A Assignment On:

Introduction of Foreign Exchange, Foreign Exchange Market : Nature, Participants and its Structure.

Submitted To:
Dr. J.K Chandel

Submitted By:
Atul Roll no.9 Semester 7th

Content
1. Chapter 1
Introduction to foreign Market. Exchange Rate Determination.

Page No.

2. Chapter 2
Definiation Why foreign Market is Unique?

3. Chapter 3
Foreign Exchange Market in India

4. Chapter 4
Nature of foreign Market

5. Chapter 5
Participants in foreign Exchange Market Factors Influencing Foreign Exchange Market Advantages and Disadvantages

6. Chapter 6
Structures of Foreign Exchange Market

Chapter 1 Introduction to Foreign Exchange Market.

Foreign Exchange Market: Introduction to Foreign Exchange Markets Being the main force driving the global economic market, currency is no doubt an essential element for a country. However, in order for all the countries with different currencies to trade with one another, a system of exchange rate between their currencies is needed; this system, is formally known as foreign exchange or currency exchange. In the early days, the system of currency exchange is supported solely by the gold amount held in the vault of a country. However, this system is no longer appropriate now due to inflation and hence, the value of ones currency nowadays is determined through the market forces alone. In order to determine the value of a currencys exchange rate, two main types of system is used which is floating currency and pegged currency. For floating exchange rate, its value is determined by the supply and demand of the global market where the supply and demand is bound by all these factors such as foreign investment, inflation and ratios of import and export. Normally, this system is adopted by most of the advance countries like for example UK, US and Canada. All of these countries have a similarity where their market is well developed and stable in economic terms. These countries choose to practice this system due to the reason where floating exchange rate is proven to be much more efficient compared to the pegged exchange rate. The reason behind this is because for floating exchange rate, the market itself will re-adjust the exchange rate real-time in order to portray the actual inflation and other economic forces. However, every system has its own flaw and so does the floating exchange rate system. For instance, if a country suffers from economic instability due to various reasons such as political issues, a floating exchange rate system will certainly discourage investment due to the high risk of suffering from inflationary disaster or sudden slump in exchange rate. Another form of exchange rate is known as pegged exchange rate. This is a system where the value of the exchange rate is fixed by the government of a country and not the supply and demand of the market. This system is called pegged exchange rate because the value of a countrys currency is fixed to another countrys currency. As a result, the value of the pegged currency will not fluctuate unlike the floating currency. The working principle behind this system is slightly complicated where the government of a country will fixed the exchange rate of their currency and when there is a demand for a certain currency resulting a rise in the exchange

rate, the government will have to release enough of that currency into the market in order to meet that demand. However, there is a fatal flaw in this system where if the pegged exchange rate is not controlled properly, panics may arise within the country and as a result of that, people will be rushing to exchange their money into a more stable currency. When that happens, the sudden overflow of that countrys currency into the market will decrease the value of their exchange rate and in the end, their currency will be worthless. Due to this reason, only those under-developed or developing countries will practice this method as a form to control the inflation rate. However, the truth is, most of the countries do not fully practice the floating exchange rate or the pegged exchange rate method in reality. Instead, they use a hybrid system known as floating peg. Floating peg is the combination of the two main systems where one country will normally fixed their exchange rate to the US Dollars and after that, they will constantly review their peg rate in order to stay in line with the actual market value. The Foreign exchange market, or commonly known as FOREX, is the largest and most prolific financial market because each day, more than 1 trillion worth of currency exchange takes place between investors, speculators and countries. From this, we can deduce that the actual mechanism behind the world of foreign exchange is far more complicated than what we may already know, and that, the information mentioned earlier is just the tip of an iceberg.

