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Foreign Exchange

An Introduction to the Foreign Exchange Market

The foreign exchange market is a global forum for trading currencies one against another. As reported by the Bank for International Settlements this market has over $6 trillion in daily trading volume, making it the largest financial market in the world.

Such a large magnitude and universal character of this market make it a fundamental facet of international finance effecting virtually all economies, businesses, and often individual investors. At the most basic level, the foreign exchange market facilitates cross-border trade and investment.

When foreign and domestic businesses or entities are importing or exporting products or service, these transactions require the exchange of two currencies. Foreign direct investment and foreign portfolio investment require the purchase or sale of assets in another nation and hence contain exchange rate risk absent of countries’ ability to purchase and sell foreign currency when they import or export positively affect the efficiency of the economy and firms’ opportunities to expand their businesses beyond national bounders.

Foreign investments also play a vital role considered between the value of the price of a country’s goods and the value of the price of the good in other nations. Generally, a stronger country’s currency steadily increases the cost of exports and decreases the cost of imports, this condition may lead to a trade deficit. Weaker exchange rate, conversely, boosts the capital of exports and imports. Determination of the exchange rate is one of the key economic indicators and has a direct impact on a country’s economy impacting domestic monetary and fiscal policies.

The connection of the forex market to the other financial markets is direct and complex. The commodities market is the best example of that. Most of the time the world’s leading commodities such as oil, gold, and copper, and foodstuffs are priced in the U.S. dollar on the global market. As a weaker value of the dollar makes the commodities more affordable in other currencies, it generates the effect of inflation and affects the policies of central banks.

Foreign Exchange and Property

Another example is the Housing market as a foreign currency crisis can decline the attractiveness of the housing market for foreign investors and vice versa, making it a desirable and easily available investment. As an example, a private investor may decide to transfer money to Spain while the Euro rate is favourable, if they’ve purchased property, or paying a mortgage in the country.

The last example is the industrial sector as many company’s operations can be international they are highly vulnerable to exchange rate risks. Opening markets in another country with the weaker currency and paying for the goods from a country with the stronger one with an example of how industries use the forex market to hedge against currency’s depreciation, generate stability, and protect their revenue. Since international markets began, the forex market has been a vital part of trade, cross-border investment, and inexhaustible economic policies in this globalization age, and other financial markets, which ultimately affects the price level of products, real estate, and the industrial sector among many other things.