Unlike the commodity and stock markets, it is not a physical market based in one building or location. Rather, it is an organizational framework within which participants linked by telephone and computers buy and sell currencies.
The market runs 24 hours a day in the major financial centers around the world. Actual currencies are not physically traded; instead, they are transferred electronically from one bank account to another. The FX market is an over-the-counter (OTC) market. This means that all of the following are negotiable between the two counterparties in the market:
- the size of the deal
- the settlement date
- the price
If an agent has the wrong currency; the agent may wish to buy goods in Europe, but unfortunately only possesses US dollars. A foreign exchange transaction would be necessary, whereby the party would sell US dollars in exchange for the euro that it would need to buy the relevant goods.
In addition to FX transactions that are conducted for immediate delivery, there is also a large market in forward FX. These transactions commit a party to buying a certain amount of one currency in exchange for another at a predetermined rate at a specified date in the future. This allows agents who have known future cash flows payable/receivable in different currencies to fix the rate now for future transactions.
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