Exchange rates are determined in the same way as other asset prices.
The foreign exchange market, also known as the forex, FX, or currency market, involves the trading of one currency for another. Prior to 1996 the market was confined to large corporate banks and international corporations. However it has since opened up to include all traders and speculators. Today, the average daily turnover in forex markets is US$1.9 trillion, according to the Bank of International Settlements Triennial Survey. The market is growing rapidly as investors gain more information and develop more interest. In trading foreign exchange, investors bet that one currency will appreciate over another; they profit when they bet correctly and collect the profit in the form of an interest rate spread when they return to the original currency. The profit margins are low compared with other fixedincome markets. Large trading volumes can, however result, in very high profits. Most forex trading takes place in London, New York, and Tokyo, with most trading activity in London, which dominates the market at 30% of all transactions. New Yorks market share is 16%, and

Tokyos has fallen to 10% due to the growing prominence of Singapore and Hong Kong. Singapore has become the fourth largest exchange market globally, and Hong Kong is the fifth, having overtaken Switzerland. The various players in theforeign exchange market include bank dealers, 16% of which are international investors and speculators. Banks account for almost twothirds of forex transactions; of the rest, about 20% is mainly attributable to securities firms that operate in the international debt and equity markets. One type of very short-term transaction is the spot transaction between two currencies, delivering over two days and using cash as opposed to a contract. In a forward transaction, the money is not exchanged until an arranged date and an exchange rate is agreed in advance. The time period ranges from days to years. Currency swaps are a popular type of forward transaction; these involve the exchange of currency by two parties for an agreed length of time and an arrangement to swap currencies at an agreed later date. Another type is a foreign currency future, which is inclusive of interest. A standard contract is drawn up and a maturity date arranged. The time schedule is about three months. In a foreign exchange option (FX option), the most liquid and biggest options market in the world, the owner may elect to exchange money in a designated currency for another currency at an agreed date in the future. This type of transaction depends on the availability of option contracts on an organized exchange. Otherwise, such forex deals may be carried out using an over-the-counter (OTC) contract.

Chapter 2:

Meaning of Foreign Exchange Market

Definition:The Currency Market where money denominated in one currency is

bought and sold with money denominated in another currency. Exchange rates are important because they enable us to translate different counties prices into comparable terms.

The exchange is the act by which we exchange the currencies of different nations. Currencies take the same form as the currency within a country. Most of the assets traded currency in foreign exchange markets are deposits in banks. The rate of change is the price of the currency of a country in terms of the currency of another. There are two types of exchange rates, according to the date of exchange of real currency: the exchange rate Cash is the price for a transaction "immediate" (one or two days maximum for large transactions), the exchange rate is the price for a transaction that will occur at a at some time in the future, in 30, 90 or 180 days. Transactions in cash only that 40% of transactions. The foreign exchange market is clearly a forward market.

An exchange rate can be expressed in two ways: The listing on the "some" is to give the number of foreign monetary units equivalent to a unit of local currency rating to " uncertainty indicates the number of local currency units for one unit of currency foreign. For example, 20 January 1999, the euro price was U.S. $ 1.1571 in Paris (to quote some), or yet the dollar against euro was at 0.86472 (listing to uncertainty). When the euro appreciates against other currencies, the value quoted in certain amounts, but its market value to uncertainty decreases. Presentations subsequent tables and graphs focus on the exchange listing to uncertainty

The foreign exchange market (forex, FX, or currency market) is a form of exchange for the global decentralized trading of international currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers

around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies. The foreign exchange market assists international trade and investment by enabling currency conversion. For example, it permits a business in theUnited States to import goods from the European Union member states especially Eurozone members and pay Euros, even though its income is inUnited States dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation based on the interest rate differential between two currencies. In a typical foreign exchange transaction, a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market began forming during the 1970s after three decades of government restrictions on foreign exchange transactions (the Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states after World War II), when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.

Why the foreign Exchange Market is Unique?

its huge trading volume representing the largest asset class in the world leading to high liquidity;

its geographical dispersion; its continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday;

the variety of factors that affect exchange rates; the low margins of relative profit compared with other markets of fixed income; and the use of leverage to enhance profit and loss margins and with respect to account size.

