Not like the stock market, in which investors usually only trade
institutional investors, there are more parties that trade currencies. It consists
of many different parties that have different reasons for investing. Thus, it is
very important to know and understand the functions and goals of forex market
participants.
In this article, we’ll list down the main forex market
participants and their functions and motivations in this market.
Governments and Central Banks
Governments and central banks are probably the most
influential participants in the forex market. In most countries, the central
bank is an extension of the government. It conducts its policy in conjunction
with the government.
On the other hand, some governments feel that a more independent
central bank is more effective in balancing the goal of managing inflation and
keeping interest rates low, which usually spurs economic growth.
Regardless, government representatives normally have regular
meetings with the central bank for monetary policies. Therefore, central banks
and governments are typically on the same page. Central banks are usually
responsible for maintaining foreign reserve volumes and adjusting monetary policy
to meet economic objectives.
Banks and Other Financial Institutions
Along with governments and central banks, some of the biggest
participants are banks. Most people who need foreign currencies for small transactions
usually deal with such banks.
On the other hand, the transactions are much smaller than
those between banks. This is what forex market participants call interbank market.
Banks make currency transactions with each other on electronic brokering
systems.
Only the banks that have credit relationships can transact
with each other. The bigger banks usually have more credit relationships. Thus,
they receive better foreign exchange prices. Needless to say, smaller banks have
fewer credit relationships. It also means lower priority for them on the
pricing scale.
Generally, banks serve as dealers since they are willing to
buy/sell a currency at the bid/ask price. A way for banks to make money on the
forex market is when they exchange currency at a higher price than they paid to
obtain it.
Because the forex market is a global market, it is usual to
see banks having slightly different rates for the same currency.
Hedgers
Some of the largest clients on these banks are international
businesses. Businesses will inevitably need to deal with the volatility of
fluctuating exchange rates.
The management and shareholders are not very fond of
uncertainty. Dealing with foreign-exchange risks is a huge problem for many
multinational corporations.
One move that the company can take to lower the uncertainty
is to go into the spot market. They then need to make immediate transaction for
the foreign currency they need.
Unfortunately, businesses sometimes don’t have enough cash
for the spot market. Therefore, they quite often use hedging strategies to lock
in a specific exchange rate for the future.
Speculators
There are also speculators in the forex market. Rather than
hedging against changes in exchange rates or exchanging currencies to fund international
transactions, speculators attempt to make money by using fluctuating currency
rates.
George Soros is one of the most popular currency
speculators. The billionaire hedge fund manager is most famous for his speculating
of the downfall of the British pound, a decision that earned $1.1 billion in
less than a month.
The largest and most controversial speculators on the forex
market are hedge funds, which are essentially unregulated funds that use unconventional
and often very risky investment strategies to make huge returns. You can think
of them as mutual funds that don’t have the same level of regulation.
And because they can take such large positions, they can have
a really huge effect on the country’s currency and economy. Some critics even
blamed hedge funds for the Asian currency crisis of the late 1990s. Meanwhile, others
have blamed the ineptness of Asian central bankers. Either way, speculators can
have huge influence on the forex market.
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