Introduction to the Principles of Foreign Exchange

A country's premier financial market to the world is the Foreign Exchange, or commonly known as the "Forex". Forex's significance to a country's financial standing is so strong that it can set the general financial standing of the whole nation. In general sense, foreign exchange directly affects a country's local prices of goods and services and the cost of importing raw and manufactured products, and so, affects a country's monetary strength or inflation rate.

Most of what the foreign exchange is all about is macroeconomic trading and utilizes the principles of foreign exchange rate. The relative price of one currency as expressed in terms of another currency is called an exchange rate. Exchange rate, in layman's term, is how much money is required acquire another monetary value. "commodity" refers to the currency being converted to (typically, the currency being bought). The local currency being converted from relative to the commodity currency is called the "terms" currency. This creates an inverted linear relationship between the two opposing currencies. How? As the commodity currency appreciates, the terms currency depreciates as more local money is required to acquire the commodity currency. An adverse effect occurs when the commodity currency falls and the terms currency appreciates because it takes less money to buy the commodity currency using the terms currency.

Exchange rate is a dynamic and a continually varying trend. With each rise and fall (inflation and depression respectively), both ends of the exporting/importing business sectors either gains or suffers in effect. Rise in exchange rate is not beneficial to the export industry and so a recession occurs, while depreciation in the exchange rate affects the import industry. A prolonged episode of either two may lead to a phenomenon called financial crisis, when a country's demand for money suddenly rises relative to the revolving money supply. Financial crises can be of the following classifications, namely, individual crisis, multiple countries crisis and global recession each, as their names imply, affects varying degree of scope and severity.

The foreign exchange rate is dependent on several external factors, however, the government may sometimes influence foreign exchange rate in a number of ways in times of economic crisis. Monetary policies aimed at influencing the schedules, cost and availability of money and credit may be imposed in order to stabilize the current price level. This may, however, increase the government debts by manually "buying off" its own financial deficit through Expansionary or Contractionary Monetary Policies. Under contractionary monetary policy, the government tends to push up interest rates and cut down on the money supply. This is contrary to expansionary policy where interests rates are reduced in order to attract the investments. If the interest rate is plunges, exchange rate appreciates at an accelerated rate. On the other hand, a country with a fixed exchange rate is said to be "stable". Companies from those countries need not to worry about the government trying to interfere with the current of exchange rates.

The discussion of the overall principles and dealings behind foreign exchange and topics encompassing it is a broad subject matter to be discussed in one sitting. In this case, we attempted to present a bit of the very basics on the principle of forex and general ideas on yet another broad discussions on topics such as inflation, depression and monetary exchange rates. This article is not intended as a complete reference on foreign exchange but was written in order to give serious researchers a glimpse and inspiration to learn more of the subject at hand.