Updated September 15, 2016
Introduction to Financial Services: The International Foreign
Exchange Market
Overview
(primarily interest rate swaps and forward rate agreements
The international foreign exchange market is a vast,
in a single currency that are designed to manage exposure
complex assortment of globally dispersed actors and
to changes in interest rates over the duration of the swap).
transactions that comprise millions of transactions daily,
valued at trillions of dollars. On a daily basis, the value of
Foreign Exchange Market
global foreign exchange transactions eclipses the total
Market Activity. According to a triennial survey of the
global value of economic output and the value of all traded
world’s leading 53 central banks and monetary authorities
stocks and bonds. These markets are highly liquid as a
conducted by the Bank for International Settlements (BIS)
result of extensive global communications systems and
in April 2016, spot transactions and foreign exchange
electronic trading venues that operate on a 24-hour basis.
swaps dominate the traditional foreign exchange markets,
Foreign exchange markets respond rapidly to political and
as indicated in Table 1. Daily turnover in these foreign
economic events and instantaneously transmit market
exchange markets totaled more than $5.1 trillion in the
signals across national borders. Unexpected or abrupt
survey, while daily turnover in the OTC market totaled $2.7
disruptions in the foreign exchange market can roil
trillion, primarily in interest rate instruments (swaps). In
financial markets and economies around the globe with
total, daily foreign exchange turnover was $7.8 trillion,
broad implications for economic activity. For instance, in
more than three times the annual amount of U.S. exports of
January 2015, Switzerland removed the cap it had placed on
goods and services.
the foreign exchange value of its currency; in August 2015,
China depreciated its currency; and in June 2016, British
Table 1. Foreign Exchange Market Turnover
voters endorsed a referendum to pull the United Kingdom
(daily averages in April of the year indicated, trillions of US
out of the European Union. In each case, global financial
dollars)
markets experienced large shifts in positions over a short
period of time.
Year
2010
2013
2016
Foreign Exchange Transactions
Foreign Exchange Market Turnover
Foreign exchange (FX) markets facilitate international
Spot transactions
1.5
2.0
1.7
commerce by making it possible for firms to exchange
Outright forwards
0.5
0.7
0.7
currencies for exporting and importing goods and services.
The markets also supply currencies for foreign investment,
Foreign exchange swaps
1.8
2.2
2.4
for purchases of financial instruments, and to currency
Options
0.2
0.3
0.2
traders attempting to gain profits from short-term
fluctuations in exchange rates. Some governments also hold Total “traditional”
4.0
5.4
5.1
foreign currencies as reserves to protect against fluctuations
in currency exchange rates.
Over-the-Counter Derivatives Market Turnover
Interest rate instruments
2.1
2.3
2.7
Trading in the foreign exchange market occurs in both
traditional markets with organized exchanges and
Total Market Turnover
6.0
7.7
7.8
standardized products and in the over-the-counter (OTC)
United States



market that is informal with uniquely crafted products.
Traditional foreign exchange transactions consist of three
Foreign exchange turnover
0.9
1.3
1.3
kinds: spot transactions, forward transactions, swaps, and
options. Spot and forward transactions are agreements that
OTC derivatives
0.7
0.7
1.3
involve trading currencies immediately at the market
Total U.S. turnover
1.6
2.0
2.6
exchange rate (spot transactions) or at some pre-arranged
time in the future and at a pre-arranged rate of exchange
Source: Bank for International Settlements, and Federal Reserve
(forward transactions). A swap is a contract to exchange
Bank of New York.
currencies and to pay or receive interest payments over the
duration of the contract. An option is a flexible forward
In Mid-2015, the outstanding notional amount of foreign
transaction that allows the owner of the option to buy or sell
exchange OTC derivative contracts totaled $70 trillion,
a specific amount of foreign currency at a certain price
while the comparable interest rate contracts totaled $384
before the pre-determined expiration date of the option
trillion. Daily foreign exchange market activity in the
contract. Over-the-counter foreign exchange derivative
United States in the April 2016 survey amounted to $2.6
market transactions consist largely of interest rate contracts
trillion, about one-third of the total global foreign exchange
market activity in April 2016. Two-thirds of the daily U.S.
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Introduction to Financial Services: The International Foreign Exchange Market
foreign exchange market turnover was in traditional foreign
liquid assets as a buffer against adverse financial shocks
exchange transactions, with one-third in foreign exchange
have added to this global demand for dollars.
derivatives.
Figure 2. Currency Distribution of Global Foreign
Markets by Geographic Region. Foreign exchange
Exchange Market Turnover
trading activity is dominated by a few geographic locations,
(% share of average daily turnover, April 2016)
as indicated in Figure 1. London is the largest trading
center, accounting for 37% of global volume. The United
100
88
States (New York) accounts for about half the U.K. share,
80
or 19% of global trading. The next six countries—
Singapore (8.0%), Hong Kong (7.0%), Japan (6.0%),
60
France (3.0%), Switzerland (2.4%), and Australia (2.0%)—
31
combined with the U.K. and U.S. shares—account for about
40
22
26
85% of all foreign exchange transactions.
13
20
7
5
5
4
Figure 1. Geographical Distribution of Global Foreign
...
Exchange Market Turnover
(% share of average daily turnover, April 2016)
40%

Source: Bank for International Settlements, September 2016.
35%
30%
Issues for Congress
25%
Through the Dodd-Frank Wall Street Reform and
20%
Consumer Protection Act (P.L. 111-203), Congress moved
15%
to regulate parts of the foreign exchange derivatives (swap)
10%
markets by: 1) registering and regulating swap dealers and
5%
major swap participants; 2) implementing clearing and
0%
trade execution requirements for certain foreign exchange
swaps; and 3) establishing record keeping and reporting
requirements. In November 2014, however, U.S., U.K., and

Swiss regulators fined five international banks, including
Source: Bank for International Settlements, September 2016.
Citigroup and JP Morgan Chase, $4.3 billion for
manipulating the foreign exchange market. Congress may
The Role of the Dollar. The U.S. dollar is the most heavily
choose to use its oversight role to ensure that the new
traded currency in FX markets, as indicated in Figure 2. It
requirements promote transparency and greater stability in
accounts for 88% of daily foreign exchange transactions
the foreign exchange derivatives market and to determine if
and reflects the role of the dollar as the international reserve
new laws or regulations are necessary. Congress may also
currency. (Because two currencies are involved in each
choose to evaluate the effectiveness of recent exchange
transaction, the sum of the percentage shares of individual
market reforms in light of recent settlements with major
currencies totals 200% instead of 100%.) In comparison,
banks over manipulation of the foreign exchange market.
the euro accounts for 31% of trades, the Japanese yen
The increased role in international markets of such
accounts for 22%, and the British pound accounts for 13%.
emerging economies as China may also pose challenges for
Other currencies account for smaller shares: Australian
the dollar over the long run as the global economy’s reserve
dollar (7.0%), Swiss franc (5.0%), Canadian dollar (5.0%),
currency. Congress may choose to assess and evaluate the
and Chinese renminbi (4.0%). The dollar is used to fund
continuing role of the dollar as the most important reserve
commercial activities and by governments and central
currency and possible implications for U.S. economic and
banks to intervene at times in foreign exchange markets or
financial policies.
as reserves to protect their currencies from the spillover
effects of global crises. Governments also have increased
James K. Jackson, Specialist in International Trade and
their holdings of dollars and dollar-denominated assets as
Finance
safe assets as a result of increased financial openness and
exposure to capital flow volatility. In addition, regulatory
IF10112
reforms that require financial institutions to hold safe and

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Introduction to Financial Services: The International Foreign Exchange Market



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