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Foreign Exchange Markets

The dollar and the Euro - two of the major international currencies. The value of both of these currencies against the pound changes almost every minute of every day! This makes it very difficult for businesses to plan ahead. Copyright: Benjamin Earwicker and Marja F-B, both from stock/xchng.

One of the main difficulties for businesses who trade abroad is that exchange rates change. In a previous article in this series, we looked at how and why exchange rates change. Basically, the exchange rate for a foreign currency is determined by the demand and supply of currencies on foreign exchange markets.

The foreign exchange market consists of different companies who specialise in buying and selling currencies. These companies employ dealers whose job it is to buy and sell foreign currency for clients. These clients might be businesses and speculators. Businesses want to buy foreign currency to carry out their transactions with foreign customers. Some large businesses will have very complex networks of customers around the globe with millions of pounds changing hands during the course of a year.

Foreign currency markets deal in billions of pounds worth of transactions every day - the values of currencies are always changing - to be a successful trader you have to think on your feet! A few seconds might mean the difference between a gain or a loss of millions of pounds! Copyright: Neil Gould, from stock.xchng.

Speculators buy and sell foreign currencies in the hope of making a profit. In simple terms, if I changed £10,000 into dollars at an exchange rate of £1 = $2.00 I would get $20,000 in return. If I then waited for the exchange rate to fall to £1 = $1.95 and then changed my dollars back into pounds I would get 20,000/1.95 = £10,256.41p! That represents a profit of £256.41p. In reality, the profit would be less than this because of various charges for the deal but you get the idea.

Every day over $650 billion worth of currencies change hands on the foreign exchange markets and a large proportion of these deals are speculative in nature. Even small changes in the exchange rate can make a difference when you are talking about millions of pounds.

You can try your hand at seeing whether you could be a trader on the foreign currency markets by having a go at our exchange rate game.

In this resource, you are going to be given a short story about a relatively small business that has business dealings abroad. At the end of the story, you will be asked some questions to help assess your understanding of the effect of changes in exchange rates on the business and how the business might manage those changes.

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