As such, it has been referred to as the market closest to the ideal of perfect competition, notwithstanding currency intervention by central banks. According to the Bank for International Settlements,as of April 2010, average daily turnover in global foreign exchange markets is estimated at $3.98 trillion, a growth of approximately 20% over the $3.21 trillion daily volume as of April 2007. Some firms specializing on foreign exchange market had put the average daily turnover in excess of US$4 trillion.

The $3.98 trillion break-down is as follows:

$1.490 trillion in spot transactions $475 billion in outright forwards $1.765 trillion in foreign exchange swaps $43 billion currency swaps $207 billion in options and other product.

Chapter 3 Foreign exchange Market In India

Foreign Exchange Market India

The foreign exchange market India is growing very rapidly. The annual turnover of the market is more than $400 billion. This transaction does not include the inter-bank transactions. According to the record of transactions released by RBI, the average monthly turnover in the merchant segment was $40.5 billion in 2003-04 and the inter-bank transaction was $134.2 for the same period.

The foreign exchange market India is growing very rapidly. The annual turnover of the market is more than $400 billion. This transaction does not include the inter-bank transactions. According to the record of transactions released by RBI, the average monthly turnover in the merchant segment was $40.5 billion in 2003-04 and the inter-bank transaction was $134.2 for the same period. The average total monthly turnover was about $174.7 billion for the same period. The transactions are made on spot and also on forward basis, which include currency swaps and interest rate swaps. The Indian foreign exchange market consists of the buyers, sellers,market intermediaries and the monetary authority of India.

The main center of foreign exchange transactions in India is Mumbai, the commercial capital of the country. There are several other centers for foreign exchange transactions in the country including Kolkata, New Delhi, Chennai, Bangalore, Pondicherry and Cochin.

The foreign exchange market India is regulated by the reserve bank of India through the Exchange Control Department. At the same time, Foreign Exchange Dealers Association (voluntary association) also provides some help in regulating the market. The Authorized Dealers (Authorized by the RBI) and the accredited brokers are eligible to participate in the foreign Exchange market in India. When the foreign exchange trade is going on between Authorized Dealers and RBI or between the Authorized Dealers and the Overseas banks, the brokers have no role to play.

Apart from the Authorized Dealers and brokers, there are some others who are provided with the restricted rights to accept the foreign currency or travelers cheque. Among these, there are the authorized money changers, travel agents, certain hotels and government shops. The IDBI and Exim bank are also permitted conditionally to hold foreign currency.

The whole foreign exchange market in India is regulated by the Foreign Exchange Management Act, 1999 or FEMA. Before this act was introduced, the market was regulated by the FERA or Foreign Exchange Regulation Act ,1947. After independence, FERA was introduced as a temporary measure to regulate the inflow of the foreign capital. But with the economic and industrial development, the need for conservation of foreign currency was felt and on the recommendation of the Public Accounts Committee, the Indian government passed the Foreign Exchange Regulation Act,1973 and gradually, this act became famous as FEMA.

Chapter 4

Nature of foreign Exchange Market

Nature Of Foreign Exchange Market

The Foreign Exchange Market is an over-the-counter (OTC) market, which means that there is no central exchange and clearing house where orders are matched. With different levels of access, currencies are traded in different market makers: The Inter-bank Market - Large commercial banks trade with each other through the Electronic Brokerage System (EBS). Banks will make their quotes available in this market only to those banks with which they trade. This market is not directly accessible to retail traders. The Online Market Maker - Retail traders can access the FX market through online market makers that trade primarily out of the US and the UK. These market makers typically have a relationship with several banks on EBS; the larger the trading volume of the market maker, the more relationships it likely has.

