ABSTRACT
The foreign exchange market is a market in which currencies are bought and sold; many people use it to obtain currency for a holiday. Thus francs are traded for pounds and pounds for dollars and so on. The price of one currency in terms of another is called the exchange rate.1 If one currency is traded against two others, there is an implied exchange rate between the latter, called the cross rate. If the pound is traded for two dollars and a dollar for two Deutschmarks, this implies a cross rate of four DM to the pound. If this cross rate differed from the actual sterling-DM rate, then arbitrageurs would intervene to profi t by the discrepancy and, of course, in the process remove it. The market in currency for immediate delivery is called the spot market. There are also forward markets in which an agreement is made to exchange currency at a specifi ed price on a particular date, both price and date being fi xed when the agreement is made, irrespective of any future fl uctuations in exchange rates. Forward markets, discussed below in sections 9.2 and 9.4, are of great value to both traders and speculators (see also p. 182). A speculator is a person who hopes to make a profi t by correctly predicting a change in exchange rates. If the forward rate is £1=$1.70 for delivery in three months’ time and the speculator expects the rate then to be $1.50, he can sell forward sterling. He commits himself to delivering, say, £100,000 in three months’ time, knowing that he will receive $170,000 in exchange. If he is right about the exchange rate, he will be able to buy the £100,000 in the spot market for $150,000 and so make $20,000 profi t. If he is wrong, he might make a very large loss.
