What Are the Functions of Foreign Currency Exchange Markets?

By: Thomas Metcalf   Managing Your Money   December 12, 2019

The foreign exchange market, also known as the FOREX market, is a worldwide network that connects exchanges around the globe to enable round-the-clock trading from when the markets open Monday morning in Asia -- Sunday afternoon in the United States -- until the American markets close on Friday afternoon. The FOREX market provides essential functions that facilitate the growth of world commerce

Foreign Exchange Markets

Currencies are bought and sold with prices determined by supply and demand with occasional government intervention. Currency transfers are accomplished by checks and bank drafts, bills of exchange, and mail and wire transfers.

The players in the market are banks, brokers and businesses, with some individuals trading on their own accounts. The FOREX market supports world commerce by allowing the transfer of funds from one currency to another, providing credit to businesses in the import trade and offering a hedge against possible exchange-rate fluctuations.

Transfer Function

The most visible function fulfilled by the foreign exchange market is to facilitate the conversion of one currency to another. In doing so, the foreign exchange market is the mechanism that transfers purchasing power from one country to another.

When an importer in the United States imports goods manufactured in Germany, for example, the exporter wishes to be paid in euros. The conversion of U.S. dollars to euros is done through the foreign exchange market. Likewise, if an American businessman plans a trip to India, he exchanges U.S. dollars for Indian rupees through the foreign exchange market.

Credit Function

By using the FOREX market, importers can obtain credit to finance their foreign purchases. Suppose an American company wishes to purchase an inventory of Chinese-manufactured tools.

The American importer can pay for the purchase by using a bill of exchange in the FOREX market -- essentially an IOU with a three-month maturity. This instrument locks in the exchange rate and allows the importer 90 days to sell his products before the note is payable

Hedging Function

While exchange rates fluctuate, they do not ordinarily exhibit dramatic shifts, barring international crises. Nevertheless, the chance that rates may change poses a risk to traders whose business lies in buying and selling merchandise, not speculating in currency-price movements.

If a business is concerned that rates may change against him before the transaction is completed, he can make an offsetting transaction in the forward exchange market and then liquidate it when his initial transaction is completed. An exchange-rate profit in one will be balanced by a loss in the other, allowing him to complete the primary transaction with no fear of losing money because of an adverse currency movement.

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Pros & Cons of Foreign Exchange Markets

By: Bryan Keythman

The foreign exchange (forex) market is the interbank market where institutions trade currencies. It is also accessible to retail investors through online dealers or brokers. The forex market has several pros and cons that investors and traders should be aware of. Knowing what’s involved with participating in the forex market will increase your chances of success.

Size

The foreign exchange market’s size gives it several advantages. The large number of participants provides liquidity, meaning currencies are easily bought or sold, and orders are typically filled right away. The size of the market also prevents any single entity from exercising too much control over the market. Large participants, such as central banks, may influence the market, but only for a short amount of time.

Accessibility

The forex market is open 24 hours a day, five days a week. Some brokers are even open on weekends. This allows for flexibility to trade when you want. Brokers require low opening deposits, offer low transaction costs and typically charge only the bid-ask spread per trade, which is the difference between the buying and selling price. Traders can also use leverage to trade a larger amount of money than they have in their account.

Trading Styles

The forex market accommodates different trading styles. Investors can buy long or sell short in the foreign exchange market without restrictions. Investors can participate in the forex market using futures, exchange-traded funds or options, or directly through a broker in the spot market. This caters to different investment objectives.

Loose Regulations

The orex market is an over-the-counter market with no central exchange. It is less regulated than other markets. Traders typically place trades directly with their broker, who takes the other side of the trade. The lack of a central exchange results in a lack of information on certain market statistics, such as trading volume, and creates a greater risk of mispricing.

Broker Risk

The loose regulation of online brokers increases the potential for fraud. Traders must research a broker carefully before opening an account. Funds deposited with a forex broker are typically not protected if the broker goes bankrupt. Any outages in a broker’s trading system could leave a trader unable to manage open trades.

Risk of Loss

There is the potential to lose all of your money. Using leverage to trade more money than is in your account magnifies the potential loss if the market moves against you.

You may be responsible for losses greater than the funds in your account. Because currency prices are influenced by many factors, the amount of fundamental information to analyze is daunting.

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Introduction into Foreign Currency

Foreign Currency Definition   By Alex Kocic,

Currency is any generally accepted medium of exchange for goods and services in a particular country or region. Today currency normally takes the form of paper notes and coins. Foreign currency is any currency not normally used in a particular region or country.

