The exchange of different currencies is called foreign exchange. It has various effects on our daily lives. Forex is a familiar part of our lives.
An explanation of the Foreign Exchange Rate
Countries around the world usually have their own currencies. When you buy things, you can:
- Pay in your own currency
- Pay in the currency of the other country
- Pay in widely used international currencies (dollars and euros)
If you pay in the currency of the other country or in dollars or euros, you must procure that currency. The exchange (buying and selling) between these currencies is foreign exchange. And what is needed for that is the exchange rate of each other’s currencies. If you don’t know the value of your own currency and the currency of the other country, you are unable to trade because you don’t know how much to pay.
In other words, foreign exchange means the “buying and selling (exchange) different currencies”, and the exchange rate at the time is called the “foreign exchange rate”.
The exchange of two different currencies
The currency of Canada is the “Canadian dollar”. If you have the Canadian dollar, you will not have any issues shopping in Canada.
However, if you want to go to the United States and shop, you cannot use the Canadian dollar at stores because the currency of the United States is the “US dollar”. In order to buy from shops in the United States, you need to exchange the “Canadian dollar” for “US dollars”. This is the exchange of two currencies via the foreign exchange.
Foreign exchange trading
People who want to buy or sell currencies between financial institutions such as banks contact each other via telephone or the Internet and trade (exchange). This is called the interbank market (interbank market). This interbank market is commonly refer to as the foreign exchange market. Moreover, when we exchange currencies through financial institutions participating in this interbank market, the currency exchange is called foreign exchange trading (FOREX).
In addition, transactions between consumers, companies and financial institutions participating in the interbank market are collectively referred to as the customer market.
Trading occurs 24 hours a day around the world, and the exchange rate constantly changes all the time.
In the foreign exchange market, trades occur 24 hours a day, participants from various markets buy and sell currencies for their own purposes. Now, let us explain how the buying and selling of such currencies affects and how it affects the exchange rate and the mechanism of its fluctuation.
The exchange rate is ultimately determined by the balance of demand (the amount you want to buy) and supply (the amount you want to sell).
The foreign exchange (FOREX) market
To exchange these currencies, you can exchange them on the “forex market” (the place where you “buy and sell” currency exchanges).
Speaking of the market, you may think that there is a physical building called an exchange. However, there is no physical exchange. Market participants who were connected to each other through telephones in the past, are now connected through computers, and currencies are bought and sold while checking the trading conditions of each currency displayed on the screen.
If a Canadian company imports a product from the United States, you will need to convert the Canadian dollar to US dollars in order to pay in US dollars. Therefore, the transaction of “selling the Canadian dollar and buying the US dollar” is carried out, which causes the Canadian dollar to weaken and the US dollar to strengthen. If the value of exports greatly exceeds the value of imports for an extended period of time, the demand for the currency of the country will increase, and the currency will tend to rise.
Foreign exchange is accompanied by “currency exchange”
On the other hand, foreign exchange trading is conducted between different currencies across national borders. Many international transactions, such as the import/export of goods, investment in foreign securities, overseas real estate, and overseas expansion of companies, use foreign exchange to receive and pay money. When making a transaction, you must first decide on the settlement currency (in which currency you will receive or pay money), and if it is not your home currency, you must exchange the currency.
The market for exchanging currencies is called the “foreign exchange market” and the currency exchange ratio is called the “exchange rate (foreign exchange rate)”. For example, if you want to buy US dollars in Canadian dollar, and the exchange rate is 1.30 Canadian dollars per US dollar, it means that you can buy 1 US dollar for 1.30 Canadian dollars.
In fact, “foreign exchange has various effects on our daily lives”
Many people believe that the foreign exchange does not impact their daily lives, however, this is not actually true e.g. gasoline prices. Energy such as gasoline relies on imports from overseas. When importing, the price will be denominated in US dollars, but the actual payment will be made in Canadian dollar or US dollars, causing fluctuations in the exchange rate. Needless to say, if the Canadian dollar depreciates, the price will rise, and if the Canadian dollar strengthens, the price will fall. Canada also imports a lot of food, as evidenced by a food self-sufficiency rate below 40%. Therefore, any exchange rate movements can greatly affect domestic food prices.