffer spread (also known as bidask or buysell spread, and their equivalents using
slashes in place of the dashes) for securities (such as stocks, futures contracts, options, or
currency pairs) is the difference between the prices quoted (either by a single market maker
or in a limit order book) for an immediate sale (offer) and an immediate purchase (bid). The
size of the bid-offer spread in a security is one measure of the liquidity of the market and of
the size of the transaction cost. If the spread is 0 then it is a frictionless asset. When trading
FOREX we often see a two-sided quote consisting of a bid and offer. The bid is the
price at which one can sell the base currency (at the same time buying the counter currency).
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The ask is the price at which one can buy the base currency (at the same time selling the
counter currency). In every quote there are two currencies (known as the currency pair). For
example, AUD/USD 0.5000 means that 1 Australian dollar is worth 0.5000 US dollars. In
order to generate profit from their business, forex brokers quote one rate for buying a
currency (Bid) and another rate for selling it (Offer) The US dollar is the centerpiece of the
FOREX market and is normally considered the base currency for quotes. For example, a
quote of USD/JPY 110.01 means that one U.S. dollar is equal to 110.01 Japanese yen.

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CHAPTER III - FOREX PRODUCTS

Cross trades:
Trades that does not involve the USD. The Rate is calculated from the quote rates of the
individual currencies against the USD.

FX Swap trade:
The Combination of a spot and forward, where the spot is traded and reversed out in the
future. Non-deliverable Forward (NDF): Usually traded in less liquid exotic currencies.
NPV is settled in the main currency (usually USD, or EUR) based on agreed fixing, usually
by the Central Bank of the country in question. FX option: The right but not the obligation
to exchange currency at a pre-determined rate (strike) at an agreed future date. FX Option is
of two types Calls and Puts & Vanilla and Exotics. Currency Future: Standardized
exchange-traded product in many ways similar to FX forward.

Non-Deliverable Forwards (NDFs)

There are some currencies that cannot be physically delivered to the country of origin. For
example, due to currency restrictions in that country we are not therefore able to make a
physical payment of that currency. Typically, these tend to be Latin American, Asian or
Eastern European currencies. Customers may still wish to hedge/speculate against
movements in that Non-deliverable Currencys exchange rate against other currencies. E.g.
BRL (non-deliverable) / USD (deliverable). Any profit / loss are cash-settled (payable) in
USD (the deliverable currency). An NDF is a short-term, cash-settled currency forward
between two counterparties. On the contracted settlement date, the profit or loss is adjusted
between the two counterparties based on the difference between the contracted NDF rate and
the prevailing spot FX rates on an agreed notional amount.

Components of an FX Trade
Currencies: Has to be two of these for the exchange to be possible. Amount: A numerical
figure that shows the value of the trade. Exchange rate: The price of one currency expressed
in another.

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Value date:
The day the trade will settle. I.e. the funds will be debited / credited from / to your account.
Booked Right Way Round: Shows which currency one is paying and receiving. Broker: Helps
to arrange a trade on behalf of others.
Counterparties: The entities involved in the trade.
Trade Date: The day the deal was agreed Receipt Instructions: Where are we receiving our
currency? Location and Account No. Payment Instructions: Where are we paying the
currency? Location and Account No.

Financial Instruments
Financial instruments in the FX market include spot, forward, swap, future, option and
exchange traded fund. Spot A spot transaction lasts for two days except when currencies such
as the US dollar, Canadian dollar, Euro, Turkish Lira and Russian ruble are traded. In these
cases, transactions are completed on the next business day. Normally, there is no interest
involved in this transaction since it is just a direct exchange. Forward Forward transaction is
an effective way of reducing risks in the FX market. With this, traders do not exchange
money until when an agreed exchange rate between currencies is actualized. This may
happen in one day, several months or years. Swap In swap, two traders agree to make a
transaction that will be reversed in the future. Since this is not a standard operation, there is
no exchange created for this. Future Futures are standardized forward contracts and are
usually traded on an exchange created for this purpose. The average contract length is
roughly 3 months. Futures contracts are usually inclusive of any interest amounts.
Option A foreign exchange option (commonly shortened to just FX option) is a derivative
where the owner has the right but not the obligation to exchange money denominated in one
currency into another currency at a pre-agreed exchange rate on a specified date. The options
market is the deepest, largest and most liquid market for options of any kind in the world.
Exchange-Traded Fund Exchange-traded are open ended investment companies. These
financial tools in online Fx can be traded at any time throughout the duration of the day.

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Typically, ETFs are seen to repeat a stock market index but recently they are now replicating
investments in the currency markets, with an increase in their value.

