Globalization has necessitated trade between different countries. Money is almost always the medium of exchange in these transaction though some few traders may opt for different type of payment. Different countries, however, have different currencies. These currencies have different values. That presents a problem for the booming international trade. The need to convert one currency to another led to the rise of currency exchange.
Currency exchange can be defined as a business that enables customers to one currency for another. This type of business is also known as a bureau de change or the foreign exchange market. A currency exchange can either be a stand-alone business or part of a bank. Such businesses make profits by either charging a commission or adjusting the foreign exchange rate. The foreign exchange may also refer to the market where different currencies are traded virtually around the world 24/7. It is often abbreviated to Forex or simply FX.
What is the Meaning of Foreign Exchange Rate?
According to Investopedia, the exchange rate is the price of a nation’s currency based on another currency. The exchange rate therefore has two components; the foreign currency and the domestic currency. These two, domestic and foreign currencies, are quoted indirectly or directly. When the price is of one unit of foreign currency is expressed in terms of the domestic currency, that is said to be a direct quotation. When the price of one unit of the domestic currency is expressed in terms of foreign currency, that is said to be an indirect quote. When the domestic currency in not one of the two components in the exchange rate, the rate is known as a cross rate or a cross currency.
Let’s assume we have three currencies, the US dollar, which is the domestic currency, the British pound and the Euro. An indirect quotation is where one dollar is expressed in terms of the pound. When one pound is expressed in terms of the dollar, that is a direct quotation. When one pound is expressed in terms of the euro, that is a cross rate. Put in another way, the exchange rate consists of the base currency (the first currency quoted) and the counter currency. The exchange rate is also known as the forex rate.
The foreign exchange rate is used in the currency converter. As we shall see later, a currency converter helps one determine the value of their currency in another country. A converter is a tool used by many people, including business news channels, every day. You can access a currency converter using your computer or just your phone.
How is the exchange rate determined?
You might have noticed that the exchange rates keep fluctuating. This is because currencies trade in the open market and they are prone to the forces of demand and supply. When a particular currency’s demand rises or supply falls, its price or value will increase and vice versa. But this sometimes is not always the case. Two regimes can determine the exchange rates; the floating exchange rate regime or the fixed exchange rate regime. The floating system is where the market forces of demand and supply determine the rate while the fixed exchange rate system is where there is stricter regulation by the monetary authority of a particular country who set the rate. Floating regimes are consequently more volatile.
In a fixed exchange rate regime, the government, through the central bank or Federal Reserve, has to intervene by buying or selling its currency while this is unnecessary in a floating exchange rate. Central banks practicing a fixed regime have to keep the foreign reserves at a high level. This is one of the reasons why some opt for a floating system. The fixed rate is also known as a pegged rate.
There is also a hybrid of these two regimes called the managed floating rate system. In this system, the exchange rate is determined by the central banks and also the forces of demand and supply.
What does it mean to exchange currency?
Exchanging currency is fundamentally changing your currency to another country’s currency with the similar value. We do it to transact. Exchanging currency is a common practice at airports. If you are moving from the US to South Africa for example, you will find it hard to transact with the US dollar. You will need to exchange the dollar to the South African Rand. It is important to get value when you exchange currency. This is where a currency converter comes in handy. A currency converter is a software or even a calculator that converts the quantity of your currency to the equivalent quantity of another currency. A currency converter is usually a computer software to enable it to have the latest valuations of various currencies in the market.
What do I need to understand before exchanging currency?
There are two terms you need to be familiar with before proceeding to exchange currencies; the sell rate and the buy rate.
The buy rate is the price at which a foreign currency business or bank will buy the foreign currency in exchange for domestic currency while the sell rate is the rate the company or bank will sell the foreign currency for the local currency. Different businesses and banks offer different rates so ensure that you know the value of the currency you are holding against the one that you want. The currency converter will help you in this. You can get a good converter online. Sites like the CNN Money, the New York times and Bloomberg all have reliable currency converter. You can also get a currency converter app for your phone.
How do I use a currency converter?
Using a converter is very easy. Once you open the currency converter, you will get an option of selecting the base currency (the currency that you are holding) and the counter currency (The currency that you want to convert to). Once you have selected these two, input the value or quantity of the base value in the converter. Typically, the currency converter will automatically show the corresponding value or amount but in some cases, you might be required to hit the ‘convert’ or 'calculate’ button at the bottom of the converter. Almost every major business news website has a currency converter. There are also many currency converter applications for your phone.
How is the currency exchange market different from other markets?
The biggest difference is that this market is not in a regulated exchange. There is no central governing body or a clearing house. The market operates on an ad-hoc basis, and the participants have to self-regulate. The participants also have to cooperate even as they compete something they have done very well over the years.
What are the benefits of the foreign exchange market?
The currency exchange market has many advantages. First, it is a 24-hour market enabling you to work on your schedule. Anybody can also learn the foreign exchange market and used as your source of secondary income. This market is easy to understand, and tools like the currency converter are easy to use. With the converter, all you need to do is put in the value or amount, and the converter will automatically calculate the value based on the prevailing exchange rate. If you utilize your knowledge well and use the converter to confirm value before trading, you can earn lots of profits within a short time.
What are the key factors affecting the exchange rate?
Factors such as rate of inflation, government debt, interest rates, the balance of payments, terms of trade, political stability & performance, recession and speculation all affect the exchange rate. CNN money for example recently noted that the looming Brexit vote in the U.K. could be the start of a recession lowering the value of the British Pound. Mark Carney pointed out that if the UK citizens vote to exit the EU, their currency could fall “perhaps sharply”.
