Foreign Exchange Markets and Globalization - Essay Example

Foreign exchange markets as a whole play a major role in the growth and expansion of industrial globalization and international trade as a whole. The foreign exchange markets allow corporations to do business anywhere in the world in countries where the local currency is different to their own. For corporations wanting to do business internationally and perform financial transactions in their own currency, the market provides the financial tools to do business in different currencies, purchase and sell goods, invest, trade, and participate in the international financial markets with security, confidence, and relative ease.

For corporations the four main roles of the foreign exchange markets are: currency conversion, currency hedging, currency speculation and currency arbitrage (Madura, 1992). Currency conversion is one of the most used functions of the exchange for corporations trading or doing business internationally. Entities use the exchange to convert one currency to another. From the purchase of finished goods or raw materials from foreign suppliers to being able to sell your product or service internationally being converting one currency to another efficiently is paramount to global business.

The foreign exchange quotes two rates the spot and forward rate prices. The current daily exchange rate between two currencies is called the spot exchange rate (Bodie & Kane & Marcus, 2002). It is used for immediate payments or financial transactions. The value of any currency is realized by the interaction between the demand and supply of a currency relative to the demand and supply of other currencies. It is a dynamic market where rates are constantly changing based on the volume of activity for any given currency.

Since a lot of business transactions do not require payment until a later date, the forward exchange rate provides a currency exchange rate for 30, 60 and 90 days. By using the forward rate, currency hedging allows businesses to protect themselves from any potential losses that could be caused by unfavorable exchange market fluctuations. By providing a market to purchase a currency at a specific price for delivery at a later date businesses are able to protect themselves from the inherent volatility of the currency markets .

Additionally for international and multinational firms, currency hedging also helps eliminate earnings fluctuations of international subsidiaries caused by exchange rate movements therefore stabilizing their earnings. .By eliminating currency risks associated with international business they are able to lock in a price and protect their financial interests. Currency speculation allows corporations and firms interested in profiting from foreign exchange market fluctuations in specific currencies.

The companies will invest and assume a favorable financial position based on the expectation of a currency appreciating or depreciating in value. Although corporations do sometimes use this instrument to invest idle funds, this is the type of transaction that is mostly realized by hedge fund speculators, investment firms, and managers. This type of investor is not risk averse since they are in essence gambling that the exchange market will behave as they expect, therefore locking in a profit for their risk.

Currency arbitrage takes advantage of the fact that foreign exchange markets are not globally centralized, so it provides the savvy investor the opportunity to profit from the temporary small price differences that occur in the different exchange rate markets from time to time. References Bodie, Z., Kane, A., Marcus, A. (2002). Investments (5th ed.). Boston: McGraw-Hill Irwin. Madura, J. (1992). Financial Markets and Institutions (2nd ed.). Saint Paul: West Publishing Company.