Nostro, Vostro and Loro Accounts

Nostro and vostro are accounting terms used to distinguish an account held for another entity
from an account another entity holds. The entities in question are almost always, but need not
be, banks. Some customers will keep their own records of their transactions, for instance, so
they can check for errors by the bank. That record kept by the customer is also an account, of
the money the bank is holding for them. When that customer is another bank, since they also
keep other accounts (of the money they are holding for their customers) there is a need to
clearly differentiate between these two types of accounts. The terms nostro and vostro
remove the potential ambiguity when referring to these two separate accounts of the same
balance and set of transactions. Speaking from the banks point-ofview: A nostro is our
account of our money, held by you A vostro is our account of your money, held by us
1) Vostro Account: Account held by a foreign bank in a domestic bank is called Vostro
account. A Vostro is our account of your money, held by us. A Vostro account with a credit
balance (i.e. a deposit) is a liability, and a vostro with a debit balance (a loan) is an asset.
For example Bank A (Barclays Bank of UK) opening an account in Bank B(ICICI Bank of
India), this is Vostro account for Bank B(ICICI Bank of India).
2) Nostro Account: Account held by a particular domestic bank in a foreign bank is called
Nostro account. A Nostro is our account of our money, held by you. A bank counts a Nostro
account with a credit balance as a cash asset in its balance sheet. Here in the above example
given in Vostro account the same account is a Nostro account for Bank A(Barclays Bank of
UK), or if Bank B(ICICI Bank of India) opens an account in Bank A(Barclays Bank of UK)
then that account is a Nostro account for Bank B(ICICI Bank of India). Nostro accounts are
usually in the currency of the foreign country. This allows for easy cash management because
currency doesnt need to be converted. 3) Loro Account: An account held by a domestic bank
in itself on behalf of a foreign bank. The latter in turn would view this account as a Nostro
account. A Loro is our account of their money, held by you. Loro account is a record of an
account held by a second bank on behalf of a third party; i.e, my record of their account with
you. In practice this is rarely used, the main exception being complex syndicated financing. If

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any other bank for the purpose of a transaction refer to an account maintained by yet another
bank in some other countries it is known as loro account. An expression used, for example,
by one bank when telling another bank to transfer money to the account of a third bank. In
correspondent banking, an account held by one bank on behalf of another bank (the
customer bank); the customer bank regards this account as its Nostro account. The
Loro account is an account wherein a bank remits funds in foreign currency to another bank
for credit to an account of a third bank.

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CHAPTER IV - GLOBAL LINKAGE OF FOREIGN

EXCHANGE MARKETS
The Concept of Offshore Banking
Describing an institution, especially a bank that exists in a foreign country. Colloquially, the
term refers to institutions that exist in known tax havens. Individuals and companies use
offshore accounts to avoid or evade taxes in their home countries. As a result, some emerging
financial centers have objected to being called "offshore," asking for parity with the
developed financial world. There are currently approximately 32 recognized Offshore
Financial Centers, (OFCs) or low tax jurisdictions' across the world. These jurisdictions
commonly have low tax and are lightly regulated paving the way for offshore companies to
benefit from prosperous infrastructures. Many Offshore financial centers are current or
former British Colonies or Crown Dependencies, and often refer to themselves as offshore
jurisdictions. There has been much debate into what makes a country an offshore financial
jurisdiction. As such, the generally accepted characteristics include the following:
The country has a number of financial businesses that predominantly do business with
non-residents
The business will have an infrastructure, external assets and liabilities which are out of
proportion with the domestic economy
Significantly lower corporation tax rates
Lenient financial regulation An offshore bank is a bank located outside the country of
residence of the depositor, typically in a low tax jurisdiction (or tax haven) that provides
financial and legal advantages.
These advantages typically include: greater privacy (see also bank secrecy, a principle born
with the 1934 Swiss Banking Act) low or no taxation (i.e. tax havens) easy access to deposits
(at least in terms of regulation) protection against local, political, or financial instability
While the term originates from the Channel Islands being "offshore" from the United
Kingdom, and most offshore banks are located in island nations to this day, the term is used
figuratively to refer to such banks regardless of location, including Swiss banks and those of
other landlocked nations such as Luxembourg and Andorra. Offshore banking has often been
associated with the underground economy and organized crime, via tax evasion and money
laundering; however, legally, offshore banking does not prevent assets from being subject to
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personal income tax on interest. Except for certain persons who meet fairly complex
requirements, the personal income tax of many countries makes no distinction between
interest earned in local banks and those earned abroad. Persons subject to US income tax, for
example, are required to declare on penalty of perjury, any offshore bank accounts which
may or may not be numbered bank accountsthey may have. Although offshore banks may
decide not to report income to other tax authorities, and have no legal obligation to do so as
they are protected by bank secrecy, this does not make the non-declaration of the income by
the tax-payer or the evasion of the tax on that income legal. Following September 11, 2001,
there have been many calls for more regulation on international finance, in particular
concerning offshore banks, tax havens, and clearing houses such as Clear stream, based in
Luxembourg, being possible crossroads for major illegal money flows.

