1.Introduction to Wall Street and the Forex Market

The word “Wall Street” is so linked to the stock market that it appears to define the stock market. One visual addition to the term “Wall Street” is the image of Baldwin the Eagle, the mascot of the New York Stock Exchange. The term “Wall Street” is used so frequently that other economic functions of the area are ignored. The area has many banking institutions, such as First National Bank of New York, known as “Wall Street Bank”. Investment firms such as Lehman Brothers, Smith Barney, and Salomon Brothers are also in the area. Major banking companies headquartered in other states, like Chase Manhattan Control, Citicorp, The New York Trust Company, and others, utilize second offices in the Wall Street area which allow them to call themselves Wall Street institutions. It is also interesting to note that the headquarters of Irving Trust, the supplier of dollar exchange certificates, is located in the same area. The Wall Street area has more banks, more security analysts, more mutual funds, trusts and fiduciary institutions than any other part of New York. Yet, these institutions have neither the image nor the public link to Wall Street that the stock market has.

2.Key Players in Wall Street and the Forex Market

The position of the major business entities is the result of their substantial financial clout. Investment banks play a very prominent role in the forex market. Their trading activities are substantial. Market frictions can be rapidly removed, and their presence ensures that exchange rates remain within expected bounds.

Forex Market

At the heart of this market for currency trading are interbank transactions. This is the so-called wholesale business. The bid and ask prices for every currency pair, and the sheer volume of those trades, determine the interbank rates. Not everyone can participate in these primary interbank transactions. There is a distinction between major dealers and other “followers,” as evidenced by the data collected by the Bank for International Settlements

(BIS) for the triennial Central Bank Survey of Foreign Exchange and Derivatives Market Activity. Major dealers (banks and other financial institutions) report the largest shares of total turnover, buying and selling out of their own inventories.

Now that you have a good understanding of how the forex market works and the important role it plays, another key player, Wall Street, and its many public and private entities, can be examined. There is a nearly seamless interweaving that takes place between Wall Street’s key players, such as brokerage houses, banks, and hedge funds, multinational companies, central banks, and the forex market.

2.1.   Investment Banks

Given the rapid growth of the global markets in general, and of the more over-the-counter and decentralized forex market in particular, investment banks are finding themselves caught in a scramble for a larger share of a more potentially profitable financial business. While the forex business may not be large in absolute terms, it is well worth reinforcing one’s wholesale banking business with by-products from the increased concentration on a perceived profit center. Unlike other areas of trading, the forex trading business offers an investment bank the profit opportunities generated by market volatility on a twenty-four-hour basis. This fact further enhances the attractiveness of the forex dealing room within the image-conscious investment banking sector. In addition, the forex dealing room may (should?) be seen as generating useful leads into other product areas, both from legal constraints which, for example, may inhibit an investment bank from lending to a particular institution and from the reputation damage which could be suffered by financial collapse.

Investment banks both have and exploit the unique ability to create “whole new markets” based on their ability to arrange (a combination of debt and variable rate equity) and distribute a financial product. Some of the major US-based investment banks (a number of which are commercial banks, a factor which may have reduced conflicts of interest), in alphabetical order, are BancAmerica Securities, Citicorp Securities, Deutsche Morgan Grenfell, Goldman Sachs, JPMorgan, Merrill Lynch, Morgan Stanley, Lehman Brothers, and Salomon Brothers International. While the major US investment banks are still a powerful influence in the global financial markets, the last two of the three-decade march towards globalization have brought a sense of “sameness” among capital markets offering investment banks the opportunity to become more truly global in scope. Whereas the Japanese investment banks with their traditional strength in the domestic Japanese exchange markets remained for many years the more national players, liquidity on the global forex markets has contributed to the development of a more internationally based speculator market.

