Foreign Exchange Markets Summary Essay

1855 words - 7 pages

Foreign Exchange Market PAGE 1
Running Header: FOREIGN EXCHANGE MARKETForeign Exchange Markets SummaryW2 AssignmentAxia College of University of PhoenixInstructor: Brian ButlerFebruary 3, 2008Foreign Exchange Markets SummaryIn view of the fact that the international business environment is not set up with a worldwide medium for exchange, the foreign exchange market is a necessity for international trade. The major functions of the foreign exchange market are to transfer purchasing power, allocate open trade for international markets, monitor exchange rates from fluctuating to rigorously, and to aid in the import and export of goods between countries by providing credit for financing international trade.The foreign exchange market can be described as a market where the value of currency is converted from one country to another. Currency can be bought, sold or traded through the foreign exchange market at a profit or loss depending on current exchange rates. The foreign exchange market is worldwide. All currency exchanged is done through business transactions over the phone, by fax or electronic distribution networks via the internet; thus, every transaction is considered as over-the-counter.Exchange rates can be described as the amount of units of one country's currency that can be exchanged for a set amount of units of another country's currency. Therefore, the value of one currency is always determined in relation to another currency. For instance, the value one U.S. dollar ($) in terms of one China renminbi (RNB) in terms of renminbi's would be RNB/$ exchange rate. Hence, if $1 = 5 RNB, to find the value of one RNB in terms of dollars, one would divide both sides by 5 to find the exchange rate. Therefore, one RNB = 1/5 = $0.2 whereas one $ would = 5/1 = 5RNB. This equation is used in determining the value of all currency in the foreign exchange market and it is particularly useful when dealing with unfamiliar currencies (Suranovic, S. M., 2005).Exchange rates are usually broken down into three main groups: (1) spot rates, (2) forward rates and (3) differential rates. According to Abrhein, D. (2007) each of these categories can be defined as:Spot Rates: rates quoted for immediate currency exchange (usually on-the-spot or within two days)".Forward Rates: rate quoted for currency to be sold or purchased today and delivered at a specified future date (usually within one year, but after the period for the spot rate).Differential Rates: "may be either preferential or penalty rates which are limited to special markets or customers".Though exchange rates may not totally protect any one country form the social risks of inflation, it does allow all countries to transfer purchasing power among each other to control the exposure of such risks. The advantage of spot rates is that the purchaser locks in the price of currency exchange for the current rate whereby if the rate drops the purchaser will not lose money. The advantage of forward rates is that the...

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