Tax Havens
A tax haven is a foreign country or dependency that has a series of unique characteristics, the
primary one being relatively lower tax rates in comparison with other countries. In fact, many
tax havens impose no taxes at all on income earned by foreign individuals. Bank secrecy and
strict privacy laws are other important characteristics of tax havens. In fact, in some tax
havens there are prison sentences for anyone revealing private financial information. In the
US, the IRS agents' handbook defines tax haven as "a term that generally connotes any
foreign country that has either a very low tax or no tax at all on certain categories of income."
The IRS itself defines at least 30 jurisdictions around the world as tax havens, including
Austria, the Cayman Islands, Hong Kong, Liechtenstein, Panama, Singapore and Switzerland
and lesse Governments of most industrialized nations, and especially their tax collecting
agencies, would have everyone believe that the use of a tax haven is the same thing as tax
evasion. These governments frown on you relocating your money offshore. If everyone
could invest abroad and in secrecy and never pay taxes these governments would go broke.
The Governments do everything in their power to discourage citizens from moving funds
offshore because when you move your money offshore, the government loses control. It is in
no way illegal to take your money offshore, even though the government has done its part to
try to persuade you to not do so. To this end, the taxman would have the public believe that
tax havens are used exclusively for tax evasion, but that is just not the reality of the matter.
For example, in the US the IRS agents' handbook carefully notes that taxpayers use havens to
avoid taxes, not evade them. Tax avoidance is the legal reduction of taxes, while evasion is
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any illegal means of reducing or eliminating taxes. Furthermore, the IRS guide concedes that
US taxpayers may also use tax havens for tax planning reasons. This same guide also admits
that some transactions conducted through tax havens have a beneficial tax result that is
completely within the letter of US tax law. In fact, the US Supreme Court stated in Gregory
vs. Helvering (1935), 293 US 465 that taxpayers can arrange their affairs so that they can
make their taxes as low as possible. Given that admission, it becomes highly probable that
many Americans are overlooking tax havens, private international banking and offshore
investing as a fully legal means of restructuring their income and reducing their tax liability r
known places such as Bahrain, Nauru, and Turks & Caicos Islands.

Role of Arbitrage in Foreign Exchange Market

The foreign exchange market consists of many different markets and institutions. Yet, at any
given point in time, all markets tend to generate the same exchange rate for given currency
regardless of geographical location. The uniqueness of the foreign exchange rate regardless of
geographical location occurs because of arbitrage. As you recall, arbitrage refers to the
process by which an individual purchases a product (in the case foreign exchange) in a lowpriced market for resale in a high-priced market for the purpose of making a profit. In the
process, the price is driven up in the low-priced market for the purpose of making a profit. In
the process, the price is driven up in the low-priced market and down in the high-priced
market. This activity will continue until the prices in the two markets are equalized, or until
they differ only by the transaction costs involved. Because currency is going bought and sold
simultaneously, there is no risk in this activity and hence there are always many potential
arbitragers in the market. In addition, because of the speed of communications and the
efficiency of transactions in foreign exchange, the spot market quotations for a given
currency are remarkably similar worldwide, and any profit spread on a given currency is
quickly arbitraged away. In world of many different currencies, there is also a possibility for
arbitrage if exchange rates are not consistent between currencies. This is a situation of
multicurrency arbitrage, in this case called triangular arbitrage since it involves an
inconsistency between different currencies. The triangular arbitrage produces cross-rate
equality, meaning that all three exchange rates are internally consistent. Arbitragers are
constantly watching the foreign exchange to take advantage of such a situation. The arbitrage
process is thus relied upon not only to maintain a similar individual currency value in
different foreign exchange markets but also to make certain that all the cross rates between
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currencies are consistent. Arbitrage is one of the fundamental pillars of financial economics.
It seems to be generally accepted that financial markets do not offer risk-free arbitrage
opportunities, at least when allowance is made for transaction costs. This notion is directly
related to the law of one price, which postulates that in well-functioning, efficient financial
markets identical securities must have the same price, no matter how they are created. For
example, if a derivative instrument can be created using two different sets of underlying
securities, then the total price for each derivative instrument would be the same or else an
arbitrage opportunity would exist. Arbitrage is the mechanism that should ensure the validity
of the law of one price. While the assumption of no arbitrage is likely to be reasonably mild
or valid in several contexts in finance, violations of the law of one price can be rationalized
on several grounds. In general terms, the absence of arbitrage opportunities gives rise to the
so-called arbitrage paradox, first pointed out by Grossman and Stiglitz (1976, 1980). That is,
if arbitrage is never observed, market participants may not have sufficient incentives to watch
the market, in which case arbitrage opportunities could arise. A possible resolution to this
paradox is for very short-term arbitrage opportunities to arise, inviting traders to exploit
them, and hence be quickly eliminated. Also, microstructure theory shows how price
differences may occur for identical assets in markets that are less than fully centralized or
with an imperfect degree of transparency. Empirical studies have, however, been unable to
detect short-term arbitrage opportunities in a variety of financial markets. Given the high
activity level in major financial markets, such shortterm arbitrage opportunities can only be
adequately studied using real-time quotations on all asset prices involved, which are
notoriously difficult to obtain. Furthermore, one must take into account all relevant aspects of
the microstructure of the markets in order to capture the opportunities and transaction costs
that market participants face. Yet, if present, the existence and properties of risk less arbitrage
opportunities are of great interest to both academics and participants in financial markets,
given the central role of no-arbitrage conditions in the theory and practice of financial
economics.