2.2.   Hedge Funds

Fund managers agreed to take risks and be compensated for their activity. Hedge funds are available to high or sophisticated investors and institutions wishing to increase or transfer the level of risk, in which losses are limited to the amount invested. All traders want to have large gains but to limit the downside losses. Physicians have the same inherent goals. Some investors are willing to have these gains without stops, which increases the chances of an accident. These speculative activities are usually subject to margin controls and some other supervisory rules. Hedge funds are of interest in this context, since managers in these funds using market-neutral strategies can transfer some of the interest rate and stock risk seen in bonds and equities to the currency market.

Hedge funds were some of the first institutional investors to enter the spot currency market to hedge their positions and other transfers of risk already present in the bond and stock markets. Hedge funds are a specialized group of investment managers. These institutional investors are typically involved in the use of aggressive investment strategies, whether it is long or short selling, fault charges, options, derivative instruments such as currency forwards, swaps, and a variety of customizable structures. The emphasis is on capital gain, not income as in the management of pensions, but on high returns on moderate risks.

2.3.   Central Banks

Exchange rates play an important role in the demand and supply balance of goods bought and sold in different countries. This is particularly relevant in a world of rapid movement of capital. Countries normally maintain a foreign currency reserve at the central bank. This allows for the central bank to influence the demand for domestic money and react quickly to any current account imbalance, currency speculation, or capital flight. Market operations are ruled by domestic money base or other domestic money, and effects of rules vary determined by the type of exchange rate used. Central banks may opt to set a fixed exchange rate or a floating exchange rate. In addition, central banks are affected more or less directly when changes in exchange rates impact on domestic goods, assets, and incomes. Central banks usually have ensured the currency stability through large profits or losses on the foreign exchange market. Therefore, it is considered rational to accept the cost of this stabilization in contrast to the cost of high and unpredictable inflation. In addition to the aforementioned, it should also be pointed out that the growth of capital funds can have strong positive effects on income, while at the same time highlighting the possible negative effects derived from financial instability.

A central bank is responsible for manufacturing and putting notes and coins into circulation. At the same time, each country’s central bank is also responsible for the stability and security of its country’s currency. This is done through various monetary techniques, such as issuance requirements or banking operations. Another key task of a central bank is to implement the country’s monetary policy. This is normally done in cooperation with or under the direction of the government. The objectives of monetary policy may be to keep the value of domestic money stable, or to achieve a certain rate of inflation. These goals may mean different things for different countries. Central banks also regularly publish economic reports, forecasts, and other crucial data. All of this data can influence the forex markets in many different ways.

3.Market Dynamics and Influencing Factors

Currency specialists know that for a foreign exchange trader to be successful, he or she must be aware of and keep track of world events. The reason for maintaining a reach that extends far beyond the customer’s line of sight is that in some cases it is the combined response of a customer that is significant, not its individual drivers. Moreover, there are some exchanges of foreign currencies where intervention by the central bank can guarantee that the exchange rate will stay constant, even if it is seriously out of line with the balance of payments model’s intrinsic rate. Both the central bank and the traders of currency options know that their country’s reserve is limited. Aware that they can only bracket a percentage of the options written and that the forex market at times is a dangerous place for country reserves, they are prevented from intervening every time the exchange is on the edge of suffering a catastrophic speculative attack. However, they do hedge or trade options to limit their risk exposure under these circumstances, or to guarantee that only fewer more currency attacks can be sustained.

Despite the common perception by senior management, corporate decision-making is, in fact, not based on a static model that involves constant versus variable cash position or constant exchange rate exposure. To be credible, traders and extractors of currency option pricing models must acquire a thorough appreciation of the ever-changing world surrounding their target exchange rates. Three categories of factors influence not only whether an entity will hedge its foreign exchange exposure at a given time but, to a growing extent, which instruments are used when transacting such derivative assets: multitudes of customers; central bank intervention; and the actions of the Interbank trader. To this end, Wall Street’s needs and actions other than their own are for the first time defined. Knowing this should make interbank and other foreign exchange market participants more effective. They exploit these needs with derivative instruments that soar beyond the equation’s solution sets to maximize their revenue.

