Contents
What is the concept of Foreign Exchange?
Foreign Exchange (forex or FX) is the trading of one currency for another. For example, one can swap the U.S. dollar for the euro. Foreign exchange transactions can take place on the foreign exchange market, also known as the Forex Market.
How Does Foreign Exchange Work?
The market determines the value, also known as an exchange rate, of the majority of currencies. Foreign exchange can be as simple as changing one currency for another at a local bank. It can also involve trading currency on the foreign exchange market. For example, a trader is betting a central bank will ease or tighten monetary policy and that one currency will strengthen versus the other
Example of Foreign Exchange
A trader thinks that the European Central Bank (ECB) will be easing its monetary policy in the coming months as the Eurozone’s economy slows. As a result, the trader bets that the euro will fall against the U.S. dollar and sells short €100,000 at an exchange rate of 1.15. Over the next several weeks the ECB signals that it may indeed ease its monetary policy. That causes the exchange rate for the euro to fall to 1.10 versus the dollar. It creates a profit for the trader of $5,000
By shorting €100,000, the trader took in $115,000 for the short-sale. When the euro fell, and the trader covered their short, it cost the trader only $110,000 to repurchase the currency. The difference between the money received on the short-sale and the buy to cover is the profit. Had the euro strengthened versus the dollar, it would have resulted in a loss.
Need of Foreign Exchange
Today, we live in a world where the exchange of goods and services happens for money. This money is in the form of a particular currency. Now, the value of one currency will not be the same as that of another. This is why Foreign Currency is the spine of international investments and global trading. Without it, it would be nearly impossible to determine the value of goods and services imported and exported by different countries to each other. And without having the possibility to trade, companies that rely on overseas resources and talent would be completely crippled. Also, there would be major problems for foreign travelers to buy or sell anything while abroad.
Individuals and businesses trade currencies whenever goods are bought and sold abroad. Thus, a currency exchange market has developed around these practices, with hedging practices used for volatile trading periods. The foreign exchange is historically centered on the large central banks, large financial houses, and multinational business corporations. However with the advent of independent currency traders like us at Pure FX, the practice has extended to small businesses and even individuals. These small traders are having a significant effect on the foreign currency exchange market. This makes foreign currency trading easily the most efficient and liquid trading platform available.
- Letter of Credit: Meaning, Importance and Required Document
- Documents used in export trade its types and contents
- Restrictions on deposits to foreign currency accounts
- What is the obligation to submit foreign currency?
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