The short form of foreign exchange is forex and the asset class that is dealt with here is currencies. The act of exchanging the currency of one country’s with another currency of a different country for different reasons like commerce, tourism, etc. As there are many businesses which operate on a global scale, it is quite an essential one need to conduct transactions using different currencies.
The currencies are now allowed to freely float against each other and the values of the currencies get varied which has created the need for the services of foreign exchange. These services are being offered by the investment commercial banks on behalf of the customers. Also, it has resulted in creating a speculative environment wherein the currencies get traded with one another using the internet with the purpose to earn a profit.
While the forex transactions are usually carried out by a bigger financial institution even the individual investors could opt for trading here as it offers an excellent trading opportunity. It has very low fees and commission, which makes it easily accessible to all the investors.
There are two unique features to the currency being an asset class:
You will be able to gain value in the rate of exchange
You will be able to earn the differential rate of interest between the two different currencies.
Forex as speculation
As the currency values keeps fluctuating constantly between the different countries currency due to varying demand and supply factors like trade flows, interest rates, economic strength, geopolitical risk and tourism, there exists an opportunity to bet against the change in values either by selling or buying one currency against other with the anticipation that the currency which you bought will gain in its value in the future and the currency you sold will weaken against the counterpart.
Forex as hedge
Commercial organizations that are doing business with foreign countries are always at a risk due to the fluctuation in the value of the currency when they need to sell or buy goods from another country. Hence, the forex will facilitate to hedge that risk by arriving at a fixed rate so that the transaction can be concluded in the future without losing out any money.
In order to accomplish this, the organization or the trader has to sell or buy currencies in the swap or forward markets wherein the bank will fix a rate so that he will be aware of the exact rate of exchange and he can be prepared to mitigate his company’s risk. Even the futures market too can offer a way to hedge the currency risk but it depends on the trade size and the currency involved. The futures market is less liquid and operates on a centralized exchange whereas the forward markets, exist within the interbank system and are decentralized.
Advantages of trading in forex
It is the largest market with regard to the volume traded
It offers the highest liquidity
One can trade 24 hours a day around the globe
It can be easily accessed