Market Hours Forex is a market that trades actively as long as there are banks open in one of the major financial centers of the world. This is effectively from the beginning of Monday morning in Tokyo until the afternoon of Friday in New York. In terms of GMT, the trading week occurs from Sunday night until Friday night, or roughly 5 days, 24 hours per day. Price Reporting Trading Volume Unlike many other markets, there is no consolidated tape in Forex, and trading prices and volume are not reported. It is, indeed, possible for trades to occur simultaneously at different

prices between different parties in the market. Good pricing through a market maker depends on that market maker being closely tied to the larger market. Pricing is usually relatively close between market makers, however, and the main difference between Forex and other markets is that there is no data on the volume that has been traded in any given time frame or at any given price. Open interest and even volume on currency futures can be used as a proxy, but they are by no means perfect.

No trading field Unlike the stock trading, foreign exchange transactions take place without any trading market and trading field. The absence of any unification of the operation market and business network, one of the main features of the foreign exchange currency market is that it has no centralized market like a stock exchange. Consisting of an advanced information system, foreign exchange trading network has formed into a global, non-formal organization. Although the foreign exchange traders are not required to hold a membership of any organization, they must obtain their colleagues trust and approval. Freedom to operate Different geographical position of the various financial centers and with the foreign exchange market functions 24 hours each working day, the foreign exchange market remains in complete circulation. With 24 hours of uninterrupted operation, from Monday to Friday each week, free from any time and spatial barrier is an ideal environment for investors. The freedom to operate in multiple markets is an interesting aspect of foreign exchange nature. Perpetual motion in prices One of the other characteristics of the foreign exchange is that the fluctuations in the exchange rate will cause one currency to lose its monetary value, while others to gain. So there is a continuous motion in prices. In the foreign exchange market, the exchange rate refers to the exchange ratio between the currencies of two countries. Fluctuations in the exchange rate change will cause one currency to lose its monetary value, and at the same time increase the monetary value of another currency. Unlimited Potential for Profit and Loss

The most effective manner to illustrate the "unlimitedness" of the market environment is to compare it to gambling. With any gambling game you will always know exactly how much you can win or lose each time you play. You decide exactly how much you want to wager, you know exactly how much you can win as well as lose, and you may even know the mathematical odds of either possibility. This is not the case in market environment. In any particular trade you never really know how far prices will travel from any given point. If you never really know where the market may stop, it is very easy to believe there are no limits to how much you can make on any given trade. Several psychological factors go into assessing the market's potential accurately for the price movement in any given direction. The possibility for unlimited profits may in fact exist, but how realistic it is in any given trade is another matter.

Chapter 5

Participants Of Foreign Exchange Market

Various participants Of foreign Exchange Market:

1. Governments: Governments have requirements for foreign currency, such as paying staff salaries and local bills for embassies abroad, or for arraigning a foreign currency credit line, most often in dollars, for industrial or agricultural development in the third world, interest on which, as well as the capital sum, must periodically be paid. Foreign exchange rates concern governments because changes affect the value of product and financial instruments, which affects the health of a nations markets and financial systems.

2. Banks: There are different types of banks, all of which engage in the foreign exchange market to greater or lesser extent. Some work to signal desired movement in the market without causing overt change, while some aggressively manage their reserves by making speculative risks. The vast majority, however, use their knowledge and expertise is assessing market trends for speculative gain for their clients.

3. Brokering Houses: These exist primarily to bring buyer and seller together at a mutually agreed price. The broker is not allowed to take a position and must act purely as a liaison. Brokers receive a commission from both sides of the transaction, which varies according to currency handled. The use of human brokers has decreased due mostly to the rise of the interbank electronic brokerage systems.

4. International Monetary Market: The International Monetary Market (IMM) in Chicago trades currencies for relatively small contract amounts for only four specific maturities a year. Originally designed for the small investor, the IMM has grown since the early 1970s, and the major banks, who once dismissed the IMM, have found that it pays to keep in touch with its developments, as it is often a market leader.

5. Money Managers: These tend to be large New York commission houses that are often very aggressive players in the foreign exchange market. While they act on behalf of their clients, they also deal on their own account and are not limited to one time zone, but deal around the world through their agents.

