Currency Exchange Definition:
A currency exchange could be either a stand-alone business or part of a larger organization like a bank that permits customers to exchange one currency for another. The exchange rate quoted by the enterprise will be quite close to the spot rate. Profit is generated from the difference between the two values or through commission. The participants are capable of buying, selling, exchanging and speculating currency.
Also referred to as the foreign exchange market, it is the world’s biggest financial market, yet remains a highly unregulated business. The rate of exchange determines the value of one’s foreign investment. For instance, both volatile exchange rates and high, stable ones discourage such investments. In case of a low, stable rate, foreign investment is encouraged at the cost of low-valued currency’s economy.
Functions:
The foreign exchange market performs the following three functions:
Transfer Function: With the assistance of credit instruments like bills of foreign exchange, electronic transfer, and bank drafts, participating countries can transfer purchasing power.
Credit Function: Bills of exchange, though a common mode of international payment, has a maturity period of three months. During this time, the importer needs to avail credit in order to take possession of goods. Then only he could sell them and attain the capital to pay off the bill.
Hedging Function: With the objective to avoid losses due to fluctuating exchange rate the participants make the mutual decision of hedging. This signifies that they consent to sell and buy goods at the current price and exchange rate.
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