What is the role and business purposes of foreign exchange?

In the world of finance, the exchange rate is a measure of the value of two currencies. Simply put, you are exchanging the Great Britain Pound for Dollars, there is a rate set which you can exchange it for. Now, the rate is pre-determined based on the current global financial market. So, the bottom line is in exchange rates you value one country’s currency to the other one.

How cross border payment services work?

International money transfer services work because different countries have currencies that are worth different amounts. One pound is close to one frank, but it is worth over a hundred yen. The differences in the exchange rates happen due to the countries financial, political and environmental situation. A given currency value may fall or rise depending on the state they are in both politically and environmentally. For example: Because of the Pandemic, the world came to a standstill. Businesses could not function properly. Many had to close their doors temporarily and some even had to call it quits forever. The global economy took a hit as a result and the currency exchange rate decreased worldwide.

An Introduction to Foreign Exchange Rates

So what happens if I go out of Britain to a different country? Will the Great Britain Pound be of no value there?

No, that would be silly. Instead, you can exchange one currency for another one. However, if you exchange a pound for money that belongs to another country, then the value of your money will not be the same as it was in pounds. You exchange the pound for the local currency. If you exchange 1 pound you will get the equivalent in the local currency.

Here is an example that will help you understand the concept of the exchange rate. Let us say that you are going to Japan to visit your friend. You will need some money to buy food and shop there. But you cannot use the British pound to purchase food, pay for hotels or shopping. So you need to transfer some money to your Japanese friend converted to Japanese yen. When you convert your cash into yen, you will see that 1 pound is equal to roughly 140 yen. 

It does not mean that you have a lot of money to spend in japan because of the exchange rate. The price of things in japan is relative to its currency. IPhone 11 will cost £729. On the other hand, in Japan, the iPhone 11 will cost 40,000 yen to 70,000 yen depending on the storage capacity.

Fascinating is it not! But remember, when you exchange Japanese yen for pounds, you will get back the same amount of pounds. There are different cross border payment services that you can avail when necessary. 

Who Decides The Exchange Rate?

In some countries, their government fixes the value of the currency and changes the rate when they feel it is necessary. But the currencies of most countries are traded just like stocks in a market called the foreign exchange market.

The exchange rate is decided by various economic factors like how fast the country is growing, how stable they are and the interest rate in each country.

What Currency Is Used By People From Two Different Countries Who Do Business With Each Other?

Two parties doing business would either pay in the currency of one of the two countries. Or they might be using US dollars or Euro as they are very widely accepted currencies.

Crazy Foreign Currency

The Mexican peso is less than the Canadian dollar, but they have some rough value to each other. But why are the Iranian rial and Indonesian rupee worth so little compared to the British pound?

There are three explanations to this phenomenon. 

  • One is that many countries have gone through inflation in their past like Indonesia.
  • Another explanation is that some currencies do not have a unit for a hundred of something. For instance, the yen does not have a unit to find a hundred yen. Instead, you keep counting yen off that point. On the other hand, the Great British pound subdivision of units.

Most people think that if they go to Japan, they are rich if they take a few thousand pounds. But that is not true as prices adjust and it does not matter to the market what currencies are worth. You will see a few pounds buy a lot whereas it requires thousands of units in another currency.

  • The values of currencies change over time and they are worth different amounts because they have no reason to be linked together. There was no universal point where we all agreed to one unit of money across the world with the same value. 

Nations have started at different points and have gone through movements like inflation, deflation, increase and decrease of demand for currencies etc. people got used to their local changes. So honestly it would be stranger if the world has a universal currency. It is like asking for a universal language that every country or even isolated tribes understand.

 Final Thoughts

The world of foreign currency may seem daunting, but you are not alone. SkylineFx is the cheapest money transfer company that provides foreign exchange services for businesses and individuals.

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