Last Updated 07 Sep 2020

The foreign exchange market

Words 3986 (15 pages)
Views 797
Table of contents

Introduction

The foreign exchange market is truly global and one of the most important ones in the world. The foreign exchange transaction refers to exchange of one country's currency with another country's currency for economic reasons. As a result it is always better to understand this market from the business point of view. To start with, let’s discuss the Islamic view of such markets. This assignment is included two main parts. The first one is about the whole market in general divided into three subparts. The first discusses the definition for the foreign exchange market, its importance, the process for dealing in this market, the average of daily transactions, the time of such transactions, and the most impactful places for such transactions and the origin for this market. The second one is about the operations in the foreign exchange market through the use of spots, forward, futures, options, and swaps. This subpart covers the definitions for each operation, examples, and the usefulness for such operations. The third is about the hedging, speculation, and arbitrage with their explanations and examples.

The second main part is about the foreign exchange market in Islam. This part is divided into five subparts. The first subpart is about trading in Islam, with definition, the evidence, and the moral principles from the Quran and Sunnah, how the trade is made and what makes a trade genuine and valid. The second is about the usury in Islam with definition, the evidence and ethical judgments from Quran and Sunnah, types with examples, and the reason why the riba is forbidden in Islam. The third is about the exchange in Islam and the rules in Islam which govern the operations in the foreign exchange market. The fourth is about the hedging, speculation, and arbitrage in Islam. It also refers to ideas from D. Sami Alsuwailem in the hedging. Moreover, it refers to the most common decisions about the speculation, and how the arbitrage is not against the rules in Islam. The fifth is about the five important cases in the foreign exchange market from the AAOII.nFinally, the assignment is concluded with the executive summary and some recommendations.

Don't use plagiarized sources. Get Your Custom Essay on

The foreign exchange market

just from $13,9 / page

get custom paper

Overview of the foreign exchange market (Forex, FX):

The forex market is the market in which currencies are traded using bid and ask rates. Foreign currency is used for the purposes of traveling, import, export, speculation, and so on. For example, if someone wants to travel to another country, he needs to exchange his home currency with the currency of the foreign country where he is going. As a result, the forex market is extremely important today for personal use, banks, central banks, commercial companies, investment management, firms, multinational corporations, financial markets, institutions, hedge funds, and retail forex brokers. This clearly shows the importance of the $US and it is nearly to be the major for the forex markets, which equals 90% of the world transactions. The forex market is peculiar because of the trading volumes, the high liquidity, the large numbers, the varieties of trades in the markets, the geographical dispersion and it is 24 hours trading a day, except on weekends, as can be seen from the figure below.

The forex market is characterized by a lot of types of transactions, it takes between the participants of anyway as it is noted above. There is no central place for the forex market because the dealers/brokers are negotiating directly together resulting in the over-the-counter market. However, the most active places for trading currencies in the world are  "about 300 participants in the forex market" and the banks and agents usually act as a major for their own customers. The average daily trade in the global forex markets is over $3 trillion. The origin of the forex markets has had a lot of stages to reach the present scenario. It started before the money even existed that is the era of barter, after that by the Romans monetary system, then to the city of London in 1696 when the English king William III urgently needed money to finance his wars against France. After that, the 19TH century saw the rise of the Sterling as a world trading currency. Then, it was the gold standard before the 1st world war. After that, it was the second world war after which the United Nations Monetary and Financial Conference(UNMFC) held at Bretton Woods New Hampshire in July 1944 came into existence, then the Eurodollar markets. Now, we have the present Forex market. The opening time for the forex market in the world.

The Operations of the Forex Market:

(BPP Financial Publishing, 1994)The operations in the forex market are divided into two main kinds:

  1. Cash market
  2. Foreign Exchange Markets where the currencies are bought and sold.
  3. Eurocurrency markets where the currencies are borrowed and lent.
  4. Derivatives Markets trade in currency futures, options and swaps.

