Have you ever stopped to think about how foreign currency works? Who decides how much money from one country equals that of another? Foreign currency plays a crucial role in international trade and finance. Each country has its own currency, which is issued and controlled by its government and central bank. However, these institutions do not directly set their value compared to other countries' currencies; they only decide the design, denominations, and supply of money. It is the foreign exchange market that actually decides the value of a currency in another country.
THE FOREIGN EXCHANGE MARKET
The foreign exchange market, or Forex, is where currencies are constantly bought and sold. It
operates 24 hours a day because countries are in different time zones. Here, currency values change
constantly based on supply and demand. Participants include banks, businesses, governments, investors, and even individual traders. The exchange rate at any given moment depends on how much buyers are willing to pay for a currency and how much sellers are willing to accept.
HOW SMALL CHANGES IN EXCHANGE RATES HAPPEN
Small changes in exchange rates happen all the time because of the combined actions of participants. For example, if more people or businesses want dollars to buy US goods, invest in the US, or pay loans in USD, then the dollar becomes “more expensive” compared to the peso, and more pesos are needed to buy one dollar. It’s important to note that these changes happen between the two currencies being exchanged; in this scenario, it's the peso and the dollar. Other currencies are not directly affected by this specific change. Exchange rates are determined separately for each pair of currencies in the foreign exchange market.
WHAT FACTORS CAUSE THE SMALL EXCHANGE RATES
The value of a currency changes due to fluctuations in supply and demand in international markets. Some reasons are:
● Trade - If a country imports more than it exports, its currency can weaken.
● Investment- Foreign investors buying or selling a country's currency affects its value.
● Economy of the country- Strong economies attract investors, which increases demand for that
currency.
● Inflation and interest rates- High inflation can weaken a currency, while higher interest rates can make it stronger.
● Global events- War, natural disasters, or political instability can cause rapid currency changes.
In conclusion, the value of foreign currency is not fixed by any single person or government, but it is
determined by the global foreign exchange market. Exchange rates fluctuate constantly due to trade, investment, economic performance, inflation, interest rates, and global events.
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