Foreign Exchange Market

Nowadays, exchange rates, the prices at which one country’s money is exchanged for another country’s money, are very familiar to every one. It is viewed as part of the “international experience”. However, importers, exporters, and international investors generally do not view the coexistence of many different currencies throughout the world as a positive experience. They are more likely to see the many different moneys as a complication that adds to the cost of international transactions. Evidence suggests that there would be more international trade and international investment if importers, exporters, and investors did not face the cost of having to exchange currencies every time they exchanged products or assets across borders.

Foreign exchange with international trade

Foreign exchange markets are one of the distinguishing characteristics of the global economy. It is difficult to avoid the foreign exchange markets when conducting international business. The existence of different national currencies effectively gives all products that are traded between countries many prices rather than just one. For every traded product, there is the price in the currency of the country where the product is produced, and then there are the prices in terms of other countries’ currencies. There are many reasons why prices differ from one country to another, but the main long-run determinant of the price differences are the exchange rates between the world’s many different currencies. Exchange rates are, therefore, very important for international trade because the attractiveness of buying foreign goods or selling domestic goods overseas depends on how exchange rates translate foreign currency prices into prices denominated in the domestic currency.

Foreign exchange with FDI

Exchange rates also impact international investment. Potential buyers of foreign assets must take into consideration both the current prices and expected future returns of foreign assets compared to...