Forex rates are set by the cumulative trading of many different participants from around the world. The largest segment of the global Forex market is the interbank market. Ultimately, Forex brokers derive rates from the interbank market.
Exchange Rates
The Forex market lists exchange rates between currencies. Forex is a global, decentralized market with many different participants and high liquidity. Exchange rates constantly shift as market participants buy and sell currency in the Forex market.
Interbank Market
The interbank market is a group of large banking institutions that constantly trade currencies with each other. These banks are the major players in Forex. The trading conducted in the interbank market sets the exchange rates that get passed on to the other Forex participants.
Retail Brokers
Retail brokers derive rates based on the interbank exchange rates. Forex brokers are a much smaller segment of Forex than the interbank market and, therefore, retail brokers simply pass on rates to customers. This process is similar to the way in which any other retail institution buys a product or service in the wholesale market and then passes it on to customers in the retail market.
The Spread
Retail brokers profit from the spread, which is the difference between the rate at which someone may buy or sell a currency pair. There are two primary methods retail brokers use to implement the spread. When offering a fixed spread, the broker widens the spread they receive from the interbank market and profits from the difference. Alternatively, a broker may offer a variable spread that contracts or expands based on market volatility.
Source - eHow
