Forex, or foreign exchange, can be defined as a network of buyers and sellers who exchange currency at a predetermined price. It is the process by which individuals, businesses, and central banks exchange one currency for another—if you have ever traveled abroad, you have most likely made a forex transaction.
Some forex is done for convenience, but most of the currency conversions are done for profit. Due to the number of currencies converted daily, price fluctuations in some currencies can be very volatile. This volatility makes forex very attractive to traders. It increases the risk and the potential for great profits.
Importance of Forex Trading
The importance of the foreign exchange market can be understood by studying its role in the country's economy. Forex markets exist primarily to meet the currency needs of exporters, importers, and travelers.
The foreign exchange market is needed for the following important functions that drive a country's economy:
International Trade
Exporters need to convert payments received from foreign buyers into local currency. Similarly, when purchasing goods abroad, the importer must convert the local currency to US dollars. In addition, large companies need US dollars to set up branches, warehouses, or factories elsewhere in the world. Exchange conversion is also required to complete the merger or acquisition. Such requirements can only be met through the forex market.
Settlement of Financial Products
Payments are often sent from one country to another as financial instruments (checks, bills of exchange, letters of credit, international wire transfers, etc.). The trading process is complex and can involve more than one bank, but it is the foreign exchange market that determines the exchange rate used to determine the amount to be credited to the recipient's account.
When one country lends to another for a development project, it usually opens a credit line in favor of the companies involved in the project. Such products are also processed at exchange rates that are common in the foreign exchange market.
Hedging
Hedging is also done in the forex market by investors who have purchased higher-risk assets outside their country of residence. Investors will look for safe assets such as the Japanese yen and the Swiss franc, especially as political tensions between the two countries (such as the United States and North Korea) increase. Without the forex market, it would be difficult to realize such a transaction in a short period of time.
Inflation Control
In general, central banks operating under a stable government hold large amounts of reserve currency as part of their foreign exchange reserves. Central banks also intervene in the foreign exchange market as needed to ensure that local currencies remain weak. A weak domestic currency will increase export competitiveness.
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