What happens in the foreign exchange market can have a fundamental impact on the sales, profits, and strategy of an enterprise. Accordingly, it is very important for managers to understand the working of the foreign exchange market and the impact of changes in currency exchange rates for their enterprise. The foreign exchange market is a market for converting the currency of one country into that of another country. An exchange rate is simply the rate at which one currency is converted into another.
The Functions of the Foreign Exchange Market.
The foreign exchange market serves two main functions. .
The first is to convert the currency of one country into the currency of another. .
The second is to provide some insurance against foreign exchange risk, by which we mean the adverse consequences of unpredictable changes in exchange rates.
CURRENCY CONVERSION.
Each country has a currency in which the prices of goods and services are quoted. International businesses use foreign exchange markets in four main ways.
First, the payments a company receives for its exports, the income it receives from foreign investments, or the income it receives from licensing agreements with foreign firms may be in foreign currencies. To use those funds in its home country, the company must convert them to its home country's currency.
Secondly, international businesses use foreign exchange markets when they must pay a foreign company for its products or services in its country's currency. The foreign exchange market enables companies based in countries that use different currencies to trade with each other.
Third, international businesses also use foreign exchange markets when they have spare cash that they wish to invest for short terms in money markets.
4th is Currency speculation which typically involves the short-term movement of funds from one currency to another in the hopes of profiting from shifts in exchange rates.