Riskless Arbitrage in the FX Market

Round-trip, Covered Arbitrage Covered interest rate parity (CIP) postulates that it is not
possible to earn positive returns by borrowing domestic assets for lending abroad (or vice
versa) while covering the exchange rate risk through a forward contract of equal maturity.
Domestic and foreign interest-bearing assets can be considered similar if they are of equal
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maturity and share the same characteristics, such as liquidity and political and default risk.
Commonly, CIP is expressed as (1 + id) = 1/S (1 + if) F; (1)
where id and if denote domestic and foreign interest rates on similar assets, respectively; S is
the spot nominal exchange rate; and F is the forward exchange rate of maturity equal to that
of the interest-bearing assets. The spot exchange rate is expressed in units of domestic
currency per unit of foreign currency. The common expression of CIP in equation (1) neglects
transaction costs, however. Such costs may be largely captured by market quotes of interest
rates and exchange rates which are expressed in terms of ask and bid quotes. The spread
between ask and bid rates/quotes for an asset is assumed to take into account inventory,
information and processing costs associated with the trading of the asset. One-way Arbitrage
Recognition of the fact that funds are borrowed and lent at different rates makes it important
to consider the behavior of traders that are looking for the highest risk less returns on their
endowments and of those who are looking for the cheapest borrowing opportunities. In the
following sub-sections we consider these cases and point out their relationships with the
conditions for profitable round-trip arbitrage, i.e. the case of CIP. Owner Arbitrage The
concept of owner arbitrage (OA) refers to the case where a trader has an endowment of funds
in some currency and wants to lend the funds to obtain the highest possible risk less net
return. Such traders weigh the option of lending own funds at the market bid rate for the
endowment currency, against the option of converting the funds to another currency at the
spot exchange rate and lending them at the market bid rate for that currency, while
eliminating the exchange rate risk at the maturity of the lending contract through a forward
contract. Borrower Arbitrage The concept of borrower arbitrage (BA) refers to the case where
a trader is searching for the cheapest way to finance an investment. Such traders face the
option of borrowing funds in the desired currency directly, or to borrow funds in another
currency and convert them to the desired currency at the spot exchange rate, while
eliminating the exchange rate risk at the maturity of the borrowing contract through a forward
contract. In this case, funding costs avoided by choosing the relatively cheaper borrowing
opportunity essentially represent risk-free net return.

Conditions for arbitrage

Arbitrage is possible when one of three conditions is met: The same asset does not trade at
the same price on all markets ("the law of one price"). Two assets with identical cash flows
do not trade at the same price. An asset with a known price in the future does not today trade
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at its future price discounted at the risk-free interest rate (or, the asset does not have
negligible costs of storage; as such, for example, this condition holds for grain but not for
securities). Arbitrage is not simply the act of buying a product in one market and selling it in
another for a higher price at some later time. The transactions must occur simultaneously to
avoid exposure to market risk, or the risk that prices may change on one market before both
transactions are complete. In practical terms, this is generally possible only with securities
and financial products that can be traded electronically, and even then, when each leg of the
trade is executed the prices in the market may have moved. Missing one of the legs of the
trade (and subsequently having to trade it soon after at a lower price) is called 'execution risk'
or more specifically 'leg risk'. In the simplest example, any good sold in one market should
sell for the same price in another. Traders may, for example, find that the price of wheat is
lower in agricultural regions than in cities, purchase the good, and transport it to another
region to sell at a higher price. This type of price arbitrage is the most common, but this
simple example ignores the cost of transport, storage, risk, and other factors. "True" arbitrage
requires that there be no market risk involved. Where securities are traded on more than one
exchange, arbitrage occurs by simultaneously buying in one and selling on the other.