6. Corporations: Corporations are the actual end-users of the foreign exchange market. With the exception only of the central banks, corporate players are the ones who affect supply and demand. Since the corporations come to the market to offset currency exposure they permanently change the liquidity of the currencies being dealt with.

7. Retail Clients: This includes smaller companies, hedge funds, companies specializing in investment services linked by foreign currency funds or equities, fixed income brokers, the financing of aid programs by registered worldwide charities and private individuals. Retail investors trade foreign exchange using highly leveraged margin accounts. The amount of their trading in total volume and in individual trade amounts is dwarfed by the corporations and interbank markets.

Other financial institutions involved in the foreign exchange market include:

Stockbrokers Commodity Firms Insurance Companies Charities and Private Institutions Private Individuals

Factors Influencing Forex Market:

The changes in the forex market are a cumulative effect of economic factors, political conditions and market psychology.

Economic factors: The economic policies, balance of trade as well as inflation and growth rates of an economy influence the exchange rate of a currency. An economy's productivity also influences its exchange rates positively.

Political conditions: Political stability is one of the key factors operating behind forex market fluctuations. Also events in one country may affect the exchange rate of neighboring country's currency.

Market psychology: Forex markets are highly responsive to expectations and market perceptions. The participants often rely their decisions on long term trends of economic indicators.

2. Foreign Exchange Reserves i n India

As on August 24,2012 Variat ion over Week End-March 2012 End -De cember 2011 Year ` Total Reserves Bn. US$ Mn. ` 16,081.2 290,179.3 Bn. US$ Mn. ` Bn. US$ Mn. ` Bn. US$ Mn. ` Bn. US$ Mn.

14.4 1,259.9 1,019.9 4,218.2 276.5 6,509.4 1,431.1 28,995.3

(a) Foreign Currency Assets + 14,281.0 257,872.5 14.8 1,215.7 * 975.9 2,196.2 274.5 5,060.8 1,101.7 28,322.2 (b) Gold $ 1,435.1 25,714.7 52.6 1,308.4 17.0 905.6 315.7 366.0 (c) SDRs @ 242.9 4,386.0 0.2 29.4 14.3 83.3 7.0 43.0 29.2 254.5 (d) Reserve Position in the IMF** 122.2 2,206.1 0.2 14.8 22.9 630.3 22.0 500.0 15.5 784.6
+ Excl ud es ` 43 .7 b il l io n/ US $ 79 0 mi ll io n i n ves t ed in fo r eig n cur r en cy d eno mi na t ed bo nd s i ss u ed b y IIFC (UK). * Fo r ei g n cur r en cy as s ets expr es s ed i n US do l la r t er ms i n cl ud e t h e eff ect o f a pp r eci at i on /d epr eci a ti on of no n -US cu rr en ci es (s u ch a s Eu ro , St er li ng , Yen ) h eld in r es er ves . Fo r d et a il s , p l ea s e r ef er to th e Cu r r en t S ta ti s ti cs s ecti on of th e RBI Bu l l et i n . * * Res er ve Po si t io n i n t h e In t ern a ti on al Mo n et ar y Fu nd (IMF), i .e., Res er ve Tr an ch e Po s it io n (RTP) wh i ch was sh o wn as a memo i t em f ro m Ma y 23 , 20 03 to Ma r ch 2 6 , 20 04

h a s b een in cl ud ed i n t h e r es er ves f ro m t h e week end ed Apr il 2 , 20 0 4 i n keepi ng wi th th e in t er na tio n al bes t p ra cti ce. @ In clu d es S DR 3 ,0 82 .5 mil li on (eq u i va l en t t o US$ 4,8 8 3 mil l io n) a l lo cat ed u nd er g en er al al lo cat i on an d S DR 2 14 .6 mi l li on (eq u i va l en t t o US$ 34 0 mi l li on ) a l lo cat ed u nd er s p ecia l a ll o ca t io n b y IMF d on e o n Aug us t 2 8 , 2 00 9 a nd S ep t ember 9 , 2 00 9 , r esp ecti vel y. $ Includes `314.6 billion (US$ 6,699 million) reflecting the purchase of 200 metric tonnes of gold from IMF on November 3, 2009.

