Foreign Exchange Operations: Master Trading Agreements, Settlement, and Collateral

CHAPTER 1

Introduction to Foreign Exchange

The foreign exchange market is the market where currencies are traded. A currency is the money of a country. It serves as the country's legal tender, the medium with which debts can be discharged and taxes can be paid.

As a general rule, every country has its own currency, though there are some prominent exceptions. By extension, practically every country has a central bank (DeRosa 2009).

Large money-center banks are the primary dealers in foreign exchange, trading in spot, forward, forward swaps, and options. Central banks are also instrumental to the foreign exchange market, acting as policy agents for their respective governments and as operators of the primary settlements systems. This chapter will introduce the key players, the varieties of transactions, and the important conventions of the marketplace.

DEFINING MONEY

In an international context, we say currency, but in a local environment the term is money.

Currency, or money, is curious in at least one regard. At its core, it is a creation of a central bank. Monetary economists describe central bank money, or high-powered money, as the sum of currency outstanding and in the hands of the public plus commercial bank deposits (or reserves) held at the central bank. This part of the money supply is state created. Add to this the money that is created privately in the banking system through expansion because of fractional reserve requirements. The implication is that money is a hybrid ...