Exchange Rates

Before looking at how the rate is set, it helps to know who is buying and selling currency, because every reason to buy one currency is a reason to sell another. The syllabus lists six main reasons.

• Trade in goods and services. An importer must pay foreign firms in their currency, so it sells its own currency to buy theirs. Foreign buyers of a country's exports do the reverse, buying that country's currency to pay for the goods.
• Investment in capital goods between countries. A firm building a factory abroad (foreign direct investment) needs the host country's currency to pay for land, machinery and labour.
• Payment of profit, interest and dividends between countries. Profits earned by a firm operating abroad, and interest or dividends paid to foreign investors, have to be converted into the receiver's currency.
• Workers' remittances. Migrant workers send part of their wages home, converting the currency they earn into the currency of their family's country.
• Speculation. Traders buy a currency they expect to rise and sell one they expect to fall, hoping to profit from the change in its value.
• Government intervention in currency markets. A central bank may buy or sell its own currency to influence the exchange rate.