Forex Spot Market:

The spot is the quotation between two currencies for immediate delivery. The settlement for this transaction usually takes two- business days. Moreover, this trade represents a direct exchange between two currencies, and the interest is not included in the agreed-upon transaction. The spot market divided into two parts, the bid price, and the asking price. As a result, the difference between the two prices is the profit for the dealer. It is an agreement between two currencies at a pre-decided rate for an exchange on a specific date in the future, it must be over two-business days, and this duration of the trade can be a few days, months, or years. The forward market is part of the broader derivatives markets. The other common markets in derivatives are futures, options, and swaps. The forward market is important for reducing risks resulting from exchange rate movements when importing, exporting, borrowing, and investing. As a result, the forward market is very important for the parties involved.

Forex Future Market

It is a contract traded on organized exchanges in standard units to deal and exchange two currencies at a specific future date at an agreed rate. This date must be set at one of particular four dates "the third Wednesday of March, June, September, or December". The average of the transaction or contract takes usually 3 months to be settled. As a result, the futures market is nearly the same for the forward transactions. The first currency futures contracts were offered in 1972 on the Chicago Mercantile Exchange.

Forex Option Market

It concluded from it is a contract that confers the right to buy or sell currency at a specified price on a specified future date. This contract gives the buyer/the seller the opportunity, not the obligation. In the same way, the word of the option not gives the choice to the buyer as to completes the contract or not but refers to the chosen date of delivery. The first currency option contract was offered in 1982 on the European Options Exchange in the Netherlands. The forex options market (Kuepper, Getting Started In Forex Options) is the deepest, largest, and most liquid market for options of any kind in the world.

Forex Swap Market

It concluded that it is an agreement to buy, sell, borrow, or lend currency at an agreed price at a future date. Moreover, the swap market has three common kinds of operations:

  1. An agreement in the spot market at the same time an agreement to reverse the transaction in the forward market.
  2. An agreement to exchange two currencies in the forward market.
  3. An agreement to borrow one currency and lend another.

The forex swap market is used for many reasons, for example:

  1. To converts one currency into another temporarily without developing a net exchange position.
  2. To avoid risk or reduce the risk when making a market for many future dates and currencies.
  3. To build up a swap position forward against forward.

Hedging, Speculation, and Arbitrage

The relation between hedging, speculation, and arbitrage is very complicated. Because the hedging is completely reverse of speculation and the arbitrage gets the benefits from the unstated relation between the hedging and the speculation. To make it more clear it can be seen by the explanation below.

Hedging

It refers to the act of eliminating, avoiding, or covering foreign exchange risk. The need for hedging arises because of:

  1. The spot exchange rates are only useful for the present. For example, who except to makes or receives payment in a future date, the risk might be the rate of exchange currency goes up or down. Moreover, they will have to pay more or receive less.
  2. It is achieved by avoiding open positions in the forex market. Open positions refer to imbalances in foreign currency assets and liabilities maturing in the future.

For example: if a US exporter, who expects to receive £2000 in six months. The anticipated sum is worth $4000 at a current spot rate of £1=$2,00, but should the sterling depreciate to £1=$1,50, by the end of this period. The US customer will receive only $3000 and will lose $1000. If however, the US exporter had initially contracted to sell sterling forward at six months forward rate of £1=$1,90, for example, he would have received $3800 and he will lose just $200, which better than $1000.

Speculation

It is the opposite of hedging, which usually takes place in the forward market. Also, it takes weather with strong or weak currencies. The speculators expect or seek the risk, so the speculation is buying or selling foreign currency with the intention of producing profits by exactly expecting the direction of currency price changes. The speculator can make a profit when the prices go up or down, for example for both:

  1. When the prices go up. For example, if the speculator expects the spot rate of a currency to be higher in three months.  Could he bid the currency in the spot market today's spot rate, hold it for three months. Then sell it in the spot market after three months. If hi is right, he will make a profit, otherwise he could lose.
  2. When the prices go down. For example, if the speculator expects the spot rate to be lower in three months, he could borrow the foreign currency and exchange it for the national currency at today's spot rate. After three months, if the spot rate on the foreign currency is sufficiently lower, he can make a profit by being able to repay the foreign currency to clear his foreign exchange loan at the lower spot price.

