Introduction

Transactions in foreign currencies take place when one country's currency is purchased (exchanged) with another country's currency. The price agreed upon or negotiated for the currency purchased is referred to as the foreign exchange rate.

Major commercial banks in the money market centers throughout the world are responsible for the majority of foreign currencies bought and sold. Among the leading money market centers are New York, Zurich, Frankfurt, London and Tokyo. Besides taking positions for their own accounts, these banks will also act as correspondents for other banks and commercial customers. Because of the worldwide communications systems that are now available (telexes, telephone and computerized linking systems) trading in foreign currencies is on a bank-to-bank basis (principal-to-principal) or employing the use of a "money broker" as agent between banks is known as the Interbank market. (Note, there is no specific location or organized exchange where these transactions occur.)

Foreign exchange rates (since the market is instantaneous) tend to be nearly the same all over the world. Rate differences are almost immediately equalized due to the workings of currency traders and arbitrageurs. For example, if Swiss francs could be sold for $.48 in Zurich, and only $.46 in New York, currency traders and arbitrageurs would buy Swiss francs in New York and sell them in Zurich. The increased demand in New York would drive the price up, while at the same time the surplus in Zurich would push prices lower. The overall effect would be to stabilize rates in the two cities. It must also be remembered that the foreign currency market is a 24-hour market. When banks in New York are first opening for business, London banks have already been trading for five or six hours and, by the same token, when banks in Tokyo are closing, banks in Los Angeles are first opening. Naturally, regardless of where a money center is located, trading will be heaviest when business hours overlap between money centers.

Commercial entities execute foreign currency transactions for a variety of reasons. Importers and exporters require foreign currencies in order to finance their business. Takeovers of foreign enterprises require the currency of that country. Repaying of foreign debt, financing a foreign subsidiary, or reinvesting for higher returns are all reasons that would precipitate a foreign currency transaction by a commercial entity.

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