Forex: Speculation
The opposite of hedging is called 'speculation', the act of taking a net asset position ('long
position') or a net liability position ('short position') in some asset class, here a foreign
currency; that being said, speculating means committing oneself to an uncertain future value
of one's net worth in terms of home currency. It can therefore be assumed that anybody who
speculates is acting on the basis of something he or she expects about the future price of the
foreign currency. Although speculation has indeed played such a sinister role in the past, it is
an open empirical question whether it does so frequently. More to the present point, we
should recognize that the only concrete way of defining speculation is the broad way just
offered. Anybody is a speculator who is willing to take a net position in a foreign currency,
whatever his motives or expectations about the future of the exchange rate. The foreign
exchange market provides the same bridge between currencies for speculators as for hedgers,
since there is no credentials check that can sort out the two groups in the marketplace. The
profitability in speculating a foreign currency depends on whether or not one expects the
value of that currency to drop by as great a percentage, as its interest rate exceeds the
domestic interest rate. The existence of a foreign exchange market does not guarantee that
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speculation will be profitable. It only makes speculation feasible for those willing to take the
chance. If it is generally feared that a certain currency in some country will drop in value
soon, say, U.S. importers are likely to press for prompter payment from its foreign customers,
who are allowed to repay in such currency. If the U.S. exports happen to be in dollars, then it
is the foreign importer who has an incentive to pay such currency to get dollars now, while
each currency still buys more dollars. In order to avoid bad deals in fx world, speculation in
forex is necessary. Forex speculation helps you to determine which currencies should be
bought and which must be sold. It is essential for you to speculate over the prices of different
currencies and make transaction on it. As we all know forex trade is related to buying and
selling of two different currencies and can help you to earn good profit on it. Somehow
speculation in forex can destabilize currencies and prevent them from projecting a country's
economic fundamentals. But one needs to understand that speculation in fx is not only reason
for destabilization of currencies. However, most of the speculators purchase currencies whose
value they expect to increase and sell currencies whose value they expect to decrease. Fx
speculation is necessary if you want to earn a desirable profit from your forex trade.
Moreover, most of the speculator likely reverses their currency position to earn profits when
the currency value moves towards their expected direction. This reversing in buying and
selling leads to the fluctuation of the currency value. Trading strategies of speculators are
little different from the other fx market participants. They do the buying and selling of
currencies when others traders arent actively participating in fx market. Moreover,
speculating fx means committing oneself to an uncertain future value of one's net worth in
terms of home currency. So, anybody can be a speculator who is willing to take a net position
in a foreign currency, whatever his motives or expectations about the future of the exchange
rate.

Hedging
A hedge is a type of derivative, or a financial instrument, that derives its value from an
underlying asset. This concept is important and will be discussed later. Hedging is a way for a
company to minimize or eliminate foreign exchange risk. Two common hedges are forwards
and options. A Forward contract will lock in an exchange rate at which the transaction will
occur in the future. An option sets a rate at which the company may choose to exchange
currencies. If the current exchange rate is more favorable, then the company will not exercise
this option.
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A foreign exchange hedge (FOREX hedge) is a method used by companies to eliminate or

hedge foreign exchange risk resulting from transactions in foreign currencies. This is done
using either the cash flow or the fair value method. The accounting rules for this are
addressed by both the International Financial Reporting Standards (IFRS) and by the US
Generally Accepted Accounting Principles (US GAAP). The producers and users of
commodities who use the futures market are called hedgers. Buying and selling futures as a
risk management tool is called hedging.
What is hedging as it relates to forex trading?
Hedging is buying or selling futures contracts as a temporary substitute for buying or selling
the commodity at a later date in the cash market. When a currency trader enters into a trade
with the intent of protecting an existing or anticipated position from an unwanted move in the
foreign currency exchange rates, they can be said to have entered into a forex hedge. By
utilizing a forex hedge properly, a trader that is long a foreign currency pair, can protect
themselves from downside risk; while the trader that is short a foreign currency pair, can
protect against upside risk.
The primary methods of hedging currency trades for the retail forex trader are through:
Spot contracts, and Foreign currency options. Spot contracts are essentially the regular type
of trade that is made by a retail forex trader. Because spot contracts have a very short-term
delivery date (two days), they are not the most effective currency hedging vehicle. Regular
spot contracts are usually the reason that a hedge is needed, rather than used as the hedge
itself. Foreign currency options, however are one of the most popular methods of currency
hedging. As with options on other types of securities, the foreign currency option gives the
purchaser the right, but not the obligation, to buy or sell the currency pair at a particular
exchange rate at some time in the future. Regular options strategies can be employed, such as
long straddles, long strangles and bull or bear spreads, to limit the loss potential of a given
trade.
Risk Aversion
Risk aversion is a trading pattern that results when unfavorable conditions are bound to occur.
This is caused by the liquidation of risky assets and diverting the funds into safer assets. In
the foreign exchange market, traders liquidate the funds they envisage potential risks and
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divert them into more secure ones like the US dollar. However, it is being observed that most
traders use these more secure currencies because of fear rather than the results shown on
economic statistics. For example, during the global economic meltdown of 2008, the US
dollar was unaffected while other currencies depreciated. The success of the US dollar was
achieved despite the similar negative results caused by the crisis in the United States.

Carry Trade
Currency carry trade refers to the act of borrowing one currency that has a low interest rate in
order to purchase another with a higher interest rate. A large difference in rates can be highly
profitable for the trader, especially if high leverage is used. However, with all levered
investments this is a double edged sword, and large exchange rate fluctuations can suddenly
swing trades into huge losses.

