Foreign Exchange Market
by Business & Economics Research Advisor, from the Library of Congress

The characteristics of the FX market that make it so unique are: the volume of trading, liquidity of the market, geographical dispersion, the 24 hours trading day (except on the weekends), the number and variety of market traders, and the factors that affect the exchange rate. This market has a number of marketplaces where currencies are traded at different rates. To avoid exploitation by arbitragers, difference in rates are usually kept at a minimum. Banks all over the world are involved in foreign exchange trading, but the main trading centers are located in Tokyo, London and New York, allowing the market to remain open 24 hours a day; when Asian trading is ending, European trading is starting, and U.S. trading ends the daily session. Traders do not have to wait for the market to open. Monetary flows and economic changes such as GDP growth, interest rates, inflation, and budget and trade deficits or surpluses, cause fluctuations in the exchange rate. Because news affecting foreign exchange is well publicized, insider information is almost nonexistent in the FX market.
One factor causing fluctuation in the exchange rate is
A) interest rates.
B) lack of weekend trading hours.
C) insider information by arbitragers.
D) geographical dispersion of the FX market.

The country which has the largest interest rate, attracts both domestic and foreign investors, as they all want to earn a retribution as high as possible. If they invest their money in operations that promise higher interests, they would earn higher profits.

Therefore, investors from the country with lower interest rates exchange their domestic currency, increasing its supply on the monetary markets, for the foreign currency, increasing the demand of the latter in the monetary markets, in order to be able to invest in the country with more favourable interest rates. As a result of these money movements, the currency from the country with attractive interests rates appreciates against the currency of the country with less attractive rates.