Foreign Exchange Rates One of the Major

Foreign Exchange Rates

One of the major complaints companies and individuals have with foreign exchange rates and flexible exchange rates is that they are too volatile because they float. Several factors contribute to the volatility of the rate of exchange. These include the balance of trade, currency substitution, the differential speed of adjustment of asset markets vs. goods markets, and the news. The balance of trade affects the exchange rate because countries are always shipping goods back and forth (O'Sullivan & Sheffrin, 2003). If a country really needs a particular good, it will be willing to pay more for that good than it would if it did not need the good as strongly. Countries that have more leverage from a trade standpoint can also affect the exchange rates, because the balance of trade is very different for countries that are strong than for countries that are weak when it comes to trading (Sanger & Wines, 2010). With there being so many issues affecting trade, companies can become very confused about the best way to handle their finances.

Currency substitution also matters, because countries that are using foreign currency in a trade instead of their home currency have much less control over the cost of the trade (Sanger & Wines, 2010). The more foreign currency that is being used, the lower the level of control that is seen and the higher the trade imbalance might be. In some cases it can work out very well when a country uses foreign currency, but there are many cases of currency substitution that have not worked out well. Companies should generally avoid substitution of currency when they can use their home currency instead (O'Sullivan & Sheffrin, 2003). Flexible exchange rates and currency substitution rarely work out well for a company that is attempting to work with companies in another country. For companies that are highly skilled - and a bit lucky - however, it is possible to use flexible exchange rates and currency substitution to improve their financial position.

The differential speed of adjustment of asset markets vs. goods markets is another area that is highly significant. When currencies are viewed at asset price and traded in a financial market, those currencies demonstrate strong correlation with the equities market (Sanger & Wines, 2010). It is possible to make or lose money on the foreign exchange market, just like the stock market. Both speculators and investors focus on that market, and they must learn the right times to buy and sell so they can make money (O'Sullivan & Sheffrin, 2003). If they buy and sell during the wrong times they will end up losing money - and they could potentially lose a large amount of money because the foreign exchange market can be very volatile at times. The volatility of the market is something that has to be carefully considered when a company is interested in foreign exchange, since each and every company has its own issues on which it must focus in order to remain financially viable and continue to grow and develop (Sanger & Wines, 2010).