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FX Derivatives Trader School by Giles Jewitt

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Chapter 4FX Derivatives Market Structure

Market structure is a topic that is often skipped over. In practice though, it is vitally important because it defines how clients interact with the trading desk and how the trading desk accesses liquidity to hedge their risk.

In some financial markets all participants access a centralized market or exchange anonymously on the same terms. The FX derivatives market, however, is an over-the-counter (OTC) market, meaning that there is no centralized exchange and a clear distinction exists between banks and their clients. Note that “banks” here refers to large international banks with FX derivatives trading desks.

Fundamentally, bank FX derivatives trading desks transact with clients, aggregate and offset the risk where possible, and close out unwanted residual risk. More specifically:

  • Clients come to bank trading desks for prices, often via a sales desk within the bank. Usually the client simultaneously submits the same price request to multiple banks and deals on the best price as per Exhibit 4.1. Traders usually make two-way prices for clients because they do not know for certain whether a client is a buyer or a seller of a particular contract.
  • Bank trading desks transact with each other either via the interbank broker market or the direct market (a price request directly between a trader at one bank and the corresponding trader at another bank). The majority of bank-to-bank transactions occur in the interbank broker market. This structure ...

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