The foreign exchange currency market is currently one of the largest trading markets in the world. It is a decentralized financial market used expressly for the trading of currencies and determines the values of one country’s currency in relation to other currencies around the globe. A foreign currency market exists due to the fact countries trade and sell products and services to other countries globally. Importers rely on the exchange rate to indicate how much foreign currency they need to purchase to pay for goods and services. Essentially, the price of foreign currency is commonly called the foreign exchange rate.
Foreign exchange rates are normally expressed in value of the foreign currency compared to the value of the home currency. For example, if the value of the Australian dollar, AUD, is expressed at $A1.50, this indicates the holder of one US dollar, USD, would need to pay $1.50 USD in exchange for $1.00 AUD. This value will fluctuate depending on the strength of the AUD; when the AUD is stronger the exchange rate goes up and when the AUD is weaker the exchange rate goes down. The AUD is normally quoted in two measures; value as compared to the US dollar, USD, and what is known as the trade weighted index, TWI.
The Value of a Dollar
The strength of the Australian dollar can be indicated by its value as compared to the US dollar at any given time. When the value of the Australian dollar is increased, it is directly indicative of the amount of trade for goods and services with the US and the value of export contracts executed in USD. The Australian dollar value is closely related to the value of the US dollar and it can swing significantly depending on the strength of the US dollar against other foreign currency on the foreign currency exchange market.
The trade weighted index is a wider measure of the value of the Australian dollar against what is called a “basket” of other currencies. The basket is composed of all of Australia’s trading partners and their currency values. There are currently 24 other currencies in this basket, the total of which make up approximately 90% of the export and import trade for the entire country. The trade weighted index utilizes currency values which are assessed by the Australian government once per year, in October. The assessed values are then determined on the previous fiscal year’s trade figures, using the figures for the entire year from the previous October. The trade weighted index is calculated at three points on every trading day, nine in the morning, twelve noon and four in the afternoon. The final figure is the one which is reported throughout the media outlets and is published in the following day’s print media outlets.
Market Valuations and Hazards
Market based foreign exchange rates can fluctuate on a minute by minute basis for some currencies. Normally, the exchange rate for a currency will increased based on supply and demand. When demand exceeds supply, this will generally cause the currency value and exchange rate to increase at any given time. The demand for a currency is often directly related to other factors that are happening in the country at any particular point. These factors can include the value of the Gross Domestic Product, general levels of business and trade with other countries and the unemployment rate. The unemployment rate affects the demand for currency because people who are not making additional income will generally not spend their money, thus decreasing both the demand and the exchange rate value for the currency.
Unfortunately, there are hazards in relying exclusively on the foreign exchange market for currency rates. There are countries who allegedly maintain their currency at an artificially low rate, devaluing the currency and producing an advantage for the country with respect to international trade. When a countries currency value remains low, the cost of goods and services provided is low for other countries that are in trade agreements. The downside of this artificial devaluation is an increase in the cost of goods and services for citizens and businesses in the country with the lower currency exchange rate. In any country that interacts and trades goods and services with other countries, there will generally be a currency value benefit for one or the other. Rarely is the currency of one country exactly equal to the currency of any other country.