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Currency Exchange | Exchange Rates

The foreign exchange (currency, ForEx, or FX) market is where currency trading takes place. FX transactions typically involve one party purchasing a quantity of one currency in exchange for paying a quantity of another. The foreign exchange market that we see today started evolving during the 1970s when worldover countries gradually switched to floating exchange rate from their erstwhile exchange rate regime, which remained fixed as per the Bretton Woods system till 1971.

Today, the FX market is one of the largest and most liquid financial markets in the world, and includes trading between large banks, central banks, currency speculators, corporations, governments, and other institutions. The average daily volume in the global foreign exchange and related markets is continuously growing. Traditional daily turnover was reported to be over US$3.2 trillion in April 2007 by the Bank for International Settlements.[1] Since then, the market has continued to grow. According to Euromoney's annual FX Poll, volumes grew a further 41% between 2007 and 2008.[2]

The purpose of FX market is to facilitate trade and investment. The need for a foreign exchange market arises because of the presence of multifarious international currencies such as US Dollar, Pound Sterling, etc., and the need for trading in such currencies.

Currency Exchanges are often located inside banks or travel agents, as well as in international airports, train stations, etc. They make profit, and compete, by manipulating two variables: the exchange rate they use to calculate transactions, and an explicit commission for their service.

The exchange rates charged at the currency exchange are generally related to the rates available to the banks themselves, adjusted to make a profit. A currency exchange will often display a board listing separate "We buy" and "We sell" rates for each currency they deal in; this allows them to "sell" a currency (e.g. a UK currency exchange converting sterling to euros) at a lower rate than they "buy" it (e.g. converting the euros back to sterling).

As an example, if the internationally traded rate on a particular day was 1.50 euros per pound, making £100 worth €150; a currency exchange might "sell" euros at a rate of 1.40 (so that £100 gets the customer only €140) and "buy" at 1.60 (so that it takes €160 to get £100); the difference makes the profit for the currency exchange. Their round-turn profit on these trades would be €160 - €140 = €20, or 13.33%.

Commission is generally charged as a percentage of the amount to be exchanged, subject to a minimum fee for small transactions. Some currency exchanges advertise themselves as commission-free, and then make up the lost profit through the exchange rates they offer. As an additional complexity, some currency exchanges offer special deals on either commission or exchange for customers returning from holiday with leftover foreign currency bought at that currency exchange. Currency exchanges sometimes buy or sell coins of foreign currencies at a higher profit margin, due to the higher cost of storage and shipping compared with banknotes.