Foreign currency exchange rates are set in the major Forex markets of the world which are London, New York and Tokyo. Forex markets were developed to facilitate international trade. Foreign currency exchange rates vary according to the perceived value of one currency versus another. Those doing business across international borders use tools such as Forex currency options trading to hedge the risk that foreign currency exchange rates will change and cause business losses.
How Many Yen to the US Dollar?
As in all markets, pricing is based on supply and demand. If the US Federal Reserve backs off its quantitative easing financial stimulus program, interest rates in the US will go up. This will make the US dollar more attractive to Forex traders. The demand for US dollars goes up. A trader who is holding Yen, British pounds, Euros or other currencies may wish to buy US dollars but only at the right price. This is the supply issue. Traders look at the relative strength of the economies of the two nations whose currencies they trade. They look at balances of payments, national debts or reserves, monetary policy of the respective central banks, employment numbers and national politics. Traders also consider what the market as a whole is doing. Technical analysis of Forex pairs allows traders to profit from the daily and even minute to minutes changes in foreign currency exchange rates. Technical analysis is based on statistics and is more accurate when trading volume and liquidity are high. Thus traders use these tools in trading the major Forex currencies, one against another. The major currencies are these:
|United States Dollar||USD|
Eighty-five percent of all foreign currency trades include the US dollar. In fact, most minor currencies only trade versus the dollar. Thus foreign currency exchange rates of one minor currency versus another are really the rate of one currency versus the dollar and the rate of the dollar versus the second currency.
What Will the Future Bring?
When an airline in South Korea buys a jet from Boeing it will pay in US dollars upon delivery. The order is placed and a contract is signed. However, the plane may not be available for a year at which time the South Korean airline will need to convert its South Korean Won (KRW) to US dollars (USD) to make payment. Let us say that the price of the jet is $40 million USD. At the current exchange rate:
40,000,000.00 USD = 42,689,767,200.00 KRW
The Korean airline will convert 42.7 billion won to make the purchase of a $40 million jet. However, the company cannot simply put this amount of money in the bank and wait because foreign currency exchange rates vary over time. The common approach is for the buyer, in the case the airline, to purchase call options on the US dollar with South Korean won. If the value of the dollar rises against the won the airline will simply execute the call contract which will give it the right to buy dollars with won at the original contract price. If the dollar falls against the won in a year the company lets the call contract expire and simply buys the necessary number of dollars but with fewer won than expected and receives the airplane. Options allow companies doing business across borders to hedge risk on one hand and allow currency speculators to engage in profitable currency trading as well.