Foreign Exchange Market

An international financial market where the currencies of various countries are exchanged, serving as core infrastructure for exchange rate determination and international settlement and investment.

Foreign Exchange Market

Overview

The foreign exchange market (Foreign Exchange Market, FX Market) is the market where currencies of different countries are exchanged, and is the financial market with the largest trading volume in the world. Unlike stock markets, where trading takes place at a specific exchange, it operates 24 hours a day as an over-the-counter (OTC) market in which banks, securities firms, central banks, and others are connected by telephone and electronic networks. Exchange rates are determined by supply and demand in this market, and transactions for various purposes—trade settlement, overseas investment, risk hedging, arbitrage, and others—take place simultaneously.

Main Content

Definition and Functions

The basic functions of the foreign exchange market are ① exchange of international means of settlement, ② transfer (hedging) of exchange rate fluctuation risk, ③ cross-border movement of funds, and ④ price discovery (exchange rate determination). A company receiving export proceeds in dollars and converting them into won, or an institutional investor buying dollars to purchase overseas assets, both go through this market.

Market Participants

Financial institutions such as banks: As dealers at the core of the market, they quote prices and supply liquidity.
Central banks: They seek market stability through management of foreign exchange reserves and intervention (smoothing operations) during sharp exchange rate fluctuations.
Corporations and individuals: They conduct transactions for real demand purposes such as trade settlement, overseas travel, and remittances.
Hedge funds and investment institutions: They increase market volatility through arbitrage and position investment while supplying liquidity.
Brokers: They intermediate interbank transactions and provide anonymity.

Market Structure and Products

Depending on the counterparty, it is divided into the interbank market and the customer market, and by product includes spot exchange (Spot), forward exchange (Forward), FX swaps (FX Swap), currency futures (Currency Futures), currency options (Currency Option), and others. Spot exchange customarily settles on T+2, while forwards and swaps are used to adjust the settlement date to the future or as means of funding and investment.

Determinants of Exchange Rates

Exchange rates are determined by a combination of factors such as interest rate differentials between the two countries, differences in inflation rates, the balance of payments (current account and capital account), economic growth rates, political and geopolitical risks, and market sentiment. Representative theories include purchasing power parity, interest rate parity, the balance of payments theory, and the asset market approach. In the short term, interest rates, policy expectations, and risk appetite have a major influence; in the long term, productivity and prices do.

Settlement and Infrastructure

Settlement of large-scale foreign exchange transactions is handled by the CLS (Continuous Linked Settlement) system, reducing settlement risk arising from time zone differences. International remittances and transfers are made through the SWIFT network, and countries are improving settlement infrastructure to internationalize their currencies.

Market Size

According to the Bank for International Settlements (BIS) triennial survey, the average daily trading volume of the global foreign exchange market reached about 7.5 trillion USD in 2022, and has continued to increase since, and is estimated at around 9 trillion USD by around 2025. This is tens of times the world's annual GDP, and the share of financial transactions is overwhelmingly larger than that of real transactions.

South Korea's Foreign Exchange Market

Since the 1997 foreign exchange crisis, South Korea has pursued liberalization of foreign exchange transactions in stages. The won/dollar market has been closely linked to the offshore non-deliverable forward (NDF) market, and in 2023 the foreign investor registration system was abolished. Starting in July 2024, the opening hours of the domestic foreign exchange market were extended from the previous 9 a.m.–3:30 p.m. to 2 a.m., overlapping with the time zone of the London financial market, which is evaluated as a basis for expanded participation by foreign financial institutions and internationalization of the won.

Latest Trends

In 2024–2025, the foreign exchange market showed patterns in which the dollar index and emerging market currencies surged and plunged whenever expectations surrounding the timing and extent of the U.S. Federal Reserve's rate cuts changed. The won/dollar exchange rate rose to the 1,470 won range amid political uncertainty and a strong dollar trend at the end of 2024, expanding volatility, and in 2025, U.S. trade policy, tariff imposition, and geopolitical conflicts emerged as major variables.

Structural changes are also clear. First, major countries including South Korea are extending foreign exchange market opening hours and allowing offshore participation, increasing market accessibility. Second, central banks of various countries are conducting cross-border payment experiments using CBDCs (central bank digital currencies) and tokenized deposits, and discussions on stablecoin regulation are affecting the foreign exchange settlement ecosystem. Third, movements to expand local currency settlement to reduce dependence on the dollar, centered on BRICS and others, continue, but the dollar's status as a key currency remains overwhelming. Fourth, as the share of algorithm- and AI-based automated trading and electronic trading platforms grows, the liquidity supply structure and volatility patterns are changing from the past. Finally, after the case of frozen Russian assets, a reevaluation of the safety of foreign exchange reserves and expanded gold purchases have emerged as a common trend among central banks.