The Figures Of Forex Trade:

Foreign Exchange swaps - $1765 billion Spot Transactions - $1490 billion Outright Forwards - $475 billion Options and other products - $207 billion Currency swaps - $43 billion

The most traded currencies in the forex market are:

1. U.S Dollar (USD) 2. British Pound Sterling (GBP) 3. Euro (EUR) 4. Canadian Dollar (CAN) 5. Australian Dollar (AUD) 6. Swiss Franc (CHF) 7. New Zealand dollar (NZD) 8. Japanese Yen (JPY)

Top 10 currency trader

% of overall volume, May 2012 Rank 1 2 3 4 5 6 7 8 9 10 Name Deutsche Bank Citi Barclays Investment Bank UBS AG HSBC JPMorgan Royal Bank of Scotland Credit Suisse Morgan Stanley Goldman Sachs Market share 14.57% 12.26% 10.95% 10.48% 6.72% 6.6% 5.86% 4.68% 3.52% 3.12%

Most traded currencies by value Currency distribution of global foreign exchange market turnover ISO 4217 code (Symbol) % daily share (April 2010) 84.9% 39.1% 19.0% 12.9% 7.6%

Rank

Currency

1 2 3 4 5

United States dollar Euro Japanese yen Pound sterling Australian dollar

USD ($) EUR () JPY () GBP () AUD ($)

6 7 8 9 10 11 12 13 14 15

Swiss franc Canadian dollar

CHF (Fr) CAD ($)

6.4% 5.3% 2.4% 2.2% 1.6% 1.5% 1.4% 1.3% 1.3% 0.9% Other Total[67] 12.2% 200%

Hong Kong dollar HKD ($) Swedish krona New Zealand dollar SEK (kr) NZD ($)

South Korean won KRW () Singapore dollar SGD ($)

Norwegian krone NOK (kr) Mexican peso Indian rupee MXN ($) INR ( )

Top 20 - Indian Forex Brokers

# Forex broker Forex broker review For Against Vote Stats Commens Q&A News Status

NordFX

75%

25%

Swissquote

71%

29%

Admiral Markets

65%

35%

eToro

57%

43%

AvaFx

55%

45%

Saxo Bank

51%

49%

LiteForex

49%

51%

MRC markets

48%

52%

Kshitij

47%

53%

10

Alpari

45%

55%

11

iFOREX

45%

55%

12

Easy Forex

43%

57%

13

FXOpen

43%

57%

14

FXCM

42%

58%

15

FxCompany

41%

59%

16

ForexTrader India

39%

61%

17

Forex Club

37%

63%

18

Finotec

35%

65%

19

EXNESS

33%

67%

20

Dukascopy

31%

69%

Advantages

The forex market is extremely liquid, hence its rapidly growing popularity. Currencies may be converted when bought or sold without causing too much movement in the price and keeping losses to a minimum.

As there is no central bank, trading can take place anywhere in the world and operates on a 24-hour basis apart from weekends.

An investor needs only small amounts of capital compared with other investments. Forex trading is outstanding in this regard.

It is an unregulated market, meaning that there is no trade commission overseeing transactions and there are no restrictions on trade. In common with futures, forex is traded using a good faith deposit rather than a loan. The interest rate spread is an attractive advantage.

Disadvantages

The major risk is that one counterparty fails to deliver the currency involved in a very large transaction. In theory at least, such a failure could bring ruin to the forex market as a whole.

Investors need a lot of capital to make good profits because the profit margins on smallscale trades are very low.

