Money has been around in one form or another since the days of the Pharaoh, replacing former systems of bartering. But, as history progressed and scores of countries generated their own individual monies, Middle Eastern money changers found a market exchanging coins of one culture for those of another-the first foreign exchange ‘market’. Over the ages, the form of money changed from coin form to bill form, the latter flourishing in the Middle Ages. But trading and speculation across foreign currencies began to increase after World War I. This speculation was not looked upon favorably by world markets, giving rise to the Bretton Woods Accord, a proposal undertaken towards the end World War II pegging major currencies to the U.S. dollar. The dollar was in turn pegged to gold at $35 per ounce. This accord allowed currencies to fluctuate by one percent on either side of the standard, mandating that respective central banks intervene if the fluctuation was outside of those limits. Although the Bretton Woods accord accomplished the goals of its charter tore establish economic stability in post-war Europe and Japan, it ultimately failed. Other similar failed agreements were attempted in the following decades, but, ultimately in 1973, the world defaulted to free-floating currencies. *
All major currencies now move independently of other currencies, being traded by anyone who wishes. Now, hedge funds, banks, brokerage houses, corporations, and individuals all participate in the foreign exchange market either on a speculative basis, to facilitate transactions, or to hedge against currency risks associated with their core business.
Foreign exchange is a business of exchanging one currency for another. This exchange can take two basic forms: an outright or a swap. When two parties simply exchange one currency for another the transaction is an outright. For example, if one party gives the other dollars for Euros, they have completed an outright transaction. If this exchange takes place for immediate delivery, it is called a spot transaction; if it takes place for forward delivery, it is called a forward.
Two parties can also agree to exchange and re-exchange one currency for another. For example, one party gives the other dollars for Euros for immediate delivery and simultaneously agrees to re-exchange Euros for dollars at a specified rate at some time in the future. These transactions are called swaps.
The first part of this workbook will focus on spot exchanges.