Article: Foreign Exchange
What is foreign exchange?
Foreign exchange occurs when you change one form of currency into another form of currency. If you’ve ever travelled to another country, you would have made a foreign currency exchange to travel more easily.
Foreign exchange rates are determined by global foreign exchange markets. Exchange rates are flexible and subject to change very quickly. A number of factors, such as supply and demand, economic and political conditions can influence the exchange rate.
How does foreign exchange work?
Foreign exchange rates are determined by global trading. The foreign exchange market, also known as Forex or the FX market is the world’s largest financial market.
Exchanges take place between government, banks, multinational corporations and financial institutions. On any given day, the average trade in global foreign exchange markets exceeds US $2 trillion.
Unlike other stock exchange markets, foreign exchange is unique because of the sheer volume of trade and the liquidity, the ability for assets to be quickly bought and sold, of the market.
Forex is truly global with the largest centres in London, Singapore, Tokyo and New York. Forex operates 24 hours a day, five days a week. Asian markets open the trading day. As these markets close, the European markets open. Centres in the US take over when the European markets cease trading, and the Asian markets open again the next day. The most frequently traded currencies include the US dollar, Euro, Japanese yen, the Australian dollar, British pound sterling and the Swiss franc.
Foreign exchange takes place over-the-counter (OTC). This allows assets to be traded directly between dealers and brokers. Central and national banks use their power to control money supply, interest rates and inflation to reach target rates for their currencies. Financial institutions can operate on behalf of funds and private individuals. Commercial companies complete transactions in foreign currencies.
What determines foreign exchange rates?
Since there is no one foreign exchange centre, there is no single foreign exchange rate. There are a number of different prices which are determined by the location of the centre and other important factors, such as economic and political conditions and market psychology.
Economic policy, determined by governments and banks, has a strong impact on the exchange rate. Government budgets, gross domestic product, inflation, employment, and interest rates reflect a country’s growth and economic health can determine the value of a nation’s currency, and its strength on the global market. Political instability, whether it be national, regional or international, can also impact a nation’s economy.
Market psychology also affects foreign exchange rates. Immediate access to world news can allow traders to anticipate changes in economic rates. Traders often ‘buy the rumour and sell the fact’, anticipating the impact of an economic or political event and forcing currencies high or low as a result.
Next time you travel, check exchange rates on the news to find out the value of your currency. When you arrive, check the different currency exchange companies before you settle. Use your best judgement to find the most rewarding exchange for you.