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When people convert money from one currency to another, it’s easy to see the impact currency value has on their funds. Simply put, a strong dollar makes it more affordable to purchase foreign money and a weaker dollar makes it more expensive.
But what, exactly, facilitates the exchange of one currency for another? To find the answer to this question, individuals need to understand the foreign exchange market.
These days, the foreign exchange market, also called the “forex market” or “FX market,” is the biggest market in the world with an estimated $3.5 trillion to $5 trillion dollars in transaction volume each day, says Reto Gallati, president and CIO of Raetia Investments, LLC, a private equity company based in Chicago.
The amount of forex transactions continues to grow at a rapid clip, with currency trades growing by 71 percent between April 2004 and April 2007, and by 20 percent between 2007 and 2010.
The forex market doesn’t have a centralized trading floor, which means anyone can trade, making it the cheapest, most liquid and accessible market in the world, Gallati says. The forex market is also one of the most flexible markets in terms of when trading can take place. “The forex market is not bound to opening and closing hours like stock exchanges,” Gallati says. Once the market opens on Monday morning in Wellington, New Zealand, it stays open 24 hours a day until 5 p.m. Eastern time Friday in New York.
The forex market allows people to transfer purchasing power from one country to another. Frequent travelers, individuals who own property abroad, people who send money to family back home, and parents who are making overseas tuition payments often find that it is beneficial to utilize the services of a dedicated foreign exchange provider to convert their funds.
A foreign exchange provider makes it easier to take advantage of favorable market conditions by offering real-time exchange rates rather than daily rates. Foreign exchange providers also tend to charge lower service fees than banks and have smaller spreads — the hidden costs that banks often build into their advertised exchange rates.
People working with a currency exchange service often take one of two approaches to changing currencies. There’s the “spot trade,” which means they can buy or sell money for the current price.
The second option is designed for individuals who don’t want to buy or sell currency immediately. For example, consider parents in the United States who need to make an international payment for tuition at the University of Oxford in six months. Rather than risk the market changing to unfavorable conditions, the parents can use a forward contract to lock in the current exchange rate for a specific amount of money and time.
Regardless of whether it’s a spot trade or forward contract, individuals who frequently exchange funds should understand that currency rates change without warning. Understanding the forex market and taking certain precautionary measures can help guard against potential risks for a more positive outcome.
 “2010 Triennial Central Bank Survey,” Bank for International Settlements
Example: 1USD = xx INR
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