Lac Hong University Đỗ Thị Lan Đài Foreign Exchange Market Trade across national boundaries is complicated by the fact that nations generally use different currencies to buy and sell goods in their respective markets The British use pounds, the Japanese yen, the Mexicans pesos and so on Therefore, when a good or service is purchased from a seller in another country, it is generally necessary for someone to convert one currency to another This adds to the complexity of international exchange This complication could be avoided if the trading partners were to uses a common currency This is precisely what 12 European nations have decided to These countries have adopted a common currency—the euro—that is now uses to conduct trade throughout entire region Most exchanges across national boundaries, however, still involve currency conversion If you travel in Europe, Asia, or South America, you will have to convert your dollars to another currency in order to purchase items This chapter will focus on the foreign exchange market The foreign exchange market trades currencies It lets banks and other institutions easily buy and sell currencies The purpose of the foreign exchange market is to help international trade and investment A foreign exchange market helps businesses convert one currency to another For example, it permits a U.S business to import European goods and pay Euros, even though the business's income is in U.S dollars Presently, the foreign exchange market is one of the largest and most liquid financial markets in the world Traders include large banks, central banks, currency speculators, English in Foreign Trade Lac Hong University Đỗ Thị Lan Đài corporations, governments, and other financial institutions The average daily volume in the global foreign exchange and related markets is continuously growing Daily turnover was reported to be over US$3.2 trillion in April 2007 by the Bank for International Settlements Since then, the market has continued to grow According to Euro-money's annual FX Poll, volumes grew a further 41% between 2007 and 2008 The exchange rate (also known as the foreign-exchange rate or FX rate) is one of the most important prices because it enables consumers in one country to translate the prices of foreign goods into units of their own currency Specifically, the dollar price of a foreign good is determined by multiplying the foreign product price by the exchange rate (the dollar price per unit of the foreign currency) For example, if it takes $1.50 to obtain pound, then the British shoes priced at 30 pounds would cost $45 (30 times the $1.50 price of the pound) An appreciation in the value of a nation’s currency means that fewer units of the currency are now required to purchase one unit of a foreign currency For example, in 2000, only 92.3 cents were required to purchase a European euro, down from 106.5 in 1999 As the result of this appreciation in the value of the dollar relative to the euro, goods purchased from countries in euro zone became less expensive to Americans An appreciation increases the purchasing power of domestic currency for foreign goods When a depreciation occurs, it will take more units of the domestic currency to purchase a unit of foreign currency A depreciation reduces the purchasing power of the domestic currency for foreign goods English in Foreign Trade Lac Hong University Đỗ Thị Lan Đài The exchange rate regime is the way a country manages its currency in respect to foreign currencies and the foreign exchange market It is closely related to monetary policy and the two are generally dependent on many of the same factors The basic types are a floating exchange rate, where the market dictates the movements of the exchange rate, a pegged float, where the central bank keeps the rate from deviating too far from a target band or value, and the fixed exchange rate, which ties the currency to another currency, mostly more widespread currencies such as the U.S dollar or the euro Floating rates are the most common exchange rate regime today For example, the dollar, euro, yen, and British pound all float However, since central banks frequently intervene to avoid excessive appreciation or depreciation, these regimes are often called managed float or a dirty float Just as countries calculate their gross domestic product (GDP) so that they have a general idea of their domestic level of production, most countries also calculate their balance of international payments in order to keep track of transactions across national boundaries The balance of payments (or BOP) summarizes all international economic transactions between a country and all other countries for a specific time period, usually a year It reflects all payments and liabilities to foreigners (debits) and all payments and obligations received from foreigners (credits) Balance of payments is one of the major indicators of a country's status in international trade, with net capital outflow The balance of payments comprises the current account, the capital account, and the official reserve account English in Foreign Trade Lac Hong University Đỗ Thị Lan Đài The current account is the sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid) The capital account records all transactions between a domestic and foreign resident that involves a change of ownership of an asset It is the net result of public and private international investment flowing in and out of a country This includes foreign direct investment, portfolio investment (such as changes in holdings of stocks and bonds) and other investments (such as changes in holdings in loans, bank accounts, and currencies) The current exchange rate regime is not a pure flexible rate system Governments sometimes seek to modify the foreign exchange values of their currency by engaging in official reserve transactions A substantial appreciation of a currency will make it more difficult for a nation’s export industries to compete in world markets In an effort to improve the competitiveness of export industries, governments will sometimes respond to an appreciation by purchasing foreign currency reserves (and selling the domestic currency) in the foreign exchange market Conversely, if a nation’s currency is depreciating rapidly, the government may seek to halt the depreciation by using some of its foreign currency reserves to purchase the domestic currency in the foreign exchange market English in Foreign Trade ... foreign goods English in Foreign Trade Lac Hong University Đỗ Thị Lan Đài The exchange rate regime is the way a country manages its currency in respect to foreign currencies and the foreign exchange. .. goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid) The capital account records all transactions between a domestic and foreign. .. country and all other countries for a specific time period, usually a year It reflects all payments and liabilities to foreigners (debits) and all payments and obligations received from foreigners