History and evolution of the foreign exchange market

History and evolution of the foreign exchange market

History and evolution of the foreign exchange market

History and evolution of the foreign exchange market
History and evolution of the foreign exchange market

Because there was no central marketplace for transacting foreign exchange in the early 1970s, exporters and importers could not accurately track daily movements in the currencies. In fact, they had no prior experience with floating exchange rates and therefore no in-house expertise. They were at the mercy of the moneychangers, the Banks. Overnight foreign exchange became a huge source of bottom revenue to the banking industry.

To offset the risks of holding currency positions taken as a result of customer transactions, the major banks entered into informal reciprocal agreements to quote each other throughout the day on preset amounts. It was understood that a certain maximum spread would be upheld, except under extreme conditions. It was further agreed that the rate would be supplied in a reasonable amount of time. Generally this meant the FX dealer made the price within seconds, and therefore without calling another bank for a second opinion. This was called direct dealing and all the major banks participated.

In the beginning, banks were quoting customers one-way prices. The customer would say where could I sell $10M USDJPY and the bank set a rate. The bank left itself plenty of room for error, oftentimes quoting as much as 50 points below the current market. This was a bonanza for the banks. However, a lot of money was lost when other banks called for a rate.

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