Foreign Exchange Markets and Currency Forwards › Foreign Exchange Markets and Currency Forwards

The foreign exchange market, commonly known as forex or FX, is the largest and most liquid financial market in the world. With daily trading volumes exceeding $7.5 trillion, the FX market dwarfs equity markets by orders of magnitude. This enormous scale exists because virtually every international transaction, whether importing goods, investing abroad, or sending remittances, requires exchanging one currency for another.

Unlike the stock exchanges we examined in Chapter 1 of this part, the FX market operates as a decentralized over-the-counter (OTC) network spanning the globe. There is no single exchange or central location. Instead, trading occurs continuously through an interconnected web of banks, dealers, corporations, and electronic platforms. This structure creates a market that never sleeps: when London closes, New York is in full swing; when New York winds down, Tokyo opens.

Currency forwards extend the forward contracts we studied in earlier chapters to the FX domain. Building on the pricing frameworks from Part II, Chapters 5 and 7, we'll see how interest rate differentials between countries determine forward exchange rates through a fundamental relationship called interest rate parity. This relationship forms the backbone of global currency hedging strategies.