The interbank market is the top-level foreign exchange market where different currencies are exchanged by the banks. The banks can either deal through electronic brokering platforms or they can also deal with one another directly. The two competitors in the electronic brokering platform business are The Electronic Brokering Services (EBS) and Reuters Dealing 3000 Matching and they together connect over 1000 banks. The currencies of most developed countries posses floating exchange rates. The values of these currencies fluctuate relative to other currencies and they don’t have a fixed value.
The interbank market forms an important segment of the foreign exchange market. It is such kind of a wholesale market through which most currency transactions are channeled. Mostly the trading among Bankers are carried out through them. The interbank market has got 3 main constituents and these are:
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the spot market
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the forward market
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SWIFT (Society for World-Wide Interbank Financial Telecommunications)
The interbank market is unregulated and decentralized. The interbank market does not have any specific location or exchange where these currency transactions take place. Despite of all the facts, the regulation of foreign currency options takes place in the United States and they are traded on the Philadelphia Stock Exchange. Further, on a daily basis closing spot prices are published by the Federal Reserve Bank.
Market makers
Unlike the Stock Market, the Foreign Currency Exchange Market (Forex) does not posses a physical central exchange like the NYSE does at 11 Wall Street. Without a central exchange, market makers make or set the currency exchange rates. Constantly a bid and ask price is quoted by the banks which are based on expected currency movements taking place and thereby they make the market. Very large currency trading (forex) transactions are being handled by major Banks like UBS, Barclays Capital,Deutsche Bank and Citigroup. These transactions are often in billions of dollars. The primary movement of currency prices is caused by these transactions.
There are other factors also that contribute to currency exchange rates and these factors include forex transactions made by smaller banks, hedge funds, companies, forex brokers and traders. The involvement of companies are in forex transaction is due to their need to pay for products and services that are supplied from other countries which use a different currency. On the other hand forex transaction of a much smaller volume with comparison to banks are used by forex traders, in order to benefit from expected currency movements by buying at cheap prices and selling at a higher price or vice versa. This takes place through forex brokers who play the role of a mediator between a pool of traders and also between themselves and banks.
In setting currency exchange rates Central banks also play a role by altering interest rates. The traders are stimulated to buy their currency by increasing interest rates as it provides a high return on investment and this drives the value of the corresponding central bank’s currency higher with comparison to other currencies.
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