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In the first video of this two-part video series, Elisa introduces us to sustainability. She begins by looking at the difference between sustainability and corporate social responsibility, two terms that can be easily confused.

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Introduction to FX Markets I

Introduction to FX Markets I

Kees van den Aarssen

35 years: FX & financial markets

In this video, Kees discusses the Foreign Exchange (FX) market and the importance of understanding Money Markets. He goes into detail on the popularity and volume of currencies traded in the FX market.

In this video, Kees discusses the Foreign Exchange (FX) market and the importance of understanding Money Markets. He goes into detail on the popularity and volume of currencies traded in the FX market.

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Introduction to FX Markets I

17 mins 36 secs

Overview

The foreign exchange (FX) market is the world’s biggest over-the-counter or OTC market, trading a daily average of USD 6.6 trillion. FX turnover is more than 80 times the volume of international trade, which is accounted for by currency hedging and speculation.

Key learning objectives:

  • Understand how big the FX market is and what the major trading centres are

  • Outline the main currencies used in the FX market

  • Understand why are FX volumes so high

  • Explain what happens when a company hedges an FX transaction

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Summary

How big is the FX market and what are the major trading centres?

The foreign exchange (FX) market is the world’s biggest over-the-counter or OTC market. There is no physical market; trading is conducted in the dealing rooms of banks, brokers and other non-bank financial institutions. According to the Bank for International Settlements’ (BIS) comprehensive triennial survey of April 2019, 90% of the total volume came from 11 countries; the rest from 40 other locations. London (greatly helped by its time zone) accounts for 43.1% of turnover, followed by the US with 16.5%. London and New York account for about 60% of global turnover. The next three (Singapore, Hong Kong and Tokyo) account for over 20%.

What are the main currencies used in the FX market?

The BIS survey includes trading volumes of 36 different currencies, 20 of which have volumes of 1% or more. The US dollar tops the list with 88% i.e. for almost every FX transaction one side is USD. The Chinese Renminbi represented less than 1% in 2010 but was most recently ranked 8th with 4.3% and is now the most actively-traded emerging market currency. The next most popular currency is the euro, while EUR/USD is by far the most popular, with almost a quarter of FX trading volume. The four most actively traded currency pairs are: EUR/USD, USD/JPY, GBP/USD and AUD/USD.

Market convention is that the rate quoted describes how much of one currency you can buy for one dollar with the exception of GBP/USD (a.k.a. Cable) which says how many dollars you can buy for £1. All currencies are represented by a three-letter code. The first two letters represent the country (derived from the ISO 3166 standard of 249 countries); the third letter is the first letter of the currency in that country. For example in JPY: JP stands for Japan and Y for the Yen.

Why are FX volumes so high? Explain what happens when a company hedges an FX transaction

The FX market traded about USD 6.6 trillion on average every day, at the April 2019 BIS survey. According to the WTO, the annual turnover of global trade is just over USD 20 trillion every year. While much international trade drives a need for currency hedging, as companies export into foreign currency jurisdictions, the FX market turns over more than 80 times the volume of international trade. The FX market is used to do things other than hedge exposures that arise from international trade in goods.

Example:

US company X agrees to sell goods to European company Y at a price of 100m euros on 60-day terms. Company X is a dollar-based company so when it receives the EUR 100m, it has to exchange them into US dollars. Company X can wait for the euro payment and exchange it for USD at the prevailing rate in 60-days. Or it can neutralise the risk that the euro will fall in value over the next 60-days by hedging its exposure today. If it chooses the latter, it follows five steps:

  1. Company X calls Bank A and agrees to sell EUR 100m to the bank in 60 days. Bank A agrees to sell Company X an equivalent amount in USD at the same time. The parties agree the rate today for that future exchange.
  2. Bank A hedges its exposure with Bank B, taking the total notional traded to EUR 200m.
  3. Bank A then uses the position to fill an order with Hedge Fund C, which wants to express its view on the future direction of EUR/USD. This takes the total traded notional to 300m.
  4. If delivery of goods is delayed by 30 days and payment happens 30-days later than originally envisaged, company X will call Bank A to restrike the original trade.
  5. Bank A will then need to call Bank B to restrike its own hedge.

Hence hedging activity to support EUR 100m of international trade has spawned EUR 500m of FX activity. Currencies are also seen as a speculative vehicle where investors can take a view on an industry or country. Since FX is so liquid, it is relatively easy to short on a negative view and this activity is of course completely unrelated to international trade in goods and services.

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Kees van den Aarssen

Kees van den Aarssen

Kees has over 30 years of experience in Financial Markets. He has sophisticated expertise in sales and trading roles working in Foreign Exchange and Money Markets. He now conducts seminars, workshops and training courses for clients all over the world.

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