History of Foreign Exchange
The history of FOREX dates back to the earliest times when currency didn't exist and purchases were made with the Barter System. As trading became more popular, coins were minted from preferred metal and eventually shifted to the use of paper. These forms of currency were originally backed by gold but after the First World War the FOREX market went through a series of changes like the "Run on Banks" during the Great Depression. These changes resulted in restrictions on capital flows being removed from most countries, leaving the market forces free to adjust rates according to their perceived value. Due to this in the last few decades foreign exchange trading has developed into the worlds largest global market.
Functions of Foreign Exchange
The foreign exchange market is the mechanism by which a person of firm transfers purchasing power form one country to another, obtains or provides credit for international trade transactions, and minimizes exposure to foreign exchange risk.
Transfer of Purchasing Power:
Transfer of purchasing power is necessary because international transactions normally involve parties in countries with different national currencies. Each party usually wants to deal in its own currency, but the transaction can be invoiced in only one currency.
Provision of Credit:
Because the movement of goods between countries takes time, inventory in transit must be financed.
Minimizing Foreign Exchange Risk:
The foreign exchange market provides "hedging" facilities for transferring foreign exchange risk to someone else.
Customers are anyone who engages in the foreign exchange market through the services of banks. Customers include tourists, importers, exporters, investors, etc.
Commercial Banks are the most active participants of the foreign exchange market. They deal with international transactions and offer services for conversation of one currency into another. In general, commercial banks act as intermediary between exporter and importer who are situated in different countries.
Exchange Brokers locate the most competitive buying and selling prices, and these prices are immediately broadcast to a large number of banks by means of hotlines/loudspeakers in the banks dealing room/contacts many dealing banks through calling assistants employed by the broking firm. If any bank wants to respond to these prices thus made available, the counter party bank does this by accepting the deal. The brokers charge commission for the services rendered.
The Central Banks of countries are responsible for maintaining the external value of the domestic currency. In other words, they maintain order in the movement of exchange rates. They do so through exchange rate management or reserve management.
Exchange rates are the prices at which currencies trade
Exchange rates allows you to see a country's balance of payments due to the financial sector consisting of sales and purchases with foreign countries consisting of different currencies.
Supply and demand in the Foreign Exchange Market determine the exchange rates.
The main shifter on this graph is the value of money itself. For example, if the US dollar appreciates (more valuable) , the demand for it will decrease.
If the US dollar depreciates (less valuable), the supply will increase.
Government policy can also affect the exchange rates in the FOREX:
Floating exchanges rates follow the current and real exchange rates
Fixed exchange rates have a set exchange rates regardless. When governments choose this route, it often results in either a exchange rate deficit or surplus and may leave their country more vulnerable to recession
Foreign Exchange Transactions
The transaction is immediate delivery of the exchange usually within two business days. It is 43% of all transactions.
The delivery of the transaction occurs at a future date that is previously agreed upon at a specified amount. The exchange rate and lengths are negotiable. It is only 9% of transactions.
This is the simultaneous purchase and sale of currency. Two different dates will be used and is 48% of all transactions.
Foreign Exchange in Today's Economy
The FOREX is an extremely influential part to today's economy. Nearly all countries participate in trade in order make up for the lack of resources they within their own country lines
Exchange rates can be easily applied to today's economy because most countries depend on trade (i.e. imports, exports). Without the ability to convert between currencies, there would be no trade.
Strenghths of the FOREX Market
Weaknesses of the FOREX Market