3.1.   Economic Indicators

The Purchasing Power Parity theory is second in importance after the interest rate differentials theory for the understanding of the movements of the exchange rates of leading industrial countries. The PPP theory is explained in Chapter Chart 2.3.1.8. The Overlapping Curve Model of the Forex Market Data indicates that movements in a great country’s balance of payments have no explanatory power for fluctuations in its exchange rate.

In the United States and Western Europe, about 4 million young people with no schooling drop out of the system each year. Since their number is close to 20% of those who complete the mandatory schooling system, the exclusion concept is particularly important. The probability that they will find a job and thus become unemployed is close to 40% for educated workers. Excluding these two groups from the labor market statistics allows us to find the real rate of unemployment.

This last conclusion is particularly relevant for many economists and policymakers who think that the implementation of full employment will allow those who are currently on the fringe of the labor market to find a job. For this last group (the concept of which has been defined above), the unemployment rate is close to 7 to 12%. In the USA alone, we count between 1.5 and 2 million people within this group who are currently not reported in the statistical labor survey.

Should those who accept employment they consider unsuitable or who are waiting for improvements in the working environment (for example, better pay or shorter working hours) be classified as employed or unemployed? Answer: they should be classified as part of suspended employment.

The two criteria determining the calculation process for the unemployment rate are: Should people working part-time in order to meet a separate requirement be considered as employed or as unemployed? Answer: part-time workers should be classified neither as employed nor as unemployed.

If a newspaper publishes information that unemployment is at its lowest for 15 years, we should remember that such low is the consequence of how the authorities gather the employment figures and how they calculate the percentage of unemployed. To do this, one must examine the methodologies used by the statistical offices to write a list of recommendations to correct the numbers according to the sound economic criteria. This work has indeed been carried out already by well-known American economists and politicians, but the recommendations listed here are worth remembering.

3.2.   Geopolitical Events

The forex market is shaken by an event and central banks know this, and I am going to show that, let’s say, they do it! The night preceding a meeting with central bank participants in order to discuss the festival, there may be wild and big stop-hunts, for big and fast profits. Then, the participants are received with a great stage production or show. The event finishes with the great dollar-value announcement made to the expected audience, as if they did not know about the plan in advance, carefully by the book. Next, planned strategies and theories are known before and afterward confirmed. All at taxpayers’ and market risk. They have won on the wiki, before the official declaration. Participants listen to the soap-opera day live, but they knew the ending yesterday, or perhaps weeks ago. The evident event risk is mainly the meaning of relative currency value. The forex market is indeed a great machine to juice some non-invasive procedures imposed on certain economies, as if the objective were to swiftly collect profits based on mass deception. Certain x-enform institutions and x-institutions need to amend corollary no.1 to their mother’s bank post-system. You have no moral right to inspire manipulative inertia upon official press releases.

The forex market goes simply mad after any significant announcement, and it will start making predictions five or ten minutes before the hour for central bank announcements. Suppose a country would grant aid to another, the market would be on alert hours in advance. Furthermore, if the aid was a faint of secret, in a few minutes-to-hours window the market would be in turmoil once the juicy details were made public by someone, without intentional (or illegal?) disclosure. This kind of event – central banks announcing their own actions – cannot be regulated or punished, if the rule of reason did not exist. Automatic execution only mitigates the phenomena listed in the previous question. The central bank would not be held responsible. It would continue to make arbitrary decisions. Instead, fast and furious profits would tend to end, unless robots found ways to profit without getting killed. The regulatory schizophrenia here is palpable. Okay, a little speculative logic of my own, to assign some fun-factor to this.

Since currencies are a main medium for international trade, geopolitics often bring to participants in the forex market short-term changes that can make the market wait for signs from the involved governments in order to decide whether they should buy or sell a specific currency. A kind of pump-and-dump game, especially if the country’s government controls the market. Geopolitical events, which can linger for days or even weeks, can both support and damage the confidence of the market in using certain types of central bank communication. Such acts of governments and central banks may also cause distrust over the setting of currency values, because the decisions made are basically arbitrary and can be tailored to the short-term needs of a nation, a region, or the world. These shortcut solutions may be useful as donations, for instance.

