The foreign exchange market refers to a trading place for foreign exchange transactions or a place where various currencies are exchanged. The foreign exchange market exists because:
Trade and investment
Importers and exporters pay for one currency when importing goods and receive another cash when exporting goods. This means that when they settle accounts, they receive and pay in different currencies. Therefore, they need to convert part of the currency they receive into a currency used to purchase goods. Similarly, a company that buys foreign assets must pay in the cash of the country concerned. Therefore, it needs to convert its currency into the currency of the country concerned.
The exchange rate between the two currencies will change with changes in the supply and demand between the two currencies. A trader buys a currency at one exchange rate and sells that currency at another more favorable exchange rate, making a profit. Speculation roughly accounts for the vast majority of transactions in the foreign exchange market.
Due to exchange rate fluctuations between two related currencies, companies with foreign assets (such as factories) may suffer some risks when converting these assets into the national currency. When the value of a foreign investment denominated in a foreign currency remains unchanged for some time, if the exchange rate changes and the importance of this asset are converted to the domestic currency, a profit and loss will occur. Companies can eliminate this potential profit and loss through hedging. This is the execution of a foreign exchange transaction, and the result of the transaction offsets the profit and loss of foreign currency assets caused by exchange rate changes.