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the Swiss intervention was an outright failure. The authorities were forced to stand aside against the weight of Swiss franc buying and by August 2011 EUR/CHF had touched 1.05. In the same month the Swiss authorities adopted a zero interest rate policy to deter inflows.

      Conclusion

      This topic is very broad and while we can see that the role of intervention has generated a lot of debate and research amongst the academic community, the results are not clear cut. This, however, has not deterred a number of monetary authorities from intervening with some frequency. This has been particularly evident in Asia.

      The importance to the market is that intervention does influence exchange rates and hedging policy. The difficulty for the market lies in determining the degree of impact and its sustainability.

      Endnotes

      3 IMF Board Decision No 5392-(77 63), adopted April 1977. [return to text]

      4 G-5, 22 September 1985. [return to text]

      5 G-7, 22 February 1987. [return to text]

      6 Taylor, 2006. [return to text]

      3. The Basics of Foreign Exchange

      A definition of foreign exchange

      All claims on foreign currency payable abroad, whether consisting of funds in foreign currency held with banks abroad, or bills or cheques, again in foreign currency and payable abroad, are foreign exchange (also called Forex or FX). In the trading of foreign exchange between banks only foreign currency held with banks abroad is concerned. For the purposes of this book foreign exchange only applies to bank balances denominated in foreign currency.

      Foreign bank notes are not foreign exchange in this sense. They can be converted into foreign exchange provided they can be placed without restriction to the credit of an ordinary commercial account abroad. A currency, whether in foreign exchange or bank notes, is deemed convertible if the person holding it can convert (exchange) it freely into any other currency. Convertibility may be unrestricted or partial. Sterling, since 1979, is fully convertible whether the holder is resident in the UK or abroad, and regardless of whether it is a matter of current payments or financial transactions. Some countries recognise only external or non-resident convertibility.

      Regulations may also draw a distinction, as far as convertibility is concerned, between funds arising from current transactions (goods and services) and those coming from purely financial operations. Exchange controls were common in the West until the 1980s. They now tend to be operated in emerging countries, especially in Asia and the Far East. It is important to ascertain prior to any transactions what conditions apply. It is usually easy to invest into a country but can prove extremely difficult to repatriate.

      The foreign exchange market

      The foreign exchange market is not a physical place. It operates on a global basis through a computer-linked group of banks whose function is to facilitate trading by providing buying and selling prices to the main participants (these are noted below). This is known as an over-the-counter (OTC) market. Banks are the intermediary between foreign exchange supply and demand. The interbank market is the wholesale market and this is where the banks trade with one another.

      The development in communications and dealing technology has meant that there is a uniform price for a particular currency throughout the financial centres of the world. The main centres of trading are London and New York. Trading is continual from Sunday evening 20.00 GMT to Friday evening 22.00 GMT.

      Historically, transactions would occur over the phone, telex or via brokers but now dealing platforms and electronic broking systems dominate, for example EBS. According to the BIS (Bank for International Settlements) Triennial central bank Survey 2010, the foreign exchange market turnover is about $4trn a day, which makes it the largest, most liquid financial market in the world.

      These characteristics of the foreign exchange market – high liquidity, 24-hour trading and price fluctuation – are attractive to speculators and this explains why this market has become the largest in the world.

      Currency pairs and ISO abbreviations

      In the market, abbreviations are used to refer to the various currencies. These can be represented by commonly used symbols or three letter codes as set by the International Organization for Standardization (ISO). The following ISO codes are used in this book:

       pound sterling (GBP)

       US dollar (USD)

       euro (EUR)

       Swiss franc (CHF)

       Japanese yen (JPY)

      This group of currencies are generally referred to as the majors, based quite simply on the volumes transacted. The Australian dollar (AUD) is sometimes also included, although it normally comes under the commodity currency umbrella which includes Canada (CAD), New Zealand (NZD), South Africa (ZAR) and Norway (NOK).

      In foreign exchange two currencies are always involved. The rate of exchange is the price of one currency in terms of another. For example, the relation of British pounds to US dollars will be shown as GBP/USD.

      The size, scope and growth of the foreign exchange market

      Market share by country

      The foreign exchange market share by country can be seen in Table 3.1.

      Table 3.1 – Foreign exchange market share by country in 2007 and 2010

      The UK dominates foreign exchange trading, with a market share of 37% in 2010 (up from 35% in 2007). The growth in the UK becomes even more stark when compared with 1995 when its market share was 29%. The euro-zone’s market share has virtually halved since 1995 and now accounts for just 9%. The US accounted for 18% in 2010, which is broadly in line with the past ten years’ experience. The US is followed by Japan on 6%.

      The other main trading centres, Singapore, Switzerland and Hong Kong, account for around 5% each with Australia accounting for 4%. A notable loser in recent years has been Japan, which has seen its share collapse from 10% in 1995, possibly reflecting a stagnant economy and banking problems.

      Growth of foreign exchange trading

      The pace of growth in foreign exchange trading has slowed in recent years, but the numbers are nonetheless impressive. Looking at the data in Table 3.2, the top row – Foreign exchange instruments – shows that overall turnover in the world markets in 2010 was up 18% on 2007 and over 300% since 2001. The growth was largely driven by spot transactions, which were up 48%, and by outright forwards, which increased by 31% from 2007 to 2010. These are referred to in the market as plain vanilla transactions by virtue of their simplicity.

      Table 3.2 – Global foreign exchange market turnover by instrument

      Source: BIS (Bank for International Settlements)

      The figures show that spot trades account for 37% of transactions, which is similar to 1998 levels and up from 30% in 2007. This particular situation may be a result of the 2007-09 financial crisis, as company boardrooms might have been less inclined to use more sophisticated instruments and looked to take a more conservative approach.

      The use of options fell to USD 207bn per day in April 2010, from USD 212bn in 2007, although one should not lose sight of the rapid growth in the preceding decade. The most actively traded instrument remains foreign

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