The foreign exchange markets

A foreign exchange market (the 'forex') is where one currency is exchanged for another. The UK is the main centre in the world for foreign currency trading. This chapter examines the nature of exchange rates which is followed by a discussion of the determination of exchange rates. There is little, if any, agreement on the factors determining the demand for and supply of currency in the foreign exchange market. Three principal relationships are discussed in the chapter: purchasing power parity, covered interest rate parity and the international Fisher relation. The chapter explores the nature of the foreign exchange market and the types of business carried out on the market. Four types of forex business are conducted: spot transactions, outright forward transactions, foreign exchange swaps and currency swaps. The chapter also briefly summarises the empirical evidence concerning the efficiency of the forex.