Market Participants
With a daily volume exceeding $4 trillion per day, the foreign-exchange (FX) market is the largest market in the world. In this market, currencies are exchanged in order to trade goods and services across borders, make investments abroad, repatriate profits, and hedge against or speculate on future exchange-rate movements. Because of this market’s size and importance, an understanding of the participants in this market is essential.
Participants in the foreign-exchange market can generally be divided in two groups: buy-side and sell-side participants. The sell-side participants are fewer in number and as such, sell-side market participants can be much larger.
With regard to foreign-exchange markets, which of the following do you think best describes sell-side market participants?
Correct!
In fact, being competitive in foreign-exchange trading requires significant IT investments, extensive business relationships, and a broadly distributed client base. As such, only a few very large multinational banks are able to provide sell-side services competitively.
Incorrect.
Central banks sometimes become participants in foreign-exchange markets when they seek to influence a currency’s relative value or when they attempt to manage foreign-exchange reserves, but they are not generally considered to be sell-side participants.
Incorrect.
In some cases, sovereign wealth funds have access to large sums of foreign-exchange reserves—particularly in export-oriented or oil-endowed nations. However, these funds generally act to meet their governments' public policy goals and are not typically categorized as sell-side participants.
Sell-side participants are generally comprised of very large multinational banks and number only a few in total. These multinational banks are typically large enough that they can complete many foreign exchange transactions without relying upon other intermediaries, instead matching buyers and sellers internally. Why do you think smaller regional or local banks are not also categorized as sell-side participants?
Incorrect.
Conversely, large investments in infrastructure and technological expertise make economies of scale critical in the foreign-exchange market. It is for this reason that sell-side activity has been concentrated within a few very large firms.
Correct!
In fact, the largest banks dealing in foreign-exchange are routinely able to connect buyers and sellers and complete foreign-exchange transactions without revealing any trading activity externally.
Incorrect.
If this were true, a serious reconsideration of our banking practices might be in order!
Turning to the buy-side participants, these foreign-exchange traders can vary from small to very large. When considering these traders, which of the following would you consider to be a large and important buy-side participant?
Incorrect.
While individual traders such as these (technically called “retail accounts”) would be categorized as buy-side participants, their volume is typically smaller than that observed from other buy-side participants.
Incorrect.
While it is true that large multinational banks often do satisfy foreign-exchange market transactions internally, these banks are more commonly categorized as sell-side participants.
Correct!
In fact, investment funds, and in particular hedge funds, are among the most important buy-side participants in terms of daily foreign-exchange volume.
Since they have the power to issue currency, central banks are commonly mislabeled as sell-side participants. However, they are generally classified as buy-side participants. Why do you think central banks are classified as buy-side market participants?
Incorrect.
In fact, central banks also often intervene in foreign-exchange markets to influence the value of their domestic currencies. This is particularly true when a currency’s value is pegged to another currency or a basket of currencies.
Incorrect.
Central banks—particularly in developed economies—hold vast reserves, and one reason central banks may enter a foreign-exchange market as a buy-side participant is to manage those reserves. When a central bank deems it necessary to support the value of the domestic currency, the central bank can use its reserves to purchase the currency, thereby driving the currency's demand and price higher.
Correct!
Central banks do not provide foreign-exchange services to tourists, hedge funds, sovereign wealth funds, and other buy-side participants. As such, they would not be classified as sell-side participants.
Thus far, large multinational banks have been classified as sell-side participants while central banks, sovereign wealth funds, hedge funds, and tourists have all been categorized as buy-side participants. It is also worthwhile to consider scenarios where these roles may be less clear. With that in mind, which of the following is most accurate?
Incorrect.
In some cases, such as retail account traders (which includes tourists and day traders), participants are easily classified as buy-side participants. In other cases, classifying certain traders can be less straightforward.
Correct!
In fact, hedge funds can become significant participants in volume, influencing or even quoting exchange rates.
Incorrect.
Central banks largely participate in foreign-exchange markets in order to manage reserves or alter currency values. As such, their role of intervention makes them more clearly classified as buy-side participants.
In summary:
[[summary]]
Because of the extensive expertise and infrastructure needed to operate on the sell side of the foreign-exchange market, the sell side generally consists of large multinational banks
Because of government regulations, central banks are the only true sell-side participants as they are the only entities that can serve as intermediaries between foreign-exchange buyers and sellers
Because sovereign wealth funds have accumulated so much wealth, they are now exclusively considered to be sell-side participants in foreign-exchange markets
Smaller regional and local banks benefit from economies of scale in the foreign exchange market
Smaller regional and local banks do not have the extensive client base needed to frequently pair buyers and sellers of a currency
Smaller regional and local banks extensively dabble in foreign-exchange speculation, with the bulk of their customer deposits making them buy-side participants
Tourists seeking to convert currency in order to visit foreign nations
Large multinational banks that seek to purchase currencies so they can meet client demand for foreign-exchange transactions
Investment funds such as management funds, insurance companies, or other institutions that manage reserves, endowments, or pensions
Central banks only intervene in foreign-exchange markets when large sell-side participants are unwilling to make foreign-exchange transactions in their currencies
Central banks act as buy-side participants only when intervening to cause their currencies to depreciate
Central banks typically only engage in foreign exchange to intervene in exchange-rate movements or to manage foreign-exchange reserves
There is a clear distinction between sell-side and buy-side participants in foreign-exchange markets at all times
In some cases, buy-side participants can become large enough to influence terms of trade, and as such, they may act as sell-side participants
Central banks have only recently been classified as buy-side participants
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