Foreign exchange is the conversion of a foreign currency from a particular country to the currency of another country. Read more about foreign exchange below!

Foreign Exchange Is

Foreign Exchange is a conversion of one country's currency to another country's currency at a certain level known as an exchange rate of foreign exchange. A country's currency is measured according to the law of supply and demand. Therefore, the value of a currency can be a benchmark for another country's currency, for example the US dollar. The value of a country's currency can also be determined by the government of that country.
 
However, there are many countries that float their currencies freely against other countries' currencies, which makes them continue to fluctuate. FX transactions must have elements of two currencies, namely one currency to be purchased and another currency to be sold. When combined, the two are generally referred to as a currency pair. For example, if an FX player wants to make a USD transaction against IDR, then the currency pair is USD/IDR with USD as the reference currency and IDR as the counter currency.

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The definition of the foreign exchange market is

The foreign exchange market is a market where foreign exchange rates, such as the yen, euro or pound, are traded for local currencies, such as the US dollar. This “market” is not centralized, but rather a decentralized network that remains highly integrated through modern information and telecommunications technology. The foreign exchange market (forex, FX, or currency market) is a decentralized or over-the-counter (OTC) global market for trading currencies.
 
This market determines the exchange rate for each currency. It covers all aspects of buying, selling, and exchanging currencies at current or predetermined prices. In terms of trading volume, it is by far the largest market in the world, followed by the credit market. The main participants in this market are the larger international banks (BIs). Financial centers around the world act as anchors for trading between different types of buyers and sellers around the clock, with weekend exceptions. Because exchange rates are always traded in pairs, the forex market does not determine the absolute value of currencies but rather determines their relative value by determining the market value of one exchange rate when paid for with another exchange rate. Example: 1 USD is worth X CHF, or JYP or CAD, etc.

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Functions of the Foreign Exchange Market

The various functions of the Foreign Exchange Market are as follows:
  • Transfer Function: is the most basic and obvious function of the foreign exchange market, which is to transfer funds or foreign currencies from one country to another to complete their transactions. The market essentially changes one currency to another.
  • Credit Function: FOREX provides short-term credit to importers to facilitate the flow of goods and services from various countries. Importers can use their own credit to finance overseas purchases.
  • Hedging Function: Another or third function of the foreign exchange market is to protect the value of foreign exchange risk. Parts in foreign exchange are often afraid of fluctuations in exchange rates, which means the price of one currency in relation to another currency. This can lead to losses or profits for the parties involved.

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Types of Forex Transactions

Forex traders transact in one of three different markets: the spot, forward, or futures market.

Forex Spot Market

The spot market is the most straightforward Forex market. The spot rate is the current exchange rate. A spot market transaction is an agreement to trade one currency for another currency at the prevailing spot rate. Spot transactions for major currencies are settled within two business days or weekdays. The main exceptions are the US dollar and the Canadian dollar, which are settled on the next business day. Prices are determined on the market date, but money is exchanged on the value date.

The Role of the US Dollar

The US dollar is the most actively traded currency. The most common currency pairs are the USD and the Euro, the British pound, the Japanese yen and the Australian dollar. Trading pairs that do not involve the dollar are called crosses. Common crosses include the Euro and Pound and the Euro and Yen. The spot market can be very volatile. Short-term movements are dominated by technical trading, which bases trading decisions on the direction and speed of currency movements. Long-term changes in currency values ​​are driven by fundamental factors such as a country's interest rates and economic growth.

Forex Forward Market

A forward trade is any sale that is settled further in the future than the spot price. The forward price is a mix of the spot rate plus or minus forward points that compensate for the interest rate differential between the two currencies. Most forward sales have maturities of less than one year in the future but longer maturities are possible. As in the spot market, the price is fixed on the transaction date but the money is exchanged on the maturity date. Forward contracts are tailored to the requirements of the counterparties. They can be for any amount and settled on any date that is not a weekend or holiday in either country.

Forex Futures

Unlike other foreign exchange markets, forex futures are traded on established exchanges, most notably the Chicago Mercantile Exchange. Forex futures are derivative contracts in which a buyer and seller agree to a transaction at a specified date and price. This type of transaction is often used by companies that do much of their business overseas and therefore want to hedge against the brunt of currency fluctuations. It is also subject to speculative trading.

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