Ever since currency trading was deregulated in the 1970s the foreign exchange money market has been growing in popularity as an option for investors to get their money to work for them. Although the foreign exchange market is ostensibly available so that businesses can handle import and export transactions more easily and conveniently, nevertheless the vast majority of trading on the forex is speculative in nature.
That is to say, about 70%-90% or all the transactions on the forex are just buying and selling with no intention of ever taking possession of the currencies in which they are trading. Rather, they are only speculating on the direction the currencies they are trading in are going to go. Ever since 1996 hedge funds have acquired a reputation for aggressively speculating on the forex market.
There are several theories which explain the changes in the forex rates of exchange in a floating exchange rate regime. Fixed rate regimes are when governments control the value of the exchange rate, but today the majority of currencies are floated. There are at least 3 common theories about what determines the rates of exchange:
- The conditions of international parity of purchasing power, interest rates and the Fisher Effect.
- Balance of payments which focuses largely on tradable products.
- The asset market model which also focuses mostly on services and tradable goods, totally ignoring the part that international capital flows play.