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Currency exchange is the trading of one currency against another. Professionals refer to this as foreign exchange, but may also use the acronyms Forex or FX.
Currency exchange is needed in many circumstances. Consumers usually come into contact with currency exchange once they travel. They go to a bank or currency exchange bureau to convert their "home currency into , the currency of the country they intend to travel to.
They might also buy goods in a foreign country or via the internet with their credit card, in which case they will find that the amount they paid in the foreign currency will have been converted to their home currency on their credit card statement.
Even though each such currency exchange is a fairly small transaction, the aggregate of all such transactions is significant. Businesses typically have to convert currencies once they conduct business outside their home country. They exporting goods to another country and receive payment in the currency of that foreign country, then the payment should frequently be converted back to the home currency.
Similarly, if they need to import goods or services, then businesses will often need to pay in a foreign currency, needing them to first convert their home currency into the foreign currency. Big companies convert large amounts of currency every year. The timing of when they convert can have a big effect on their balance sheet and bottom line. Investors and speculators require currency exchange every time they trade in any foreign investment, be that equities, bonds, bank deposits, or real estate.
Investors and speculators also trade currencies directly to be able to benefit from movements in the currency exchange markets. Commercial and Investment Banks trade currencies as a service for their commercial banking, deposit and lending customers. These institutions also usually participate in the currency market for hedging and proprietary trading purposes.
Governments and central banks trade currencies to improve trading conditions or to intervene in an attempt to adjust economic or financial imbalances. Even though they do not trade for speculative reasons --- they are a non-profit organization --- they often have a tendency to be lucrative, since they usually trade on a long-term basis.
Currency exchange rates are determined by the currency exchange market. A currency exchange rate is usually given as a pair consisting of a bid price and an ask price. The ask price applies when purchasing a currency pair and represents what has to be paid in the quote currency to obtain one unit of the base currency. The bid price applies when selling and represents what will be obtained in the quote currency when selling one unit of the base currency. The bid price is always less than the ask price.
Purchasing the currency pair implies buying the first, base currency and selling (short) an equivalent amount of the second, quote currency (to pay for the base currency). (It is not required for the trader to own the quote currency before selling, because it is sold short.)
A speculator buys a currency pair, if she believes the base currency will go up relative to the quote currency, or equivalently that the corresponding exchange rate will increase. Selling the currency pair implies selling the first, base currency (short), and buying the second, quote currency.
A speculator sells a currency pair, if she believes the base currency will go down relative to the quote currency, or equivalently, that the quote currency will increase relative to the base currency. After purchasing a currency pair, the trader will have an open position in the currency pair.
Following such a transaction, the value of the position will be close to zero, because the value of the base currency is pretty much equal to the value of the equivalent amount of the quote currency. In fact, the value will be somewhat negative, due to the spread involved.
For more information, get in touch with Currency Traders at www.mynetto.com
Article Source: FxTradingStock.com
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by: Bobby Lee
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Date: Sun, 13 Feb 2011
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