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Financial Engineering: The Evolution of a Profession by Cara M. Marshall, Tanya Beder

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Chapter 7

The Foreign Exchange Market

Laurent L. Jacque

The Fletcher School (Tufts University) and HEC School of Management, France

Foreign Exchange Market Snapshot

History: Since time immemorial, foreign exchange trading was conducted almost solely for the purpose of enabling international trade in goods and services. However, with the breakdown of the Bretton Woods system of fixed exchange rates in 1971, the foreign exchange (forex, FX) market has experienced exponential growth powered by improved technology, the unrelenting dismantling of foreign exchange controls, the accelerating pace of economic globalization, and the design of powerful algorithmic trading models. It is now an asset class in its own right.

Size: The over-the-counter foreign exchange derivatives market has grown from $18 trillion in 1998 to $49 trillion in 2009. The exchange-traded market, which is exceptionally smaller than the OTC market, has increased from $81 billion in 1998 to $311 billion in 2009.

Products: Major foreign exchange products include spot and forward contracts, as well as currency swaps, options, and swaptions. Exchange-traded currency futures and options are also widely-used instruments.

First Usage: The first widely-publicized OTC foreign exchange derivative was a currency swap that was executed in 1979, when IBM and the World Bank agreed to exchange interest payments on debt denominated in different currencies—the Swiss franc and German mark from IBM were exchanged for U.S. dollars ...

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