The foreign exchange market facilitates trade between countries.
The foreign exchange market is the largest financial market in the world. With a network of currency traders working from major financial centers around the world, the foreign exchange market operates 24 hours a day. The New York Bank of the Federal Reserve quantifies turnover of the foreign exchange market at $1.5 trillion every day. This amount of money demonstrates the multiple functions the foreign exchange market plays in financial transactions and investment around the world.
Exchange Rate
The foreign exchange market establishes the value of the world's currencies relative to each other. For example, the value of U.S. dollars can be converted to an equal amount of purchasing power in Mexican pesos. Establishing value parity among currencies is one of the key functions of the foreign exchange market because it facilitates transactions around the world. However, economic events around the world still influence the foreign exchange market, including central bank interventions, inflation, business cycles, and political developments among other factors.
Global Commerce
One of the key functions of the foreign exchange market is to provide governments and businesses the capacity to make transactions in local currency. Since there is no one global currency in existence, investors, businesses and governments convert currencies to make transactions. For example, if a U.S. manufacturer makes direct foreign investments in China, the manufacturer will likely need to make some transactions, like paying employee salaries, in Chinese yuan.
On a global scale, international trade is an increasingly important part of national economies around the world. The New York Bank of the Federal Reserve tabulates global trade in 1950 at $58 billion. By 2000 global trade was valued at $6.3 trillion. As a result, the foreign exchange market unites national economies into a single global marketplace.
Investment
Like other financial marketplaces, the foreign exchange market provides the opportunity for investors to make money. Generally, investors make money in the foreign exchange market from the spread between the value of currencies. In financial markets, a spread is the gap in value between two financial instruments. Spreads are important because if timed right, currency speculators can make large amounts of money from trading currency. For example, the New York Bank of the Federal Reserve calculates that currency prices can change by as much as 20 times in one minute. By this standard, there are continual opportunties to profit from currency spreads during the business day.
