The Foreign Exchange Market

Individuals participate in the foreign exchange market for a number of reasons. On the demand side, one principle desire for foreign currency is to purchase goods and services from another country or to send a gift or investment income payments abroad. For example, the desire to purchase a foreign automobile or to travel abroad produces demand for a currency in which those goods or services are produced. The second reason may be to acquire foreign currency is to purchase financial assets in a particular currency. The desire to open a bank account, purchase foreign stocks or bonds or acquire direct ownership of real capital would fall into this category. A third reason that individuals demand foreign exchange is to avoid losses or make profits that could arise through changes in the foreign exchange rate. Individuals acquire that currency today at a low price in hopes of selling it at a profit later at a high price and thus make a profit. Such risk-taking is activity is referred to as speculation in a foreign currency. Others who have to pay for an imported item in the possibility that the foreign currency will become more valuable in the future and would associate with the changes in the exchange rate are referred to as hedging. The total demand for foreign currency at any one point in time thus reflects these three underlying demands: the demand for foreign goods and services, the demand for foreign investment and the demand based on risk-taking or risk-avoiding activity. It should be clear that the demands on the part of a country’s citizens correspond to debit items in the balance-of-payments accounting framework.
Participants on the supply side operate for similar reasons (reflecting credit items in the balance-of-payments). Foreign currency supply to the home country results firstly from foreigners purchasing home exports of goods and services or making unilateral transfers or investment income payments to the home country. For example, U.S. exports of wheat and soybeans are a source of supply for foreign exchange.&nbsp.&nbsp.