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Foreign Exchange (Forex) Definition
Measure content performance. Develop and improve products. List of Partners vendors. Foreign Exchange forex or FX is the trading of one currency for another. For example, one can swap the U. Foreign exchange transactions can take place on the foreign exchange market, also known as the forex market. The forex market is the largest, most liquid market in the world, with trillions of dollars changing hands every day. Rather, the forex market is an electronic network of banks, brokers, institutions, and individual traders mostly trading through brokers or banks.
The market determines the value, also known as an exchange rate , of the majority of currencies.
Exchange Rate Regimes
Foreign exchange can be as simple as changing one currency for another at a local bank. It can also involve trading currency on the foreign exchange market. For example, a trader is betting a central bank will ease or tighten monetary policy and that one currency will strengthen versus the other. These represent the U. There will also be a price associated with each pair, such as 1. If the price increases to 1.
In the forex market currencies trade in lots , called micro, mini, and standard lots. A micro lot is 1, worth of a given currency, a mini lot is 10,, and a standard lot is , When trading in the electronic forex market, trades take place in set blocks of currency, but you can trade as many blocks as you like. For example, you can trade seven micro lots 7, or three mini lots 30, or 75 standard lots 7,, , for example.
The foreign exchange market is unique for several reasons, mainly because of its size. Trading volume in the forex market is generally very large. The market is open 24 hours a day, five days a week across major financial centers across the globe. This means that you can buy or sell currencies at any time during the day.
The foreign exchange market isn't exactly a one-stop shop. There are a whole variety of different avenues that an investor can go through in order to execute forex trades. You can go through different dealers or through different financial centers which use a host of electronic networks. From a historical standpoint, foreign exchange was once a concept for governments, large companies, and hedge funds.
But in today's world, trading currencies is as easy as a click of a mouse—accessibility is not an issue, which means anyone can do it. In fact, many investment companies offer the chance for individuals to open accounts and to trade currencies however and whenever they choose. When you're making trades in the forex market, you're basically buying or selling the currency of a particular country. But there's no physical exchange of money from one hand to another.
That's contrary to what happens at a foreign exchange kiosk—think of a tourist visiting Times Square in New York City from Japan. He may be converting his physical yen to actual U. But in the world of electronic markets, traders are usually taking a position in a specific currency, with the hope that there will be some upward movement and strength in the currency that they're buying or weakness if they're selling so they can make a profit. The buying rate is the rate at which money dealers will buy foreign currency, and the selling rate is the rate at which they will sell that currency.
The quoted rates will incorporate an allowance for a dealer's margin or profit in trading, or else the margin may be recovered in the form of a commission or in some other way.
Different rates may also be quoted for cash, a documentary transaction or for electronic transfers. The higher rate on documentary transactions has been justified as compensating for the additional time and cost of clearing the document. On the other hand, cash is available for resale immediately, but incurs security, storage, and transportation costs, and the cost of tying up capital in a stock of banknotes bills.
Currency for international travel and cross-border payments is predominantly purchased from banks, foreign exchange brokerages and various forms of bureaux de change. Retail customers will be charged, in the form of commission or otherwise, to cover the provider's costs and generate a profit. One form of charge is the use of an exchange rate that is less favourable than the wholesale spot rate. There is a market convention that rules the notation used to communicate the fixed and variable currencies in a quotation. Cyprus and Malta, which were quoted as the base [ clarification needed ] to the USD and others, were recently removed from this list when they joined the Eurozone.
In order to determine which is the fixed currency when neither currency is on the above list i.
Exchange Rates and their Measurement
This reduces rounding issues and the need to use excessive numbers of decimal places. There are some exceptions to this rule: for example, the Japanese often quote their currency as the base to other currencies. Quotation using a country's home currency as the price currency is known as direct quotation or price quotation from that country's perspective [ clarification needed ] For example, EUR 0. Using direct quotation, if the home currency is strengthening that is, appreciating , or becoming more valuable then the exchange rate number decreases.
Conversely, if the foreign currency is strengthening and the home currency is depreciating , the exchange rate number increases. Market convention from the early s to was that most currency pairs were quoted to four decimal places for spot transactions and up to six decimal places for forward outrights or swaps.
The fourth decimal place is usually referred to as a " pip ". An exception to this was exchange rates with a value of less than 1.
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Although there is no fixed rule, exchange rates numerically greater than around 20 were usually quoted to three decimal places and exchange rates greater than 80 were quoted to two decimal places. Currencies over were usually quoted with no decimal places for example, the former Turkish Lira.
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In other words, quotes are given with five digits. Where rates are below 1, quotes frequently include five decimal places. In , Barclays Capital broke with convention by quoting spot exchange rates with five or six decimal places on their electronic dealing platform. A number of other banks have now followed this system. Countries are free to choose which type of exchange rate regime they will apply to their currency. The main types of exchange rate regimes are: free-floating, pegged fixed , or a hybrid.
Exchange rate
In free-floating regimes, exchange rates are allowed to vary against each other according to the market forces of supply and demand. Exchange rates for such currencies are likely to change almost constantly as quoted on financial markets , mainly by banks , around the world. A movable or adjustable peg system is a system of fixed exchange rates , but with a provision for the revaluation usually devaluation of a currency. China was not the only country to do this; from the end of World War II until , Western European countries all maintained fixed exchange rates with the US dollar based on the Bretton Woods system.
Nixon in a speech on August 15, , in what is known as the Nixon Shock. Still, some governments strive to keep their currency within a narrow range. As a result, currencies become over-valued or under-valued, leading to excessive trade deficits or surpluses. Research on target zones has mainly concentrated on the benefit of stability of exchange rates for industrial countries, but some studies have argued that volatile bilateral exchange rates between industrial countries are in part responsible for financial crisis in emerging markets.
According to this view the ability of emerging market economies to compete is weakened because many of the currencies are tied to the US dollar in various fashions either implicitly or explicitly, so fluctuations such as the appreciation of the US dollar to the yen or deutsche Mark have contributed to destabilizing shocks.
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Most of these countries are net debtors whose debt is denominated in one of the G3 currencies. In September Argentina restricted the ability to buy US dollars. Mauricio Macri in campaigned on a promise to lift restrictions put in place by the left-wing government including the capital controls which have been used in Argentina to manage economic instability. When inflation rose above 20 percent transactions denominated in dollars became commonplace as Argentinians moved away from using the peso.
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The controls were rolled back after Macri took office and Argentina issued dollar denominated bonds , but when various factors led to a loss in the value of the peso relative to the dollar leading to the restoration of capital controls to prevent additional depreciation amidst peso selloffs.