Institutions in the Forex Market: Impact on Global Economy & Trading

This report provides an overview of the institutions operating within the foreign exchange (forex) market, the world's largest financial market. It identifies key players such as commercial and investment banks, central banks, investment managers and hedge funds, multinational corporations, and individual investors, detailing their roles and motivations in currency trading. Commercial banks facilitate transactions and engage in speculative trades, while central banks influence currency rates through monetary policies and interventions. Investment managers trade for large accounts, and multinational corporations conduct forex transactions for international trade and hedging. Individual investors are a growing segment, basing trades on fundamental and technical factors. The report also highlights how the interaction of these participants creates a liquid, global market that impacts inflation, corporate earnings, and the balance of payments. The carry trade strategy is discussed as an example of how market participants influence exchange rates and affect the global economy. The analysis emphasizes the diverse reasons for forex trading, from profit-driven speculation to risk management and monetary policy implementation, underscoring the importance of understanding these dynamics for investors.

INSTITUTIONS IN THE FOREX MARKET
The foreign exchange or forex market is the largest financial market in the world – larger
even than the stock market, with a daily volume of $6.6 trillion, according to the 2019
Triennial Central Bank Survey of FX and OTC derivatives markets.1 The digital site
where one currency is exchanged for another, the forex market has a lot of unique
attributes that may come as a surprise for new traders. In this article we will take an
introductory look at forex, and how and why traders are increasingly flocking toward this
type of trading.
Foreign Exchange (Forex) Definition
What Is Forex?
An exchange rate is a price paid for one currency in exchange for another. It is this type
of exchange that drives the forex market.
There are 180 different kinds of official currencies in the world. However, most
international forex trades and payments are made using the U.S. dollar, British pound,
Japanese yen, and the euro. Other popular currency trading instruments include the
Australian dollar, Swiss franc, Canadian dollar, and New Zealand dollar.
Currency can be traded through spot transactions, forwards, swaps
and option contracts where the underlying instrument is a currency. Currency trading
occurs continuously around the world, 24 hours a day, five days a week.
Who Trades Forex?
The forex market not only has many players but many types of players. Here we go
through some of the major types of institutions and traders in forex markets:
Commercial & Investment Banks
The greatest volume of currency is traded in the interbank market. This is where banks
of all sizes trade currency with each other and through electronic networks. Big banks
account for a large percentage of total currency volume trades. Banks facilitate forex
transactions for clients and conduct speculative trades from their own trading desks.
When banks act as dealers for clients, the bid-ask spread represents the bank's profits.
Speculative currency trades are executed to profit on currency fluctuations. Currencies
can also provide diversification to a portfolio mix.
Central Banks
Central banks, which represent their nation's government, are extremely important
players in the forex market. Open market operations and interest rate policies of central
banks influence currency rates to a very large extent.
A central bank is responsible for fixing the price of its native currency on forex. This is
the exchange rate regime by which its currency will trade in the open market. Exchange
rate regimes are divided into floating, fixed and pegged types.

Any action taken by a central bank in the forex market is done to stabilize or increase
the competitiveness of that nation's economy. Central banks (as well as speculators)
may engage in currency interventions to make their currencies appreciate or depreciate.
For example, a central bank may weaken its own currency by creating additional supply
during periods of long deflationary trends, which is then used to purchase foreign
currency. This effectively weakens the domestic currency, making exports more
competitive in the global market.
Central banks use these strategies to calm inflation. Their doing so also serves as a
long-term indicator for forex traders.
Investment Managers and Hedge Funds
Portfolio managers, pooled funds and hedge funds make up the second-biggest
collection of players in the forex market next to banks and central banks. Investment
managers trade currencies for large accounts such as pension funds, foundations,
and endowments.
An investment manager with an international portfolio will have to purchase and sell
currencies to trade foreign securities. Investment managers may also make speculative
forex trades, while some hedge funds execute speculative currency trades as part of
their investment strategies.
Multinational Corporations
Firms engaged in importing and exporting conduct forex transactions to pay for goods
and services. Consider the example of a German solar panel producer that imports
American components and sells its finished products in China. After the final sale is
made, the Chinese yuan the producer received must be converted back to euros. The
German firm must then exchange euros for dollars to purchase more American
components.
Companies trade forex to hedge the risk associated with foreign currency translations.
The same German firm might purchase American dollars in the spot market, or enter
into a currency swap agreement to obtain dollars in advance of purchasing components
from the American company in order to reduce foreign currency exposure risk.
Additionally, hedging against currency risk can add a level of safety
to offshore investments.
Individual Investors
The volume of forex trades made by retail investors is extremely low compared to
financial institutions and companies. However, it is growing rapidly in popularity. Retail
investors base currency trades on a combination of fundamentals (i.e., interest rate
parity, inflation rates, and monetary policy expectations) and technical factors (i.e.,
support, resistance, technical indicators, price patterns).
How Forex Trading Shapes Business
The resulting collaboration of the different types of forex traders is a highly liquid, global
market that impacts business around the world. Exchange rate movements are a factor

in inflation, global corporate earnings and the balance of payments account for each
country.
For instance, the popular currency carry trade strategy highlights how market
participants influence exchange rates that, in turn, have spillover effects on the global
economy. The carry trade, executed by banks, hedge funds, investment managers and
individual investors, is designed to capture differences in yields across currencies by
borrowing low-yielding currencies and selling them to purchase high-yielding currencies.
For example, if the Japanese yen has a low yield, market participants would sell it and
purchase a higher yield currency.
When interest rates in higher yielding countries begin to fall back toward lower yielding
countries, the carry trade unwinds and investors sell their higher yielding investments.
An unwinding of the yen carry trade may cause large Japanese financial institutions and
investors with sizable foreign holdings to move money back into Japan as
the spread between foreign yields and domestic yields narrows. This strategy, in turn,
may result in a broad decrease in global equity prices.
The Bottom Line
There is a reason why forex is the largest market in the world: It empowers everyone
from central banks to retail investors to potentially see profits from currency fluctuations
related to the global economy. There are various strategies that can be used to trade
and hedge currencies, such as the carry trade, which highlights how forex players
impact the global economy.
The reasons for forex trading are varied. Speculative trades – executed by banks,
financial institutions, hedge funds, and individual investors – are profit-motivated.
Central banks move forex markets dramatically through monetary policy, exchange
regime setting, and, in rare cases, currency intervention. Corporations trade currency
for global business operations and to hedge risk.
Overall, investors can benefit from knowing who trades forex and why they do so.
Reference:
FOREX MARKET: Who Trades Currencies and Why:, SEGAL, TROY; 18 August 2021,
Investopedia (Online) https://www.investopedia.com/articles/forex/11/who-trades-forex-
and-why.asp