There are almost 200 currencies worldwide today. Although most countries have their own currency, there are some that adopt another country's currency as their own. The euro is a common currency in a number of European countries.

​ History

Before there was money people would trade, or barter, goods directly—say a certain number of cows for a certain number of tools.

This, however, became complicated as the number of goods and services traded grew. That's why a common currency was needed—to help people determine how many tools a cow was worth.

 Any durable commodity could be used as currency. Shells, furs, teeth, beaver pelts, dried corn or buckskin (hence the term "buck" for dollar).

As Niall Ferguson writes in the "Ascent of Money," the earliest known coins date to 600 B.C. and were found in the Temple of Artemis at Ephesus in modern-day Turkey. First banknotes originated in seventh-century China.

​Foreign Exchanges

 As trade grew between nations that all had their own separate currencies, there was a need to establish foreign exchanges, where foreign currencies could be bought and sold.

​This came with the birth of the gold standard in 1875. Before that, precious metals such as gold and silver were used for international payments.

Gold standard meant that any currency was backed by gold, measured in ounces. Countries were required to keep large reserves of gold to back the demand for currency. The price of an ounce of gold was set for each currency and the difference in price between two currencies became their exchange rate.

Bretton Woods System

The gold standard was abolished with the outbreak of World War I in Europe and in July 1945 replaced by the Bretton Woods system, in which the U.S. dollar, as the only currency backed by gold, became the ultimate exchange currency. It was replaced in the early 1970s by the current system of floating exchange rates in which currencies are not tied to one another or to gold.

 Considerations for Tourists

Whether you have an importing or exporting business, or simply plan to make a tourist trip abroad, there are a couple of important foreign currency considerations. Tourists should buy their foreign currency before they travel, which is usually a bit cheaper than buying it on arrival.

 For larger purchases or other expenses while abroad, it is better to use a credit card, since most credit card issuers use their own exchange rate, usually slightly lower then the rates abroad, when they bill you.

Considerations for Businesses

Businesses that buy or sell goods abroad can incur significant losses due to exchange rate fluctuations between the time of purchase and time of payment. They should talk to their bank about hedging against foreign currency rises.

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What Is Foreign Currency Valuation?   By Corr S. Pondent,

 Currency values change from time to time depending on market factors. If you have any kind of exposure to foreign currencies, you will need to be aware of foreign currency valuation.

 Definition

 Foreign currency valuation refers to the value of a foreign currency in terms of the local currency, for instance the U.S. dollar vs. the Canadian dollar. This defines how many Canadian dollars you will get for your U.S. dollar. The higher the value of the U.S. dollar vs. the Canadian dollar, the higher your purchasing power will be in Canadian dollars. 

​  Significance

 There are everyday situations in which you are likely to be affected by foreign currency valuations. If the value of the U.S. dollar goes down vs. the Canadian dollar, businesses that buy raw materials from Canada might see their costs go up. In that case, you might end up paying more for their goods.

Sapling.com 

Currency is any generally accepted medium of exchange for goods and services in a particular country or region.

​  Risk Management

  Businesses manage their foreign currency risk exposure to guard against changes in foreign currency values.

They don't want to end up paying more than they expected for imports or receiving less money than they expected for goods they export. There are various contracts that allow them to do this.

 How to Find the Value of Foreign Currency   By Carter McBride,

 Each foreign currency has a different value compared to United States dollars. The amount of one foreign currency equaling one dollar is the foreign currency exchange rate.

 This can also be inverted where the rate shows how much of a U.S. dollar equals one unit in another currency. By using the foreign currency exchange rate, people can find the value of a foreign currency. Foreign currencies is either used in another country or in speculative trading

 Instructions

         1   Determine the currency you want to find the value of. For example, an investor wants to know the value of the euro in relation to the U.S. dollar.

         2   Determine how much of the currency you want to find the value of in another currency. In the example, the investor wants to know the worth of 200 euros in U.S. dollars (USD).

         3   Search  for "Amount of Currency 1 to Currency 2" in Yahoo!, Bing, or Google. Like a regular search, these will bring up various websites, but unlike a regular search, each search engine will convert the one currency to another currency using current exchange rates.

Replace Amount with the amount you want to convert. Replace Currency 1 with the currency you are converting and replace Currency 2 with the currency you are converting to. In the example, type "200 euros to USD."

Each search engine will return a result that looks like "200 euros = 247.7400 U.S. dollars." So 200 euros has the same worth of $247.74.

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