What is the importance of Foreign Exchange?

Foreign Exchange, commonly known as Forex, means converting one currency to another country’s currency. The value of a country’s currency is either fixed by the government of the country or depends on the supply and demand of the currency. Currency trade basically occurs in two ways, over the counter (OCT) and electronically. \

One popular use of foreign exchange is when a tourist visits a country, they have to pay for the services available there by using the currency of that country. The tourists use foreign exchange to exchange their local currency for the currency of the country they are visiting. Such exchanges have a significant impact on the demand for that particular currency.

The foreign exchange market is the world’s biggest liquid market where money worth billions of pounds are exchanged every single day. Forex market does not have a concentrated marketplace. Most of the transactions take place through brokers or banks electronically.

An exchange rate is the amount of one currency required to purchase another currency. Exchange rates are never constant, they change every day. Changes in exchange rates cause either a positive or negative impact on every business. This impact depends on how the exchange rate changed.

Foreign Exchange trading usually takes place in pairs, such as GBP/USD, EUR/JPY and USD/CAD. These pairs represent British Pound Sterling (GBP) versus the U.S. dollar (USD), euro (EUR) versus the Japanese yen (JPY) and USD versus the Canadian dollar (CAD). A price is usually applied to each pair. For example, the price applicable to the GBP/USD pair is 1.39. This means that it costs 1.39 USD to buy 1 GBP. If an increase in price occurs and the price increases to 1.45 USD, then it costs 1.45 USD to buy 1 GBP. This means that the value of GBP has increased but the value of USD has decreased as it now costs more USD to purchase 1 GBP.

Some Main Functions of The Foreign Exchange Market.

The foreign exchange market is a worldwide network. 

Below mentioned are the main functions of the foreign exchange market:

  1. Transfer:

Transferring money from one country to another is the most basic function of the foreign exchange market. It is usually done to settle payments in another country. Although it just converts a country’s currency to another country’s currency, the foreign exchange transfers the purchasing power to another country.

  1. Credit:

Due to this function, a foreign exchange provides a limited-time credit opportunity to businesses to help the services from one country to another flow without any issues. Such credit function usually has a three-month limit.

  1. Hedging Function:

A major function of the foreign exchange market is to hedge the risks of foreign exchange. Fluctuations in exchange rates are common, therefore parties are afraid of these fluctuations as they can result in a profit or loss to the business. Therefore, foreign exchanges provide an opportunity called forward contacts. Forward contracts mean parties can buy, sell or exchange foreign currency at a fixed rate within a certain period of time. Forward contracts usually last for three months.

Banks are known to be the most important dealer in the foreign exchange market. Exchange banks are services offered by a bank that has branches all over the world and can easily facilitate the currency exchange process.

Forex markets are open 24 hours a day, which means that trading can be done at any time. It has fewer rules than any other economical market. Low running fees and easy access.

Investments done in foreign countries are complicated due to the fluctuations in exchange rates between countries. Movements in exchange rates can have a significant effect on the return from foreign investments. Total returns from a foreign investment can be boosted if the investment is done in a country with an appreciating currency. An investor will have the most profit when the value of both foreign currency and foreign investment will increase. 

Nowadays, rates of some currencies are increasing to their highest rates why some currencies are dropping to their lowest rates. Most foreign currencies are bought and sold based on their exchange rates which mean that the rates change due to their supply and demand in the foreign exchange market. If the supply of a currency increases and it becomes easily available then the price of that currency will decrease.

The foreign exchange market plays an important role in nurturing foreign trades and transactions. The importance of such foreign exchange services has heightened with evolving economical conditions, investments and transactions, and with improving technology which makes communication with foreign countries easily accessible.

A foreign exchange service is needed in a country to be able to pay for its imported goods and services. The bill of this imported service needs to be paid in the local currency of the country from where it has been imported. For example, if the UK imports a coffee machine from Canada then it has to pay Canada using Canadian dollars. Pounds will not be accepted by that country.

Foreign exchange services are important to determine a country’s economic health and the growth of its economy based on the exchange rates of the currency of that country. 

The foreign exchange market of the UK is completely legal and it allows traders and brokers to earn money. The UKUK is known to be the backbone of international trading. The foreign exchange of the UK has always been known for its strict rules and loyal services. The largest percentage of foreign exchange in the world that is 40% of currency exchange takes place in London, the British capital city. The economical development of the UK would suffer if it does not have the ability to trade using multiple currencies.

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