3.3.   Market Sentiment

The reason not to run against such forces is that they hold the so-called inside track on information. Faster executions by a few seconds can cause a profit or a loss – that is why traders need that edge. The foreign exchange market is unique in that it is open 24 hours a day both before and after the stock exchanges close. With European and North American stock exchange flows responsible for approximately 66 percent of its volume, the focus of foreign exchange systems has displaced from scenarios where the majority of the speculation surge occurs. Throughout the trading day, forex funds predominantly shuffle between European and North American centers simply by shifting monies from one form of foreign exchange holding to another. The rest of the movements are just small flows that can be anticipated by dealers on a daily basis. Smaller shifts from time to time generate volatility, but they never have the impact that the big orders do. Less significant foreign exchange transactions have an oversized importance.

The market may move for a variety of reasons. Generally, the place at which an upward or downward movement starts is the place from which everyone least expects a change. Trading volume is generally heavier when market interest coincides. Forex market traders watch the way investors, finance managers, insurance companies, and Wall Street professionals direct their fund flow; even presidential announcements move markets, especially if the information is unexpected. No one knows what motivates the Wall Street pros, but it seems they move their billions based on intuition or some sophisticated information they have gathered from reliable sources. As such, they seem somewhat determined to cover themselves against probable losses. On the other hand, when they risk their capital, they anticipate minimum exposure or positive outcome.

4.Trading Strategies in the Forex Market

The forex market can help a country that wishes to maintain exchange rate stability at times when this is a contradiction of monetary policy goals. In general, the forex market is anti-autonomous, as has been recognized to one degree or another within international macro models. However, the mechanisms through which the forex market can discipline the authorities are not only more specific than heretofore, they also involve private capital flows which monetary targets figure largely in the sterilized intervention process. Characteristics, trading volume is immense, due to the enormous daily trading volume in the forex market are dominant factors. The yield positions should dominate, since forex investors insist on getting a return on their funds whatever their forward exchange rate expectations. Idealistic interest rates can only be fully offset if the currency delivering them can be traded. And in the forex market, all the interest rates come in pairs.

To the extent that rapid inventory adjustments are played not just on the stock market, but even more aggressively in the forex market. Since all speculative positions in the forex market are necessarily antithetic, those who take the yield positions (by buying low-interest rate currencies and selling high-interest rate ones short) will find those making the capital gains operations. Moreover, a lively forex market permits capital gains plays for bonds too. A further corollary is that the exchange rate stabilization effect is one-sided, the interest rate resistance being weaker for currencies with a lively forex market.

5.Regulatory Environment and Compliance

The activity of those financial institutions in the forex market is not without consequences, be it on the underlying value of national assets, on the stability of foreign (and some sections of the domestic) financial markets or on the stability of a country’s balance of payments. Consequently, how a country’s central bank decides to behave itself in the forex market is of the major policy concerns facing the modern central banks. After all, those properties of the forex market require a relevant public policy to ensure the efficiency of the underlying price discovery mechanism and liquidity provided to the market through market-making activities. Given those characteristics, market micro-structure issues are also extremely relevant for the micro-practice of risk management and securities pricing in the forex market. Regulatory issues, however, play a significant role in shaping those micro-economic relations.

The foreign exchange (forex) market is worldwide. The forex market, by its very nature, does not involve a centralized or formal trading system; transactions are conducted over-the-counter (OTC), generally by telephone or the Internet. Electronic trading platforms for spot currency transactions have also evolved. Market participants are becoming more global. Most of them are financial institutions, such as banks, insurance companies, hedge funds and other fund managers, and institutional asset managers, among others. Smaller but rapidly increasing numbers of retail investors in the United States and abroad have recently begun to allocate a portion of their investment portfolios to foreign exchange.