The concept of foreign exchange rates has been in existence for over a century. Essential in the study of foreign exchange computation is the understanding of the meaning of specific terminologies. These technical terms are useful in the analysis of foreign exchange transactions.
What is Foreign Exchange Rates
The foreign exchange rate of a currency can be referred to as the rate at which a stated value of a nation’s currency can be exchanged against another convertible currency(ies).
It can also be defined as an economic activity that involves how wealth expressed in one country’s currency are exchanged in terms of another country’s currency at a particular rate and time.
Types of Exchange Rates
Currency Rate: This rate relates to the one in which the variable amount of foreign currency is quoted in terms of a fixed unit of local currency. For instance, N1 = 0.0026USD. From the example above, the local currency is fixed, while the foreign currency fluctuates.
Pence Rate: This rate refers to the rate in which the variable amount of local currency is quoted in terms of a fixed unit of foreign currency. For instance, $1 = N367
When you compare this to the currency rate, the foreign currency is fixed while the local currency fluctuates steadily.
Cross Rates: this can be referred to as rates which enable foreign exchange dealers to purchase the currency of a third country that is not directly convertible to the dealer’s currency. It is an exchange rate of two different country’s currency expressed in a third different country’s currency. The third currency is usually a common currency like the US dollar
Spot rate: spot rate is the price quoted for instant settlement on security or currency. It is quoted immediately for delivery of the currency to the buyer at least within two working days. It is the ruling rate on a particular day.
Who Are The Major Players In The Foreign Exchange Market
The major players of the foreign exchange market are categorized into the groups mentioned below, and they are;
- Central Banks
- Commercial, Merchant and Investment Banks
- Foreign Exchange Brokers
- Hedge Funds
- High Net-Worth Individuals
- Major Companies and Multinational Corporations
- Bureau De Change: Black Market Dealers
Need For Foreign Exchange
The following reasons usually instigate foreign exchange demands:
Trading: in an economy like Nigeria, where the nation relies heavily on imports, the trade must settle business transactions with foreign currency. This will trigger the need to buy foreign exchange through any of the authorized dealers.
Investments Abroad: In a situation where an investor discovers that the return on investment is more in a foreign country than is available in his local environment. He will demand foreign exchange to enable him to trade his money in the forex market.
Speculation and Hedging: Speculations can trigger the demand for foreign exchange. This is based on the anticipated movement in the exchange rate or devaluation of a particular currency.
Personal Uses: People purchase foreign exchange for personal use such as traveller’s cheque, subscriptions, or settlement of fees for a school abroad.
Several factors affect the supply and demand for foreign exchange. They include but not limited to, the following:
- Inflation Rate and Price Level
- Interest rates in other countries
- Confidence and speculations
- Balance of Payment – The difference between the country’s earnings from exports and expenses from imports
- Exchange Control Regulations
- Foreign investments
- Central Bank Intervention