Currencies float against each other to measure their worth in the global marketplace.
A currency’s value in the world marketplace reflects whether individuals and governments are interested in using it to make purchases or investments, or in holding it as a source of long-term security. If demand is high, its value increases in relation to the value of other currencies. If it’s low, the reverse occurs.
Some currencies are relatively stable, reflecting an underlying financial and political stability. Other currencies experience wild or rapid changes in value, the sign of economic turmoil resulting from runaway inflation, deflation, defaults on loan agreements, serious balance-of-trade deficits, or policies that seem unlikely to resolve the problems.
Similarly, certain currencies are used widely in international trade while others are not. That’s the result of the relative stability of the currencies and the volume of goods and services a country or economic union produces.
How Trading Works
Most currency transactions are conducted online, though some occur over the telephone. Transactions are registered in an electronic trading or dealing system.
Make a market
If a bank wants to buy a particular currency, a trader seeks a quote from a bank that is a market maker for that currency. That means the bank specializes in handling it.
Get a bid
The bank responds with the price that it would bid to buy and the price at which it would sell since it doesn’t know if the trader wants to buy or sell.
Agree to terms
If the trader wants the deal, he or she accepts. The bank that quoted a price confirms the details — what’s being bought or sold and the price — and the trader verifies the terms.
The trader who initiated the transaction enters the information in the dealing system and gets a confirmation.
The trade details are also entered in the bank’s in-house system, and confirmed with the responding bank at the end of the day, either by phone or online.
Payment is sent electronically to a corresponding currency bank. For example, a New York bank would send payment in yen to its Tokyo branch, or to a designated Japanese bank if it didn’t have a branch there.
Nothing is fixed
Currency values of even the most stable economies change over time as traders are willing to pay more — or less — for dollars or pounds or euros or yen. For example, great demand for a nation’s products means great demand for the currency needed to pay for those products.
If there’s a big demand for the stocks or bonds of a particular country, its currency is likely to rise in value as overseas investors buy it to make investments. Similarly, a low inflation rate can boost a currency’s value, since investors believe that the value of long-term purchases in that country won’t erode over time.
Governments generally try to keep their currencies stable, maintaining constant relative worth with the currencies of their major trading partners. One way to control the value of currency is by adjusting the money supply, making more money available to stimulate the economy or withdrawing money to keep inflation under control.
Another way to control currency values is by adjusting interest rates. When rates are high, international investors are more likely to buy fixed income investments in that currency. When rates are low, demand for those investments falls, often along with its exchange value.
Sometimes governments deliberately devalue their currency, bringing the exchange rate lower relative to other countries. One reason is that this makes the country’s exports relatively cheap, giving it a trade advantage.
Large-scale currency trading in the global foreign exchange market, or forex, is handled on telecommunications networks controlled by banks or other financial institutions.
In spot trading, the deal is settled, or finalized, within two days at current rates. Forward contracts involve setting an exchange rate that will apply when the currency is traded on a set date in the future. Currency swaps involve exchanging one cash flow for another, such as a stream of income in one currency in exchange for a stream of income in another currency at a preset exchange rate.
Understanding Foreign Currency Trading And Value by Inna Rosputnia
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