The foreign exchange market is
one of the most important financial markets. The $3.98
Trillion (April 2010)-per-day foreign exchange (FX) market surpasses stocks and
bonds as the largest market in the world. Foreign exchange markets are critical
for setting exchange rates between countries. It affects the relative
price of goods between countries and so can affect trade. It means that it
affects the price of imports and so affects a country’s price level (inflation
rate). It also affects the international investment and financing decision. In this
project, we will try to find why exchange rate would give many risks to a
company and how a company can hedge itself.
Foreign exchange is a commodity
that consists of currencies issued by countries other than one’s own. Like the
prices of other commodities, the price of foreign exchange i.e. exchange rate
between domestic currency foreign currency is set by demand and supply in the
market place. As for example, the demand for Japanese yen is derived from
foreigners demand for Japanese yen.
In simplest language, foreign
exchange is the system of exchanging the money of one currency for that of
another country.
Foreign exchange market is a
market for converting the currency of one country into that of another country.
The foreign exchange market has two major: Over the counter market (O.T.C) and
the exchange-traded market. The OTC market is composed of banks, both
commercial banks and other financial institutions, and it is where the most of
the foreign exchange activity takes place. The exchange-traded market is
composed of securities exchanges, (such as Chicago Mercentile Exchages,
Philadelphia Stock Exchange) where certain types foreign exchange instruments
such as exchange-traded futures, and options are traded.
The
primary purpose of the foreign exchange is to assist international trade and
investment, by allowing businesses to convert one currency to another currency.
For example, it permits a US business to import British goods and pay Pound
Sterling, even though the business's income is in US dollars.
It also supports speculation, and facilitates the carry trade,
in which investors borrow low-yielding currencies and lend (invest in)
high-yielding currencies, and which (it has been claimed) may lead to loss of
competitiveness in some countries.
In a
typical foreign exchange transaction, a party purchases a quantity of one
currency by paying a quantity of another currency. The modern foreign exchange
market began forming during the 1970s when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system.
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