Speculation could be carried out through both the spot and forward exchange markets and engages the establishment of short positions in weak currencies, which are anticipated to depreciate or to be devalued. On the other side, it is done by taking long positions in strong currencies, which are anticipated to appreciate.

Arbitrage

It is the exploitation of price differentials for riskless to make (in one or more markets) profit. The arbitrage helps to minimize and eliminate the rate differentials in many markets. It is done when there is an increase in the demand for currencies in the market where it is at a lower price or when there is an increase in the supply of the currencies in the market where it is at a higher price. Now most banks dealing in the foreign exchange currency rate movements throughout the world helps in eliminating such differentials through arbitrage or riskless profits. Whenever the rates get out of line, arbitrage takes place thereby putting the rates back in line.

There are many types of arbitrage, for example:

  1. The Financial center arbitrage. To explain that: suppose that the USDGBP exchange rate quoted in New York is the same as that quoted in London and other Financial canters. This is because if the exchange rate is $1.89/£1 in New York but is $1.87/£1 in London, it would be profitable for banks to bid pounds in London and simultaneously sell them in New York and make a profit 2 cent for every pound bought and sold.
  2. Cross currency arbitrage.
  3. Two-point arbitrage.
  4. Three-point arbitrage.

The Foreign Exchange Market in Islam:

Before starting with particularly the foreign exchange market in the Islam, it would be better to start with the trading in Islam (Albay'a) and to understand the rules in Islam about trade (Albay'a). What is more interesting is that there is a relationship between trade, usury, or interest (Arriba) and the exchange currency (Alsarf). So, let’s first explain the riba in Islam and the exchange (Alsarf).

Trading in Islam (Albay'a):

Trading in Islam is Exchange money for money or exchange of things of value by/for another thing of value with an agreement.

The ethics of trading in Islam

The trading is permissible in Qur'an, Sunnah, and Ijma'ah. First of all, the evidence from the Qur'an where Almighty Allah says in Sura Albakrah verse 275 “Allah has allowed trade”. And in Sura Albakrah verse 282 “when you are making trade it must be their witnesses”. In the second place, the evidence from the Sunnah, the prophet Mohammad (prayers and peace of Allah be upon him) said “The traders are in the option or liberties before they leave each other” (Alshanqety). Finally, the scholars agreed with the evidence and no one of them had disagreed. The reason for allowing the trading (IbnQdamah, 1997), is that the people who are involved in trade meet their needs through exchange with someone else, as no one can produce everything one needs for consumption.

How the trade is made

The trade is made by two main things, the Ejab (offer) the Qabol (accept) without these things it could not make any trade. The offer and the accept might be by speech or by action which means without speaking or by using electronic things for example e-mail or fax, etc. The offer and accept might also be by what is common in the market.

To make trade valid in Islam it is subjected to some conditions. Which are in general:

These conditions are concluded from

  1. The parties should have the legal capacity and are not bedlam or something like that. To be an adult in Islam is the age of 15.
  2. The parties should trade with mutual consent.
  3. The object involved in the trade should be allowable in Islam,
  4. The object should be owned by the seller. Because the propjet Mohammad (prayers and peace of Allah be upon him) said “do not buy what does not own”.
  5. The object should be capable of being delivered or handed. If not, this will be Gharar (risk, hazard) which is not allowable in Islam.
  6. The object should be known to both parties.
  7. The price for the object should be known to both parties.

The Riba (usury) in Islam:

The riba is the increase (interest) or the delay in special money, or the increase which an owner of the valuable property receives from an owner for giving him/her time to repay him/her time to repay his/her debt.