CHAPTER V - EXCHANGE RATES & ITS USES

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Exchange rates represent the linkage between one country and its partners in the global
economy. They affect the relative price of goods being traded (exports and imports), the
valuation of assets, and the yield on those assets. In the period of fixed or constant exchange
rates these prices, values, and yields were predictable over time. However, since 1973 we
have been living in a world of flexible rates where foreign exchange markets determine these
rates based on trade flows, interest rate differentials, differing rates of inflation, and
speculation about future events. Exchange rates can be expressed as the foreign price of a
domestic currency (i.e., the Euro price of a U.S. dollar) or its reciprocal -- the domestic price
of foreign currency. The spot exchange rate refers to the current exchange rate. The forward
exchange rate refers to an exchange rate that is quoted and traded today but for delivery and
payment on a specific future date. Fixed Exchange Rates A fixed exchange rate, sometimes
called a pegged exchange rate, is also referred to as the Tag of particular Rate, which is a type
of exchange rate regime where a currency's value is fixed against the value of another single
currency or to a basket of other currencies, or to another measure of value, such as gold. A
fixed exchange rate is usually used to stabilize the value of a currency against the currency it
is pegged to. This makes trade and investments between the two countries easier and more
predictable and is especially useful for small economies in which external trade forms a large
part of their GDP. Floating Exchange Rates A floating exchange rate or fluctuating exchange
rate is a type of exchange rate regime wherein a currency's value is allowed to fluctuate
according to the foreign exchange market. A currency that uses a floating exchange rate is
known as a floating currency.

Exchange-rate regime:
An exchange-rate regime is the way an authority manages its currency in relation to other
currencies and the foreign exchange market. It is closely related to monetary policy and the
two are generally dependent on many of the same factors.
The basic types are a floating exchange rate, where the market dictates movements in the
exchange rate; a pegged float, where a central bank keeps the rate from deviating too far from
a target band or value; and a fixed exchange rate, which ties the currency to another currency,
mostly more widespread currencies such as the U.S. dollar or the euro or a basket of
currencies.

Fluctuations in exchange rates

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A market-based exchange rate will change whenever the values of either of the two
component currencies change. A currency will tend to become more valuable whenever
demand for it is greater than the available supply. It will become less valuable whenever
demand is less than available supply (this does not mean people no longer want money, it just
means they prefer holding their wealth in some other form, possibly another currency).
Increased demand for a currency can be due to either an increased transaction demand for
money or an increased speculative demand for money. The transaction demand is highly
correlated to a country's level of business activity, gross domestic product (GDP), and
employment levels. The more people that are unemployed, the less the public as a whole will
spend on goods and services. Central banks typically have little difficulty adjusting the
available money supply to accommodate changes in the demand for money due to business
transactions. Speculative demand is much harder for central banks to accommodate, which
they influence by adjusting interest rates. A speculator may buy a currency if the return (that
is the interest rate) is high enough. In general, the higher a country's interest rates, the greater
will be the demand for that currency.

What is a PIP?
In the Forex market, prices are quoted in Pips. Pip stands for "percentage in point" and is the
fourth decimal point, which is 1/100th of 1%. A pip is a number value. In the Forex market,
the value of currency is given in pips. One pip equals 0.0001, two pips equals 0.0002, three
pips equals 0.0003 and so on. One pip is the smallest price change that an exchange rate can
make. Most currencies are priced to four numbers after the point. For example, a five pip
spread for EUR/USD is 1.2530/1.2535.
In the major currencies, the price of the Japanese yen does not have four numbers after the
point. In USD/JPY, the price is only given to two decimal points so a quote for USD/JPY
looks like this: 114.05/114.08. This quote has a three pip spread between the buy and sell
price.

Determinants of FX rates
For countries operating on the floating exchange rate regime, the exchange rates of their
currencies can be determined by the following theories: 1. International Parity Conditions:
These include theories such as relative purchasing power parity, interest rate parity, domestic
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fisher effect and international fisher effect. Although these theories work to actually
determine FX rates, they can also falter because they are formed on assumptions that are not
always true. 2. Balance of payment model: This is concerned with the exchange of goods and
services without considering the effect of the flow of money between and among nations. 3.
Asset market model: views currencies as an important asset class for constructing investment
portfolios. Assets prices are influenced mostly by people's willingness to hold the existing
quantities of assets, which in turn depends on their expectations on the future worth of these
assets. The asset market model of exchange rate determination states that the exchange rate
between two currencies represents the price that just balances the relative supplies of, and
demand for, assets denominated in those currencies.
It is not possible to predict FX rates within long time frames with these theories. The best that
can be done with these is predicting future prices that can occur within a few days. FX rates
cannot be judged on a single factor but rather by combining several factors in economics,
politics and market psychology.

