“Mom, what is this money?”
“Oh, it’s money that we can use to buy things when we go to Shanghai”
“Cool, but can’t we use ours in China?”
“Each nation has their own currency and you need to use a designated currency to buy things, sweetheart. To do so, we need to exchange ours with Chinese currency, which is called Yuan, before we visit China”
Hello readers! That was a conversation between my mother and I when I was in elementary school. And that was the first moment I saw another currency and realized there is a variety of money in this world. As you may already know, when you want to perform economical transactions in a market where your currency doesn’t work, it’s obvious that currencies must be exchanged beforehand at a quoted rate-exchange rate. Exchange rate is basically set by the demand and supply of associated currencies, just as the products we buy in our daily lives. When the demand for Korean won against the US dollar is on the increase, the value of Korean won goes up (appreciation) relative to that of the US dollar. Therefore, you can purchase more dollars with the same amount of Korean won. For each currency to be priced relative to other currencies, a public market has to be established in order for the market participants to fulfill their desired transactions with constantly changing quotes of currencies (except for currencies of fixed exchange rates). The market where a huge volume of currencies are exchanged and transferred every day around the clock is called the foreign exchange market.
According to triennial central bank survey of foreign exchange and derivatives market activity by the bank for international settlements, the size of the market has gradually grown and average daily turnover in global foreign exchange markets amounts to almost $4 trillion as of April 2010. As globalization expands continuously, more market participants appear every day and become more intertwined with each other financially, thereby increasing the size of the market as if there is no cap to this growth. However, as the market grows bigger, the increasing risk of exposure to foreign exchange markets also becomes a critical factor people need to consider in their business transactions. For example, let’s imagine a Korean exporter has a contract with an American importer. The exporter will deliver a certain amount of products on a specific date and will receive payment in one month. Since the dollar and Korean won are floating currencies, the exchange rate is subject to continuous fluctuation, meaning the exporter may not be able to accurately estimate exactly how much Korean currency will be exchanged from the payment in dollars.
If the value of US dollar goes down (depreciation) against Korean won in a month, the exporter won’t be able to purchase the amount of Korean won they could have at a current exchange rate. Therefore, it has a direct impact on the profit of the company. This foreign exchange risk also exists when you buy shares of stock from a company listed on other countries’ stock market. Not only do you need to factor in the risk of the changing price of the stock, but also the foreign exchange risk you have to bear when you sell the stock and change the proceeds into Korean won.
The importance of foreign exchange market drastically increases as the world grows to be interconnected tightly. As Koh Seung Beom, the FSC’s director general of financial policy bureau, said at 6th Asia Pacific Financial Forum, several disputes such as currency conflict between countries could surface in the process of stimulating economies since slowing economy of developed countries lately doesn’t seem to be solved in the short term. Thus, the volatility of the market could increase since the domestic financial market is very sensitive to foreign policies. We learned what the FX market is and how important it has become today. In the midst of globalized world, in the pursuit of growing up to be global leaders, it’s essential that we have the firm grasp on understanding how the FX market could affect many aspects of our lives and keep up with the trend of the global FX market.
By Sang Hee Yu (email@example.com)