Definition of Players in the Foreign Exchange Market

Players in the Foreign Exchange Market

The main participants in the foreign exchange market are commercial banks. Indeed, one say that it is the commercial banks that “make a market” in foreign exchange. Next in importance are the large Corporations with foreign trade activities. Finally, central banks are present in the foreign exchange market.

(a) Commercial Banks

Commercial banks are normally known as the lending players in the foreign exchange scene, we are speaking of large commercial banks with many clients engaging in exports and imports which must be paid in foreign currencies or of banks which specialize in the financing of trade. Commercial banks participate in the foreign exchange market as an intermediary for their corporate customers who wish to operate in the market and also on their own account. Banks maintain certain inventories of foreign exchange to best service its customers.

(b) Non-financial Corporations

The involvement of Corporations in the foreign exchange market originates from two primary sources such as International trade and direct investment. International trade usually involves the home country of the corporation. In this regard, the concern of the corporation is not only that foreign currency be paid or received, but also that the transaction be done at the most advantageous price of foreign exchange possible. A business also deals with the foreign exchange market when it engages in foreign direct investment. Foreign direct investments involve not only the acquisition of assets in a foreign country, but also the generation of liabilities in a foreign currency. So, for each currency in which a firm operates, an exposure to foreign exchange risk is likely to be generated. That is, given that a company will have either a net asset or a net liability position in the operations in a given currency, any fluctuation that occurs in the value of that currency will also occur in the value of the company’s foreign operations.

(c) Central Banks

Central Banks are not only responsible for the printing of domestic currency and the management of the money supply, but, in addition, they are often responsible for maintaining the value of the domestic currency vis-a-vis the foreign currencies. This is certainly true in the case of fixed exchange rates. However, even in the systems of floating exchange rates, the central banks have usually felt compelled to intervene in the foreign exchange market at least to maintain orderly markets.

Under the system of freely floating exchange rates, the external value of the currency is determined like the price of any other good in a free market, by the forces of supply and demand. If, as a result of international transactions between the residents and the rest of the world, more domestic currency is offered than is demand, that is, if more foreign currency is demanded than is offered, then the value of the domestic currency in terms of the foreign currencies will tend to decrease. In this model, the role of the central bank should be minimal, unless it has certain preferences i.e. it wishes to protect the local export industry.