Series 7

By Investopedia AAA

Securities Markets - The Currency Market


As a registered representative, you will also need to be familiar with the currency market and its risks. Most market economies have floating exchange rates that are determined by supply and demand. Other nations have fixed exchange rates that are set by government policy.

Fixed Rates
Fixed rates are not as prevalent as they once were because developing nations are now generally less focused on protecting their homegrown industries from imported goods and more focused on joining international agreements that favor free trade. Exchange rate controls, like all trade restrictions, have fallen out of vogue; currently, the People's Republic of China is the only major economy that controls its exchange rate.

The Role of the Central Bank
Many countries, including the United States, have a central bank that intervenes in currency markets by increasing or decreasing the amount of available money backed by its government. Should the central bank decide to shrink that amount, the value of the currency relative to others is likely to grow; conversely, if the bank expands that amount, the currency could lose value compared to others. It should also be noted that central banks do not deal with just their own countries' money; they also buy and sell the currencies and debt obligations of their partners.

In some nations, central banks are also chartered to occasionally revalue their currency after a bout of hyperinflation. For example, let's say a currency called the Swobovian hypo has an exchange rate of 5 hypos to the U.S. dollar. Now imagine that Swobovia, which only recently reformed its institutions and became a market economy, has just experienced a period of hyperinflation as part of its transition. Suddenly, a dollar buys 500 hypos, not a mere 5. As this figure starts to stabilize, the Swobovian central bank might declare that every 100 hypos is now worth 1 "new hypo". After this revaluation, the exchange rate will be back to where it has been historically.

The Third and Fourth Markets
There are two derivatives of the secondary market of which you need to be aware:

  • The third market is a term used to describe the over-the-counter, negotiated-price trading of exchange-traded securities among institutional investors. Although broker-dealers participate in the third market on their own accounts, this is not an arena in which the typical investor plays.

  • The fourth market involves the direct trading of large blocks of securities via an off-exchange electronic network. The most widely recognized fourth market portal is Institutional Networks, or Instinet.
The Securities Investor Protection Corp. (SIPC)

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