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CHAPTER VI - FACTORS THAT AFFECT FOREIGN

EXCHANGE MARKET TRENDS
The Foreign Exchange or Forex is the largest marketplace today for stock buying and selling,
and it is continually growing with more and more people investing in it. Nevertheless, as
promising as this marketplace might be when it comes to profit, like any other trade it can be
extremely volatile as well. It is therefore important to be familiar with particular factors that
affect developments within the Foreign exchange marketplace if you are made the decision in
joining this arena. After all, acquainting yourself using the many scenarios that can cause
currencies to go up or down can help you a great deal in generating decisions for when to buy
or sell. There are basically 3 main factors that affect the Foreign Exchange, a countrys
economic system, political conditions and marketplace psychology.

Economic system
Financial factors are the most basic things that create changes inside a countrys forex. When
such financial circumstances as a budget deficit or surplus is present inside a country, there
will surely be reactions in the marketplace and values will be reflected on currencies. Other
conditions may also include inflation trends, and also the general financial growth of the
country. The much more prosperous a countrys economy is, the much more investors will be
able to adhere to doing trade in a more constructive perspective. Such indicators as a
development inside a nations gross domestic product (GDP), employment levels and retail
sales among others will basically attract much more investors and that nations forex value
will likely go up.

Political Circumstances
Another extremely essential factor that affect developments in Forex, are the conditions of a
countrys political sector. This is simply because political instability or turmoil can generally
create negative fluctuations to an economic system. But if this kind of situations happens
wherein a country might rise above political obstacles, the opposite may happen and the
economic system might improve. Occasions inside a region can surely create damaging or
constructive interest among investors for a nations forex. And so, such circumstances surely
influence the developments for demands and costs of a certain currency.
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Marketplace Psychology
The perception of traders and investors will significantly affect the International Exchange
market in so several ways. After all, the marketplace is highly dependent on regardless of
whether or not individuals would want to make investments on a countrys economic system
in order to determine whether forex prices will go up or down. For instance, such conditions
wherein unsettling worldwide occasions might occur, then under the flight of quality rule,
people would generally want to search for a secure haven for their investments. Whenever
there is a higher demand to get a particular countrys economy, then a higher price will
probably be given to buyers and the currencys worth will go up and turn out to be stronger.
Other occasions that contribute to traders perceptions may be long-term developments where
people invest based on what theyve observed for a lengthy period and time, and even
economic numbers in which people may base their investments depending on what numbers
show a higher value.

Different Exchange Systems which links the Forex Market Globally

The foreign exchange currency trading market has various different foreign exchange systems
through which currencies can be traded. It is beneficial to understand various exchange
systems in forex as it helps while trading in forex markets.

Trading with Brokers:

The Forex brokers are part of the one of the different exchange systems in forex. Their
primary function is to bring closer the buyers and the sellers in the forex market from around
the world. Also, the broker exchange systems in forex helps in the quick, accurate and
efficient execution of orders of various forex traders. The majority of transactions which are
completed through the brokers using different systems in forex are via phone. The phone
lines between brokers and banks are dedicated, or direct, and are usually in-stalled free of
charge by the broker. A foreign exchange brokerage firm has direct lines to banks around the
world. Most foreign exchange is executed through an open box systema microphone in
front of the broker that continuously transmits everything he or she says on the direct phone
lines to the speaker boxes in the banks. This way, all banks can hear all the deals being
executed. Brokers communicate through Reuter, Phone or Bloomberg. Different Foreign
exchange systems used by brokers in doing the analysis of market trends. The Electronic
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Trading system was introduced in 1992. Reuters, the news company introduced the screen
quotations which created screen-based market. Under this system, prices are visible to all
market participants. Traders enter buy and sell orders directly into their terminals on an
anonymous basis.

Direct Dealing:
Another most common exchange system in forex is direct dealing. These exchange systems
in forex are based on the principle of trading reciprocity. The market maker and the bank
making or quoting a price expects the bank that is calling to reciprocate with respect to
making a price when called upon. Direct dealing used to be conducted mostly on the phone.
Dealing errors were difficult to prove and even more difficult to settle. In order to increase
dealing safety, most banks tapped the phone lines on which trading were conducted. This
measure was helpful in recording all the transaction details and enabling the dealers to
allocate the responsibility for errors fairly. But tape recorders were unable to prevent trading
errors. With the introduction of dealing systems in 1980s, the direct dealing exchange
systems in forex were changed forever.

Dealing Systems:
These types of exchange systems in foreign exchange are actually online computer systems
which are linked to the contributing banks around the world on a one on one basis. These
exchange systems in forex are highly reliable and most preferred. The performance of dealing
systems greatly depends upon the speed, reliability, and safety. Accessing a bank through a
dealing system is much faster than making a phone call. There are continuous improvements
in dealing foreign exchange in order to offer maximum support to the dealer's main function.

