The value of any particular currency is determined by market forces based on trade, investment, tourism, and geo-political risk. Every time a tourist visits a country, for example, they must pay for goods and services using the currency of the host country. Therefore, a tourist must exchange the currency of his or her home country for the local currency. Currency exchange of this kind is one of the demand factors for a particular currency.
KEY TAKEAWAYS
Foreign exchange, also known as forex, is the conversion of one country's currency into another.The value of any particular currency is determined by market forces related to trade, investment, tourism, and geo-political risk.Foreign exchange is handled globally between banks and all transactions fall under the auspice of the Bank for International Settlements (BIS).3Another important factor of demand occurs when a foreign company seeks to do business with another in a specific country. Usually, the foreign company will have to pay in the local company's currency. At other times, it may be desirable for an investor from one country to invest in another, and that investment would have to be made in the local currency as well. All of these requirements produce a need for foreign exchange and contribute to the vast size of foreign exchange markets.Foreign exchange is handled globally between banks and all transactions fall under the auspice of the Bank for International Settlements.
Foreign Exchange Rates
Inflation can have a major effect on the value of a country's currency and its foreign exchange rates with other currencies. While it is just one factor among many, inflation is more likely to have a significant negative effect on a currency's value and foreign exchange rate. A very low rate of inflation does not guarantee a favourable exchange rate, but an extremely high inflation rate is very likely to have a negative impact. Inflation is also closely related to interest rates, which can influence exchange rates. The interrelationship between interest rates and inflation is complex and often difficult for currency-issuing countries to manage. Low interest rates spur consumer spending and economic growth, and generally positive influences on currency value. If consumer spending increases and demand grows to exceed supply, inflation may ensue, which is not necessarily a bad outcome. However, low interest rates don't usually attract foreign investment the way higher interest rates can. Higher interest rates attract foreign investment, which is likely to increase demand for a country's currency.