Foreign Exchange Market

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Foreign Exchange Markets

University of Phoenix

International Business


March 14, 2010

Foreign Exchange Markets

To detail the functions of the foreign exchange market (FOREX), one must first have an understanding of what a foreign currency exchange market is, what it does, why we need it, and the benefits FOREX has on monetary systems of all participating countries. A simple explanation given by Ball, McCulloch, Frantz, Geringer, and Minor (2006), says FOREX "is a place where monies can be bought, sold, or borrowed". FOREX locations are in various countries and cities, but the major locations are in London, New York, Tokyo, and Singapore (Ball et al., 2006).

In a universe with a single currency, there would be no foreign exchange market, no foreign exchange rates, and no foreign exchange. But in our world of mainly national currencies, the foreign exchange market plays the indispensable role of providing the essential machinery for making payments across borders, transferring funds and purchasing power from one currency to another, and determining that singularly important price, the exchange rate.

According to Cross (1998), the exchange rate is "a price determined by the number of units of one nation's currency that must be surrendered in order to acquire one unit of another nation's currency". Cross also says that the exchange rate between two currencies is dependent upon official or private participants to buy and sell its currency to maintain an authorized fixed rate. The exchange rates in FOREX are set then by the market and not by governments, which is referred to as the floating currency exchange rate (Ball et al., 2006). Other approaches to determining the exchange rate like the purchasing power parity (PPP) theory which states that exchange rates in the long run will adjust to equalize the purchasing power of differing currencies (Ball et al., 2006). Thus, products in competitive...