Matching Systems:
This exchange system in forex is different from the other foreign exchange systems such as
the dealing systems. In the dealing system the currency trading is done directly and on a oneon-one basis, however in matching systems the currency trading is done anonymously and
individual traders deal against the rest of the market. This is similar with other different
systems in forex such as the trading the market with the help of a broker. However, unlike the
brokers' market, there are no individuals to bring the prices to the market, and liquidity may
be limited at times. Matching Systems are well-suited for trading smaller amounts as well.
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The dealing systems characteristics of speed, reliability, and safety are replicated in the
matching systems. In addition, credit lines are automatically managed by the systems. Traders
input the total credit line for each counter party. When the credit line has been reached, the
system automatically disallows dealing with the particular party by displaying credit
restrictions, or shows the trader only the price made by banks that have open lines of credit.
As soon as the credit line is restored, the system allows the bank to deal again. In the
interbank market, traders deal directly with dealing systems, matching systems, and brokers
in a complementary fashion.

Basis of Communication for international transfers

The rapid improvement in communication and technology has enabled the foreign exchange
dealers worldwide to link together through telephone, telex and satellite communication
network called the Society for Worldwide International Financial Communication (SWIFT).
The communication system based in Brussels, in Belgium links banks and brokers in every
financial centre. It enables the dealers to have the information of all the events that may have
an impact on the exchange rate thus making the worldwide foreign exchange centers to
function as efficient as one single market.
In the United States, all foreign exchange transactions involving dollars are cleared through
the Clearing House Interbank Payments System (CHIPS). It is an electronic fund transfer
mechanism. It is a system developed by the New York Clearing House Association for
transfer of international dollar payments. It links about 150 depository institutions that have
offices in New York. It handles more than 1, 00,000 interbank transfers daily, valued about $
500 billion. It represents about 90 percent of all interbank transfers relating to international
dollar payments.

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CONCLUSION
The real and financial linkages between countries can explain why movements in the world's
largest markets often have such large effects on other financial markets, and how these cross
market linkages have changed over time. It estimates a factor model in which a country's
market returns are determined by global, sectoral, and cross-country factors (returns in large
financial markets) and by country-specific effects. Then it uses a new data set on bilateral
linkages between the world's five largest economies and approximately 40 other markets to
decompose the cross-country factor loadings into direct trade flows, competition in third
markets, bank lending, and foreign direct investment. In the latter half of the 1990s, bilateral
trade flows are large and significant determinants of how shocks are transmitted from large
economies to other stock and bond markets. Bilateral foreign investment is usually
insignificant. Therefore, despite the recent growth in global financial flows, direct trade still
appears to be the most important determinant of how movements in the world's largest
markets affect financial markets around the globe.
The trading of currencies takes place in foreign exchange markets whose major functions, is
to facilitate international trade and investment. Foreign exchange markets, however, are
shrouded in mystery. One reason for it is that a considerable amount of foreign exchange
market activity does not appear to be related directly to the needs of international trade and
investment. Highlighting the range of activities that take part in a foreign exchange market,
we may say that speculation explains a vast amount of foreign exchange transactions
available through organized markets. Speculation is the kind of activity of making profits by
outguessing other market participants as to what future exchange rates will be.
Over the years, the foreign exchange market has emerged as the largest market in the world
and the breakdown of the Bretton Woods system in 1971 marked the beginning of floating
exchange rate regimes in several countries. The decade of the 1990s witnessed a perceptible
policy shift in many emerging markets towards reorientation of their financial markets and
these changing contours were mirrored in a rapid expansion of foreign exchange market in
terms of participants, transaction volumes, decline in transaction costs and more efficient
mechanisms of risk transfer.
The FOREX markets have become the worlds most liquid and continuous markets with
trillions of dollars being traded daily. Whether trading in the spot market, the futures markets,
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or the options markets, speculators and hedgers can find an instrument and the leverage that
meet their needs. From complex speculative strategies to everyday hedging techniques, the
FOREX markets provide the forum for dealing with currency fluctuations.
Foreign exchanges markets help keep the system of floating exchange rates functioning. As
international business increased, especially during the last quarter of the Twentieth Century,
companies around the world needed a reliable means of trading their native currencies for
goods and services from across the globe. To do this, businesses had to be able to pay for
goods in services in a currency which businesses from outside their country that they would
accept. In addition, business owners also wanted a way to store their profits in currencies
which would retain their value, especially if their national currencys value fluctuated wildly.
To meet the needs of all the market participants that was when the foreign exchange markets
came into existence.

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BIBLIOGRAPHY
BOOKS:

Derivative Market (TYBFM Sem V) Vipul Prakashan

Foreign Exchange Market (TYBFM Sem V) Vipul Prakashan

NEWSPAPERS
Financial Express
The Economic Times

WEBSITES

www.goforex.net
www.financial-dictionary.thefreedictionary.com
www.investopedia.com
www.forexcycle.com
www.actionforex.com
www.thinkforex.com
www.wikipedia.org

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