Chapter 6

Structure of Foreign Exchange Market

Structure of Foreign Exchange Market

The forex is unique among financial markets in a number of ways. One of these is that it was not traditionally used as an investment vehicle. It had, and still maintains to some extent, a somewhat more utilitarian purpose. In todays globalized economy, most businesses have some international exposure, creating the need to exchange one currency for another in order to complete transactions. For example, Honda builds its cars in Japan and exports them to the United States, where an eager American buyer exchanges his dollars for a brand new Honda. Some of this money has to make its way back to Japan to pay the factory workers that built the car, but first those dollars have to be exchanged for Japanese yen, since that is the currency the Japanese factory workers are paid in. Transactions such as this are facilitated by international banks and are done through a mechanism known as the foreign exchange market, or forex. Since

banks are used to facilitate these cross-border transactions, they naturally want to be paid for their services. This payment comes in the form of a bid/ask spread offering to buy the desired currency at a slightly lower price than they are willing to sell it at, and pocketing the difference. Considering the fact that more than $3bn moves through the forex market daily, these seemingly small fees can add up to a significant sum. Since the 1970s most of the worlds major currencies have been on a (mostly) free-floating exchange mechanism, allowing for exchange rates to be determined by market forces, that is, supply and demand. I say mostly because there have been times when major central banks have intervened in the market to manipulate exchange rates by either buying or selling large amounts of their currency, but normally this only takes place in extreme situations. There are also other central banks that choose to manage their currencies much more strictly, but these are a minority in the developed world. So in most cases, this free-floating exchange rate mechanism allowed currencies to fluctuate against one another much more, and this in turn opened the door to speculation on the future movement of exchange rates. The banks intimate knowledge of the forex market, and their high level of capitalization allowed them to be the first to speculate in the forex market, and to significantly increase their profits by doing so. An unfortunate consequence of this speculation however was that liquidity at certain times became scarce, and some necessary transactions could not be completed. In order to solve this problem, banks turned to expanding the number of participants in the market to include non-banks, thereby generating sufficient order flow (liquidity distribution) to complete clients transactions, and also to profit from these newer and less knowledgeable market participants. These less experienced forex market participants first included large funds (such as the legendary Quantum Fund), but nowadays also include your local retail forex dealer. Another unique feature of the forex market is that it is an over-the-counter (OTC) market, meaning that there is no central exchange (like a stock exchange) where transactions take place. Instead, top-tier transactions are made in the interbank market, which is a collection of the worlds largest money center banks, all free to trade currencies amongst each other at whatever rate they can agree on. Of course, it may be difficult to find your way around such a maze, so the brilliant minds at the leading banks developed the Electronic Broking System (EBS) to enable participants to easily see at what rates all the other participants are willing to deal at. A competing system was also developed by Reuters (D2). Today, one is preferred over the other

mostly on the basis of which currency pair you want to trade, with EBS used mostly for EUR/USD, USD/JPY, EUR/JPY, USD/CHF and EUR/CHF, and Reuters D2 used for all other currency pairs. In 2006, EBS was acquired by ICAP. It should be noted that while these services provide a centralized structure for pricing information, they DO NOT constitute a centralized exchange. The forex is still very much an OTC market. The 2nd tier of the market is made up of smaller bits of larger multinational institutions. This is when, for example, a bank branch in the US deals with another branch of the same bank in, say, Japan. So when you walk into your local branch and want to exchange currency, they will give you a quote which is not exactly representative of the interbank exchange rate. You are free to shop around for a better quote, and you would often be wise to do so, as rates can vary significantly from one bank to another. Most retail forex brokers are a part of the 3rd tier, as they often deal with only a single 2nd tier liquidity provider. This is not always the case, as some retail brokers offer direct access to multiple liquidity providers, and are therefore themselves a part of the 2nd tier. This is particularly true of Electronic Communication Networks (ECNs), who normally route retail traders orders directly to the interbank market. For more information about how these differences affect retail traders, please read our article on How Forex Brokers Work.

Bibilography:
http://www.forexpulse.com/foreign-exchange-market-participants