Types of Currency Markets
The forex market is among the largest markets in the world and is thus divided into three main types; the spot market, the forward market, and the futures market.
1. Spot Market
The spot market is where the payments and receipts of currencies are made on the spot or in the very near future, typically two days. The rate of exchange in the spot market is referred to as the current rate of exchange or the spot rate of exchange.
2. Forward Market
The forward market is where the two parties involved agree to a future date when they will conduct the purchase and sale of foreign currency at a rate agreed on today. The exchange rate used is known as the forward exchange rate. Engaging in forward markets transaction makes a lot of profits for some traders who speculate on the prices of a particular currency. Forward markets are also preferred by traders or managers who are anticipating a huge fluctuation on a currency they will need in future. By engaging in a forward contract now, they can minimize the risk if the exchange rate eventually fluctuates as expected. Most forward contracts have a maturity of over a year, but they can be longer sometimes. Forward contracts are tailored to suit the parties involved.
3. Futures Market
The futures market, just like the forward market, settles a bit later than the spot deals. The difference, however, is that futures market have a specific expiry date and also have a set size of the trade. The futures contracts are derivative instruments.
The Currency Converter Spares You Worry and Saves You Money
One cost that many people do not factor into their international travels is the difference in currency. There are currency exchange booths littering each international port of entry. They usually display a little digital sign with what they will exchange your money for. Often, that sign displays their current prices in a very deceptive, sometimes even blatantly dishonest, way. When people exchange cash, the exchange booth will sometimes give back a lesser value, keeping what value is left over as a profit. Some of these booths are complete rip offs. If you do not know the true currency exchange rate at that exact moment, you could be ripped off too.
There are many factors that influence the value of a country’s currency. These factors are fluid and ever-changing. They include the political stability of the country, the value of the nation’s imports versus the value of its exports, war in the region, the country’s public debt, the actions of its central bank and the stability of the county’s inflation rates. It is nearly impossible to keep on top of all the factors that influence the value of a nation’s currency, but you don’t have to. That is where the Currency Converter comes in.
The currency converter is constantly changing, just like the value of a country’s money. Every time the value of a nation’s currency changes, the website updates automatically and instantly. There is absolutely no worrying about the fluctuating changes on the value of a foreign nation’s money.
But how does this help you?
The currency converter website allows you to see the current value of a foreign nation’s currency and this allows you to save money during an international trip. The value of your foreign destinations currency is displayed on the website relative to your currency, and you can choose any home currency in the world. The site automatically displays what the true exchange rate relative the money that you hold in your hand. This gives you a solid understanding of the value of the money you have, and how much that will turn into when you get where you’re going.
By toggling the easy-to-use menu options on the converter website, you will be armed with the most up-to-date information regarding the currency in the country to which you are traveling. You will be able to shop around for the best deals for exchanging your cash in a foreign country, which saves you money, and prevents unscrupulous people from taking advantage of your lack of knowledge about the worth of your money. Plus, the website is mobile and can be used internationally on a smart phone so you can always know how much money you have.
Participants in the Foreign Exchange Markets
There are many participants in the foreign exchange market. They can be grouped into two broad classifications of wholesale and retail or even profiled to understand them even better.
1. Wholesale level
This is the largest group of players in the currency exchange. They include the banks and businesses offering foreign exchange services (bureau de change). Both the commercial banks and investment banks take part in the currency exchange. The reason for engaging this market are varied, but most offer foreign exchange services to their customers and clients hence the need to participate in the foreign exchange market. These institutions also take part in the market for speculative or hedging reasons. The government, through the central bank, also belong to this category, especially if they operate a fixed exchange rate regime. The government might get into the foreign exchange market to adjust the fiscal or economic imbalances. Governments are also known to trade in currencies to improve the economic conditions of their countries.
2. Retail level
This is where consumers and travelers fall. When you travel to another country, you will find yourself checking out the converter to change your currencies. When you acquire goods from abroad, you might need to check your preferred currency converter to see their value and eventually exchange your currency for completing the deal. Businesses conducting business across the border will also need to exchange their currency.
These are forex traders who make money without any open currency exposure. This means that the trader will look for inefficiency in the pricing of different currency pairs at the foreign exchange market and exploit them. It is a risk-free strategy which is popular with many traders. Just like the currency converter, there are many forex arbitrage tools online.
Some participants engage in this market to attempt eliminating the foreign exchange risk. The purpose of hedging is to cancel out any adverse effects that may arise from the volatility of the exchange rate. The spot market and foreign currency options provide the best option for hedging in the forex market although the latter is more effective.
5. Investors and Speculators
This is a group of people who see the fluctuations of the foreign exchange market as an opportunity to make money. Hedge funds also fall into this category. Hedge fund managers make billions in just a few weeks.
The currency exchange facilitates conversion of one currency to another. This is important when transacting in another country. These transactions may be necessitated by trade or business obligations or touring abroad. To convert your currency to another one, you will need to know the value of these two currencies against each other. To achieve this, you will need a currency converter. A currency converter is a program or software or a calculator that allows you to check how much your money is worth when exchanged to another currency. Using a converter before approaching a currency exchange business or bank will help you get the best value for your money, literally. So, if you are looking to engage in currency exchange, learn how to use a currency converter. It is simple.