The ruling of the riba in Islam:

The riba is not permissible in the Quran, Sunnah, and Ijma'ah. First of all, the evidence from Quran, Almighty Allah says in Sura Albakrah verse 275 “Allah has allowed trade and forbidden the riba.” From the Sunna, the prophet said “avoidance the seven pernicious, one of them the trading by riba” (Alshanqety). The prophet Mohammad (prayers and peace of Allah be upon him) said “cursing who is trading by riba, his agent, the witnesses and who writes the contract” (Alshanqety). And, the prophet Mohammad (prayers and peace of Allah be upon him) said “the riba is 73 kinds, the easier one is like the person who makes sex with his mother”. Finally, from the Ijma'ah the scholars agreed with the evidence above and no one of them disagreed.

The types of riba in Islam:

The prophet Mohammad (prayers and peace of Allah be upon him) said “any debt with any benefit is riba”. And the prophet Mohammad (prayers and peace of Allah be upon him) said: “gold for gold, silver for silver, wholemeal for wholemeal, barley for barley, dates for dates, salt for salt, equal for equal, like for like, hand to hand if the kinds of assets differ, it might sell them as it wishes provided it is hand to hand”.

From two Hadiths the riba is two kinds which concluded from:

  1. Riba Aldeyun (the increase in the debt), so this kind is in the debts. From the first hadith it might to said that riba Aldeyun is two sorts:
  2. A. Riba Alqurudh, which is the percentage in the loan. For example, if someone loans another one £100 and return it £110.
  3. B. Already fi Aldeyn end Hololeh, which means the increase in the debt if someone could not pay his/her debt. For example, if someone loans £100 and when the time to settle he/she could not pay the amount and take a few times with an increase in the debt.
  4. Riba Albyu'ah, which is in the trade or the commercial exchange. From the second hadith as it might be said that riba Albyu'ah has two sorts:
  5. A. Riba Alfadhl (the increase).
  6. B. Riba Alnase'ah (the delay).

The causes of the six kinds to be riba, are two of them, the cost and the weight. As a result, there are two groups; the first one is the cost which contains gold and silver. The second one is the weight which contains the rest.

To put it more clearly and to see how Riba Albyu'ah appears in transactions, suppose that:

  1. A Person exchanges gold for gold or dates for dates and are not the same in the cost or weight with delay. There will be two riba, riba Alfadhl which gold and dates are not the same in the cost and weight, and riba Alnase'ah which is the transaction is delayed or not handed at the same time because there are from the same group and kind.
  2. A Person exchanges gold for silver or barley for salt and is not the same in the cost or weight with delay. There will be riba Alnase'ah, which means the transaction is delayed. Because there are in the same group but not the same kind, which means it must be handed at the same time or the possession is delayed.
  3. A Person exchanges gold for dates, and is not the same and delayed. There will be no riba. Because there are not the same group and the same kind.

The causes of forbiddance of the riba in Islam:

Before starting with the causes, it must be good to know that, in Islam, we must follow what we have got from Qur'an and Sunnah without looking if there is harm to people or not. But if we have harm can we see it, it might appear to elaborate it with more evidence.

Firstly, riba Alfadhl (the increase in the same group and the same kinds):

  1. To avoid the waste money and the excess and the extravagance in trading in the six kinds.
  2. To avoid the monopoly.
  3. To not make people detrimental to each other and to save their money etc.

Secondly, riba Alnase'ah (the delayed in the same group) (Almetrek, 1993):

  1. This is wrongful for the debtors.
  2. The people will dislike each other etc.

To sum up, from the riba, it can be said, the money does not produce money. Although, suppose that if the meter changed from time to time, for example, today is at 100 centimeter and tomorrow at 95 next week 115, what will happen to the people who are making their transactions. This is the same for the money.

