The exchange of one currency into another happens for a lot of reasons in the global foreign exchange market. Currency exchanges can happen for speculative reasons when a trader believes one currency will strengthen against another.

It can also happen when corporations and SMEs need to transfer funds from overseas operations back into their domestic currency or if a company needs to hedge its currency risk to ensure stable cash flows from international operations. Let’s look the different aspects of the trillion-dollar global currency market in more detail.

International money transfers

Corporations and SMEs that operate internationally will regularly engage in the physical transfer of currency from overseas entities to their head office. This will involve exchanging foreign currency cash flows into the company’s domestic currency. This happens, as companies need to file their financial reports and taxes in the currency of the country in which they are headquartered.

International money transfers and currency exchanges that service individuals also play a role in the global currency market. Holidayers transferring their domestic money into foreign currency and expats sending money back to their home countries would fall under this category.

Currency risk hedging

Another important aspect that drives currency prices is corporate currency risk hedging. Internationally operating companies will often engage in currency hedging activities to ensure stable cash flows from their overseas revenue centers. This involves either using currency derivatives such as forwards or options, or, alternatively, buying one currency to offset potential adverse movements in another.

An example of that would be buying the Swiss Franc in anticipation of a potential steep drop in the value of the British Pound, should the British public vote ‘yes’ at the upcoming Brexit referendum in June. The reasoning behind that is that if the result of the referendum will be a ‘yes’ vote, then the Swiss franc will likely strengthen as many investors and businesses will place their money in Switzerland. However, should there be a ‘no’ vote, the Swiss franc won’t suddenly drop in value either. Hence, it would be a good currency hedge for businesses with operations in the UK.

Speculating

The third aspect of the global foreign exchange market is the speculator. Speculators in the forex market can be split into two categories. Retail traders, i.e. individuals trading forex using an online brokerage account, and institutional traders, such as fund managers and banks.

Currency trading has risen in popularity amongst retail traders and there is now a range of available financial products and services tailored to all kinds of traders, such as binary options trading, Islamic forex trading, CFD trading, cryptocurrency trading, etc.

Institutional traders are banks, corporate treasuries, hedge funds and mutual funds that place bets on short to medium-term movements in currency pairs, with the aim to make a speculative trading profit. They make up a large proportion of daily currency trading volume and can often move prices of currency pairs quite substantially.

Central Bank interventions

Another important market moving aspect in the currency markets are central bank interventions. Some central banks, such as the SNB in Switzerland, have a long history of intervening in the currency market to keep their currency at a level where their country’s exports stay competitively priced. Central bank interventions can cause sharp movements in currencies, which can often catch other market participants off guard.

Central bank interventions and specific monetary policy actions, such as interest rate cuts, aimed at deliberately devaluing your country’s currency can lead to a currency war, also known as competitive devaluations if several countries engage in this type of behavior. Hence, actions and statements by central bankers play a huge role in the foreign exchange market.