Foreign exchange
What is Foreign exchange?
Foreign exchange, or FX, is the market and process through which one currency is exchanged for another.
Portfolio systems should preserve trade currency, settlement currency, quote source, timestamp, side, size, value date, fees, and counterparty. Converting every historical cash flow with today's rate or a single daily close creates returns and balances that were never economically available, especially across time zones and market holidays.
Operational controls should address confirmation, settlement instructions, holidays, cutoffs, failed trades, sanctions, and payment-versus-payment where available.
Best-execution review should compare like-sized trades at contemporaneous market conditions and include rejected, delayed, and partially settled instructions.
Market structure
FX is primarily an over-the-counter global market involving banks, dealers, electronic platforms, asset managers, companies, governments, and individuals. Trading runs across time zones rather than on one central exchange. Prices, depth, credit access, and spreads can differ by venue and participant even for the same currency pair.
Main instruments
Spot transactions exchange currencies for near-term delivery. Forwards set an exchange rate for a future date, swaps combine two currency exchanges, and options provide conditional rights. Futures trade in standardized contracts. Instruments differ in settlement, collateral, liquidity, basis, counterparty exposure, and suitability for conversion, hedging, or active risk.
Why participants trade
Companies convert revenue and hedge costs, investors translate and hedge portfolios, banks intermediate flows, central banks manage reserves or policy, and traders take views on rates, growth, inflation, and risk. Large reported turnover includes swaps and dealer intermediation, so it does not equal net investment into one currency.
Portfolio relevance
Foreign assets create currency exposure that can increase or reduce base-currency return. Currency also affects issuer revenue, cost, debt, and competitiveness. Cash currency, listing currency, and economic exposure can differ. Look-through analysis should aggregate security, fund, derivative, debt, and liability exposures without assuming that every foreign listing is one-for-one FX risk.
Practical risks
Risks include volatility, leverage, gaps, liquidity, counterparty, settlement, convertibility, capital controls, funding, basis, and operational error. Retail leveraged products can lose more than deposits. Use regulated providers, understand quote direction and all costs, confirm settlement, size conservatively, and avoid treating high market turnover as guaranteed liquidity for every currency and time.
Also known as: FX, forex
Sources and further reading
- Triennial Central Bank Survey of foreign exchange and Over-the-counter Derivatives Markets, Bank for International Settlements
- Currency Management: An Introduction, CFA Institute