Some definitions need be made before the question about currency trades is properly addressed. Notwithstanding, the short answer is that large disparities in the exchange rates triggered by speculators have affected--in many cases-- the sovereignty of many nations. These speculators either as individuals or financial institutions often convert large quantities of one currency into another provoking overnight devaluations of the smaller economy. Currency appreciation or depreciation in the same context is an increase or decrease in the value of the currency.
Following World War II the Bretton Woods Conference, pursued exchange rate systems to promote global economic stability. Countries will usually peg their currency to a major convertible currency. The collapse of "soft" pegs in Southeast Asia and Latin America in the late 1990s led to currency substitution becoming a serious policy issue. Panama, Ecuador and El Salvador became fully “dollarized” economies and adopted the US dollar as legal tender.
The “Eurozone” adopted the euro as its common currency and sole legal tender in 1999, which amounted to full currency substitution despite some evident differences in other country’s economy i.e., Germany and Greece.
In a floating exchange rate system, a currency's value moves up or down in the short run this can happen unpredictably for a variety of reasons, having to do with trade flows, speculation, or other factors in the international capital market. For instance, China purchases of foreign materials by home industries pay with one or more reserve currency, thus, causing a depreciation of the home currency. However, this method of purchase with a reserve currency is far more efficient than converting from one currency to another when a commercial transaction takes place. Typically, foreign commerce is conducted with a reserve currency basket such as the US dollar, the euro or the British pound. This basket of currencies is traded in international currency exchange markets with only minor adjustments mainly due to differences in GDP output, fiscal policy and the monetary policy of each country according to the principle of long-run purchasing power parity.
The foreign exchange market (Forex) or currency market is a global decentralized or over-the-counter (OTC) market for the trading of currencies. This includes all aspects of buying, selling and exchanging currencies at current or determined prices.
Financial centers around the world function as anchors of trades between a wide range of buyers and sellers around the world. Currencies are always traded in pairs. The foreign exchange market does not set a currency's absolute value but rather determines its relative value by setting the market price of one currency pegged to another. For example 1 USD is worth X Canadian or Japanese yen etc.
The modern foreign exchange market began forming during the 1970s. This followed three decades of government restrictions on foreign exchange transactions, when countries gradually switched to floating exchange rates from the previous fixed exchange rate regime set by the Bretton Woods system. The foreign exchange market today trades in many other financial products such as currency swaps and forward transactions.
"Arbitrage" is a French word and denotes a decision by an arbitrator or arbitration tribunal. For example interest rate parity is a no-arbitrage condition representing an equilibrium state under which investors will be indifferent to interest rates available on bank deposits in two countries. The relationship between spot and forward is known as the interest rate parity.
No comments:
Post a Comment