When it comes to exchanging your country’s currency to another currency then the foreign currency exchange rates become important. Example is when you’re planning to visit Britain. While in Britain you have to shop or pay using Euro or British Pounds. To exchange your country’s currency for either Euro or Pounds, you need to visit a bank. The banks will convert your currency to the currency you want to have using the updated rate. The currency rate however keeps fluctuating so you are more likely to receive different amounts at various times.
The rate fluctuation is advantageous to currency traders who buy and sell currencies to earn profits. In some instances, retail customers participate in currency exchange markets as well as speculators, hoping to earn profits as currency values fluctuate.
In basic economics, increase in the supply equates to decrease in the price of the goods. Therefore, if your country has increased currency supply, you need more of this currency to be able to buy other currencies. This simply means that the currency with increased supply is devalued. In the foreign currency exchange market, the price and quantity of the currencies will continue to fluctuate. Currency supply in the market is affected by various factors.
The factors that affect the exchange market include speculators, foreign investors, export companies, and the central banks.
Foreign investors: This procedure includes currency exchange. A foreigner with plans to invest or do business in your country needs to convert his currency to the local currency before he can start making investments. This will increase his country’s currency supply thus depreciating its value in the exchange market. On the other hand, your country’s currency supply will decrease thus appreciating its value.
Export Companies: Example for this is a US-based export company distributing its goods and products to a company located in France. The US company will receive money from France for the products however the money will be of no use in the US so the currency must be exchanged. The US export company needs to sell the Euros received from France in the exchange market. This transaction will increase the Euro supply and decrease the dollar supply. In this situation, the value of dollar will appreciate but the value of the Euro currency will depreciate.
Speculators and Central banks: The exchange markets have a lot of speculators that are driven by the currency’s fluctuating movement in the global market. The US Central Bank, Federal Reserve, is the one that controls the country’s currency supply. To increase the country’s money supply, additional dollar bills will be printed by Federal Reserve. Central banks keep lots of currencies in reserve to influence the exchange market when needed.