This lesson explores the structure, operations, and key instruments of foreign exchange markets, the largest and most liquid financial market globally, where currencies are traded .

5.1 FX Market Structure and Participants
The FX market is decentralised and over-the-counter, operating 24 hours a day across global financial centres . Key participants include banks (market makers), corporations, central banks, and institutional investors . The market’s wholesale nature means most transactions are interbank .

5.2 Spot and Forward Markets
Spot transactions involve immediate delivery (typically T+2 settlement) . Forward contracts are agreements to exchange currencies at a predetermined rate on a future date, used to lock in exchange rates and hedge future exposures . Valuation is based on the no-arbitrage principle, linking forward rates to spot rates and interest rate differentials .

5.3 Exchange Rate Determination
Exchange rates are influenced by multiple factors . Purchasing Power Parity links exchange rates to inflation differentials. Interest Rate Parity links them to interest rate differentials . Understanding these theories is essential for assessing FX market dynamics . Key risks include foreign exchange risk—the risk of losses from adverse exchange rate movements .