1. What is foreign exchange?
1. Introduction to Foreign Exchange Foreign exchange is a payment document expressed in foreign currency for international settlement.
The IMF interprets foreign exchange as: Foreign exchange is the debt held by monetary authorities (central banks, monetary institutions, foreign exchange stabilization funds, finance ministries, etc.) in the form of bank deposits, Treasury bills, long – and short-term government securities, etc., which can be used in case of international balance of payments deficit.
Foreign exchange transaction is the act of converting one kind of foreign currency into another kind of foreign currency, and its quotation is the exchange rate, which is usually expressed by the conversion ratio between two currencies, such as USD (US dollar) /JPY (Japanese yen), GBP (British pound) /JPY (Japanese yen), etc.
There are two important points to grasp about this concept.
(1) The exchange rate is the first currency (base currency) and the second currency (valuation currency) to express the price.
For example, the exchange rate of USD /JPY (yen) is 109.2, which means that one dollar is worth 109.2 yen.
The smallest unit of the price of an exchange rate is called a “point”.
For example, the GBP /USD exchange rate has changed from 1.2495 to 1.2496, which means the exchange rate has moved up one point.
(2) A currency cannot be an exchange rate alone.
Experts warn of base money, or debt obligations issued by central banks.
It is called “base money” because it is the basis on which the entire commercial banking system can create deposit money.
Once the base money is issued, the total amount of money supply in the market will be doubled or doubled.
According to general experts, if base money is classified from the point of use, it mainly includes two kinds, that is, deposit reserves of commercial banks and cash in circulation.
The currency of valuation is the currency in which the parties stipulated in the contract to calculate the price.
The “prescribed currency” here may be the currency of the exporting or importing country, or the currency of a third country.
As an important means of financial management, foreign exchange investment has different types and functions that cannot be ignored, which will be introduced in detail below.
1. Types of Foreign Exchange There are various types of foreign exchange, which can be divided into different types according to different ways of classification.
(1) According to the degree of restrictions on foreign exchange, foreign exchange can be divided into free exchange, limited free exchange and accounting foreign exchange, as shown in Figure 1-1.
Figure 1-1 Types of Foreign Exchange by Degree of Restrictions on Exchange Experts remind the International Monetary Fund that any currency with certain restrictions on international regular payments and fund transfers is a limited freely convertible currency.
More than half of the world’s national currencies, including the renminbi, are limited freely convertible.
(2) According to different sources and uses of foreign exchange, foreign exchange can be divided into trade foreign exchange, non-trade foreign exchange and financial foreign exchange, as shown in Figure 1-2.
Figure 1-2 Types of foreign exchange by source and purpose Among them, financial foreign exchange is totally different from trade foreign exchange and non-trade foreign exchange.
For example, the foreign exchange traded between banks is financial foreign exchange, which is neither derived from tangible or intangible trade nor used for tangible trade, but used to manage financial assets in the process of various currency positions.
(3) In its characteristic sense, foreign exchange always refers to a specific currency, such as the US dollar. Foreign exchange refers to the foreign exchange with the US dollar as the means of international payment;
Sterling foreign exchange refers to foreign exchange with sterling as the means of international payment;
Yen foreign exchange refers to foreign exchange with yen as the means of international payment.
Experts remind us that trade foreign exchange, non-trade foreign exchange and financial foreign exchange are all foreign exchange in nature. There is no insurmountable gap between them, but they often transform into each other.
A position means “money” and is the amount of money that an investor owns or borrows, usually the amount of money over or under which he or she breaks even.
In the international currency market, due to various reasons, the value of various currencies are always changing, and the exchange rate is always changing.
Therefore, according to the currency value and exchange rate trend, various currencies can be classified as hard currency and soft currency, or called strong currency and weak currency.
Figure 1-3 shows hard and soft currencies.
Figure 1-3 Introduction of Hard and Soft Currencies 2. Uses of Foreign Exchange In the modern world economy, any country needs to conduct international economic and trade exchanges.
With the international flow of goods, services and capital, various cross-border currency movements for payment are inevitable, and foreign exchange, as the payment voucher of international settlement, plays a non-negligible role.
(1) As a means of payment for international settlement.
As a means of payment for international settlement, foreign exchange is one of the indispensable tools for international economic exchanges, which can promote international economic and trade development and political and cultural exchanges.
Using foreign exchange to pay off international creditor’s rights and debts can not only save the cost of transporting cash, reduce risks, shorten the payment time and speed up the capital turnover, but more importantly, the use of this credit tool can expand international credit exchanges, expand financing channels and promote the development of international economy and trade.
(2) Promote the development of international trade and capital flows.
Foreign exchange is the product of international economic exchanges. Without foreign exchange, it is impossible to accelerate the international turnover and use of capital, and international economic, trade and financial exchanges will be hindered.
To pay off international creditor’s rights and debts with foreign exchange can not only save the cost of transporting cash and avoid transportation risks, but also prevent the capital backlog and accelerate the capital turnover, thus promoting the development of international Commodity Exchange and capital flow.
(3) Facilitate the adjustment of international capital supply and demand.
For example, in order to accelerate the pace of construction, developing countries need to selectively use the short – and long-term credit funds in the international financial market, and developed countries also need to find a way out of the surplus funds.
Therefore, foreign exchange can play a role in adjusting the capital surplus between countries.
Exchange rate is an important concept in foreign exchange investment, and its definition and system will be mainly introduced in the following sections.
1. Definition of exchange rate Exchange rate, also known as “foreign exchange market or exchange rate”, is the ratio of one country’s currency to another country’s currency, which is the price of another currency expressed by one currency.
Due to the different names and values of the currencies in the world, one country’s currency against the currencies of other countries to set a rate of exchange, that is, exchange rate.
Exchange rate is the most important regulatory lever in international trade.
The cost of goods produced by a country is calculated according to its own currency. To compete in the international market, the cost of goods will be related to the exchange rate.
The level of exchange rate will directly affect the cost and price of the commodity in the international market, thus directly affecting the international competitiveness of the commodity, as shown in Figure 1-4.
As can be seen from the figure, if the exchange rate between USD and RMB is 6.8702, the price of a commodity worth 100 RMB will be 14.5577 USD in the international market.
If the dollar exchange rate rises to 7, meaning that the dollar appreciates and the yuan depreciates, the price of the commodity on the international market would be $14.29.
The lower price of the commodity, the increased competitiveness, will certainly sell well, thus stimulating the export of the commodity.
On the contrary, if the US dollar exchange rate drops to 6.5, that is to say, the US dollar depreciates and the RMB appreciates, then the price of the commodity in the international market is 15.38 US dollars. It will be difficult to sell the high-priced commodity, which will surely hit the export of the commodity.
Similarly, the appreciation of the US dollar and the depreciation of the RMB will restrict the import of goods to China, while the depreciation of the US dollar and the appreciation of the RMB will greatly stimulate the import of goods to China.
Figure 1-4 Examples of the impact of exchange rate fluctuations on the international competitiveness of commodities It is precisely because exchange rate fluctuations will bring about such large fluctuations in import and export trade that many countries and regions implement relatively stable currency exchange rate policies.
The rapid and steady growth of the imports and exports of the Chinese mainland is largely attributable to the stable RMB exchange rate policy.
2. Exchange rate system, also known as exchange rate arrangement, refers to a series of arrangements or regulations made by the monetary authorities of a country on the basic way of exchange rate changes.
Traditionally, according to the range of exchange rate fluctuations, exchange rate systems are divided into two types: fixed exchange rate system and floating exchange rate system, as shown in Figure 1-5.
Figure 1-5 Describes the fixed and floating exchange rates