Foreign exchange currency in Islam (Alsarf):

When the currencies appeared in the world, there was disagreement between Alfuqh'a, but now almost all of them agree that the currency is the same for gold and silver, because it is instead gold and silver for trading. As a result, to exchange £ for £ it must be handed it in the same time without any delayed and the same amount whether that is coins or notes, or the cost for a transaction or not if the delay happens or the amount is different, this will be riba Alfadhl and Alnase'ah. What is more, if exchanged £ for $ it must be handed at the same time without any delayed, if there is delay this will be riba Alnase'ah.

Operations in the forex market in Islam:

From the facts and discussion above, the two points are clearly evident:

  1. The transactions in the spot market are not against the rules in Islam, and this was working in the Prophet Mohammad’s (prayers and peace of Allah be upon him) time.
  2. The transactions in the forward, future, option, and swap markets are against the rules in Islam, because all these transactions are delayed; the handing or the possession is delayed.

Hedging, speculation, and arbitrage in Islam:

Fuqaha now are working to create a kind of hedging that is not against the rules in Islam, and one of them D. Sami Alsuwailem who is working in the Islamic Development Bank. He creates some kinds of hedging structures that are not against the rules in Islam but it is in general and did not make a full explanation on it. The kinds of hedging which are valuable for the whole market are currency, capital, money and commodity, asset-liability, delta-hedging, and mutual hedging. And which are valuable just for currency are natural hedging and parallel Murabaha. There are three main decisions about the speculation in the forex market, but it must be known that there is no disagreement about speculation in the forward markets, because these markets are against the rules in Islam.

As a result, the decisions in the speculation are in the spot market:

  1. Some of the fuqaha they allowed; the speculation in currencies because it is not against the rules in Islam.
  2. But some of them for example D. Abdulrahman Alatram allowed it with one condition, which is, the settlement for the transaction in the spot market is usually taken two-business days, so the speculators must not sell their new currency before the settlement, because this will be against the rules in Islam, which is the speculator sells what they did not own.
  3. D. Alder did not allow the speculation in the foreign exchange market at all, because this is a kind of Alghrar (hazard, risk) which is not allowable in Islam. What is more the speculation in the forex market does not make any benefits for the economy.

It emerges that the arbitrage does not go against the rules in Islam because the arbitrage looks for a chance to make profits from the difference in the prices in the markets. But it must be in the spot market, not the others.

Conclusion

It can be concluded from above, the forex market is very important for people, the government, and the private sector. The forex market has the main currency like the US Dollar; some very active places for forex trading are London and New York. The forex market has five main components, which are spot, forward, future, option, and swap. The spot market is usually used for important transactions, but the rest, are used for speculation. To avoid speculation, the participants in the market created hedging, but it fails against the power of the speculators. The arbitrage is between the hedging and the speculation, which is looking for a good chance to make profits from the differences in the prices existing in different markets around the world. As deduced from the report, many of the operations in the forex market are forbidden in Islam, except the spot market which is not forbidden in Islam, because it does not go against the rules in Islam. What is more empirical, it can be seen that Muslim scientists are looking for any issues existing in the markets, especially of the Islamic Development Bank, The AAOII, and the international Islamic Academy of Fiqh.

The recommendations

  1. It might be beneficial for the governments to stop or reduce speculation from the forex market as much as they can.
  2. There is a need to develop the real market which has the great potential to take this world en route progress.
  3. It is the need of the hour to develop the instruments of hedging which are not against the rules in Islam.

Remember. This is just a sample.
You can get your custom paper from our expert writers

get custom paper

Cite this page

The foreign exchange market. (2018, Sep 06). Retrieved from https://phdessay.com/the-foreign-exchange-market/

Not Finding What You Need?

Search for essay samples now

We use cookies to give you the best experience possible. By continuing we’ll assume you’re on board with our cookie policy

Your Deadline is Too Short?  Let Professional Writer Help You

Get Help From Writers