Thursday, September 3, 2009

The role of banks in the foreign exchange market (2)

The heart of the foreign exchange market in the United States is New York City. Approximately one dozen banks in that city plus a dozen banks headquartered in other U.S. cities keep active positions in 12 to 15 principal currencies, with smaller holdings of less-traded currencies. Most large foreign-exchange transactions take place between the biggest U.S. banks and major banks headquartered abroad. The largest American banks hold dollar and foreign-currency-denominated deposits in banks overseas in order to make foreign-exchange trading possible. At the same time, more than 100 foreign banks maintain offices in the United States to handle the exchange account of foreign investors, investors, traders, and government agencies. Foreign-exchange trading takes place in a three-tiered market. Banks trade with their commercial customers who need large amounts of foreign exchange for purchases of imported goods or to convert funds received from abroad into domestic currency. A second tier consists of trading mainly between domestic banks in order to make a market for foreign exchange. This market tier includes exchange trading among domestic banks, foreign central banks represented in the United States, and the Federal Reserve System. The market‘s third tier consists of trading between U.S. banks and foreign banking institutions.

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