Ever wondered how the foreign exchange market works? Today’s article is the first in a series about International business and the foreign exchange market
The foreign exchange market is a market where you can buy different currencies. The exchange rate is the rate at which one currency is converted into another.
Here is an example. I earn an income in South African Rand. At time of writing, the Rand/US Dollar exchange rate was R 14,53. So if I wanted to buy US Dollars with my Rands now, I would pay roughly R 14,53 for each Dollar. I had to add the word roughly in there, is because exchange rates change all the time, based on supply and demand. The financial institution that handles the transaction will also charge a fee. So when I buy Dollars, I will probably pay a bit more than the Rand/Dollar exchange rate suggested. When I sell sell my Dollars, I will probably get less than the exchange rate suggested. The Dollar/Rand exchange rate in my example would be 1/14.53 = 0.06882.
I mentioned above that exchange rates change all the time. Here is a little graph from the Moneyweb website to show what I mean.
The foreign exchange market is really important. International Trade would be very difficult if we still had to use the barter system. Offshore investments would also not be an option. We are better off today because we have these options.
There are some risks associated with the foreign exchange market. We cannot accurately predict the future exchange rates. Fortunately the Foreign exchange market also offers some insurance against foreign exchange risk
In my next article, I will talk a bit more about currency conversions and insurance against foreign exchange risk.
Hill Charles W L, International Business Competing in the global marketplace. Fifth Edition, Mc Graw Hill, 2005, Chapter 9