Purchase Foreign Currency - The Foreign Exchange Market
In order to purchase goods or services, or even to invest abroad, businesses and individuals must purchase first the foreign currency of the country that they are going to do business with at a specified exchange rate. In general, companies would prefer to be paid in their country’s currency or in United States dollars since it is widely accepted all over the world. Hence, international clients when paying their vendors should purchase a foreign currency to settle payments at specified exchange rates.
A sample scenario would be when Singaporeans would like to purchase barrels of oil from Saudi Arabia, they might be paying in U.S. dollars, through a purchase of that foreign currency which is in this case the U.S. dollar, and not in Singaporean dollars or Saudi Riyals. Take note that Singaporeans has to purchase the foreign currency to proceed in the transaction even if the United States was never involved in the process.
The Market
The actual purchase and selling of a foreign currency takes place in the foreign exchange market. The exchange rate is the price of a single currency against another.
A foreign exchange market, which allows a purchase of a foreign currency, is composed of a huge global network of traders, be it professional or just a plain individual. These traders who purchase a foreign currency are connected via the internet and there is no trading floor that you can usually see in exchanges like the New York Stock Exchange. Majority of the purchase of a foreign currency or foreign exchange transactions occur in the three countries namely, United States, Japan, and the United Kingdom. The remaining transactions in the market are contributed by Singapore, Switzerland, Hong Kong, Germany, France and Australia.
Trading Hours
The purchase and selling of a foreign currency through foreign exchange trading day starts at 8:00 AM which is when the London market opens and ends when the Singapore and Hong Kong market closes.
Participants
Participants who are very active in the foreign currency trading through the foreign exchange market are categorized in the following:
- Banks. Financial institutions and banks are the biggest participants in this market. These institutions purchase and sell foreign currency(ies) from each other which will also allow them to earn profits.
- Brokers. They are the “middle men” for the banks. People can call them to get for the best currency offer. The will also offer advices if individuals or companies would like to purchase a foreign currency. Brokers will charge a fee for commissions.
- Customers. Companies, individuals, travelers, businessmen belong to this category. These entities or individuals from time to time require a purchase of a foreign currency to perform specific transactions.
- Central banks. These government banks sometimes intervene to influence the value of a currency. The most popular intervention that is being done by central banks is the adjustment of the interest rates as well as the purchase of a foreign currency.
The above mentioned participants who actively purchase foreign currency in the foreign currency trading market take part in trading for the following aims:
- to earn profits taken from the fluctuating exchange rates
- to secure themselves from loss due to the fluctuating exchange rates
- to purchase a foreign currency in order to transact internationally
How Foreign Currency Exchange Rates are Determined?
To purchase a foreign currency, a trader must pay the exchange rate. There are several factors affecting the rates of currencies. Exchange rates are directly affected by the following but not limited to:
- Business Cycles
- Politics
- Payment Statistics
- Tax Laws
- Stock Market
- Inflation
- International Investment Patterns
- Government and central bank policies
- However, as with all other markets, the laws of supply and demand govern the prices of these currencies. If the demand of a specific currency is greater than that of the supply, then it is expected that the price of the said currency will rise. On the contrary, if there is abundance of supply in the currency, the price will consequently fall. If an increasing purchase of foreign currency is evident, then you can say that there is a higher demand for that currency.
Hence, the central bank, which is the nation’s monetary authority, is constantly monitoring the quantity of money supply in such that it should be at a level balanced enough that will still enable the government to achieve its economic goals. If the economic condition of a nation requires intervention from the central bank, this monetary authority will then decide whether to increase or decrease the supply of money in circulation. It is up to them whether they need to purchase or sell a specific foreign currency.
What are the Sources of Demand in Currency in the Forex Market?
- If a country’s economy is growing, if it has price stability as well as a variety of goods and services that are highly competitive in the world market, then the demand of its currency is high compared to a country that is at war and in turmoil. If a local investor feels that the economic condition of his country is worsening, then he would prefer to purchase a foreign currency from a nation which has a much stable economy.
- Foreigners and international investors will tend to invest to a nation’s financial instruments if it offers high profitability and low risks.
- Market speculations by forex traders according to the various national events that will move the currency such as:
1. Political instability of nation will cause the demand of its currency to lower down
2. A rise in interest rates set by the central banks will allow its currency to appreciate since international investors are attracted to its high returns
3. Nations that are developing and are undertaking excellent and effective economic reforms will also experience increase in value of its currency.
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