What is Foreign Exchange? – Foreign Tutorials

What is Foreign Exchange?

Foreign exchange is the conversion of one currency into another. It is an integral part of the world financial system. Without foreign exchange, many aspects of our daily life which we take for granted would not exist.

The market is the market in which currencies of different countries are traded. It is here that buyers and sellers trade in different currencies in the same way goods and services are sold. It is here in the market that the exchange rate is determined.

It is traded at the retail level in many banks and firms specializing in that business. Organized markets in New York, Tokyo, London, Zurich, Dubai, Singapore etc, trade hundreds of billions of US dollars worth of currencies each day.

It is a global decentralized or over-the-counter market for the trading of currencies. This market determines foreign exchange rates for every currency. It includes all aspects of buying, selling and exchanging currencies at current or determined prices.

The main participants in this market are the larger international banks. Financial centers around the world function as anchors of trading between a wide range of multiple types of buyers and sellers around the clock, with the exception of weekends. Since currencies are always traded in pairs, the foreign exchange market does not set a currency’s absolute value but rather determines its relative value by setting the market price of one currency if paid for with another. Ex: US$1 is worth X CAD, or CHF, or JPY, etc..

Practice Questions

1. What is a spot exchange rate?
a. The exchange rate agreed upon for a future date
b. The exchange rate at which a currency can be immediately bought or sold
c. The exchange rate used for interbank transactions
d. None of the above

2. What is a forward exchange rate?
a. The exchange rate agreed upon for a future date
b. The exchange rate at which a currency can be immediately bought or sold
c. The exchange rate used for interbank transactions
d. None of the above

3. What is a currency option?
a. A contract that gives the buyer the right, but not the obligation, to buy or sell a currency at a predetermined exchange rate
b. A contract to buy or sell a currency at the prevailing spot rate
c. A contract to buy or sell a currency at the prevailing forward rate
d. None of the above

Answers:

b. The exchange rate at which a currency can be immediately bought or sold
a. The exchange rate agreed upon for a future date
a. A contract that gives the buyer the right, but not the obligation, to buy or sell a currency at a predetermined exchange rate