Introduction to Foreign
Currency Exchange
Introduction to Foreign Currency Exchange
In the most basic of terms, currency exchange (also known as foreign exchange, forex or FX) is where you swap one currency for another. Currency exchange is necessary for a wide range of reasons, such as buying a property overseas, living abroad or transferring wages into a foreign bank account.
Here’s a quick overview of currency exchange, how it works and how to get the most from your money.
What is currency exchange?
Currency exchange is where you swap a sum of one currency for the equivalent value of another. In order to do this, you need to know the value of the currency you are buying (the ‘quote’ currency) in relation to the one you are selling (the
‘base’ currency). This ratio is the exchange rate.
Currencies are represented by three-letter codes which reference their country of origin and the name of the currency, so Pound Sterling becomes GBP and the Euro becomes EUR. Exchange rates are presented GBP/EUR, where the first currency is always the one you own. For example, a GBP/EUR exchange rate of 1.33 would mean you get 1.33 Euros for every 1 Pound.
Currencies are always traded in pairs.
There are more than 200 different currencies in circulation around the globe, but most currency trades involve one of several ‘major’ currencies, which are Pound Sterling (GBP), US Dollar (USD), Euro (EUR), Canadian Dollar (CAD), Australian Dollar (AUD) Swiss Franc (CHF) and Japanese Yen (JPY).
What causes exchange rates to change?
The value of a currency is, in part, determined by the economy of the country it comes from. It follows that a country which is currently enjoying economic prosperity would have a more valuable currency than one which is currently in economic turmoil. But because countries are constantly changing, producing news, publishing data and responding to difficulties, the value of currencies fluctuates constantly. When you have two currencies in a pair, the result is a permanently changing figure.
Many things affect the value of a currency, including growth or contraction in the economy, political scandal, freak weather events and comments from politicians or people involved in finance. Exchange rates can change daily, hourly, or even minute by minute. This can make currency exchange seem complicated, which is why many people choose to let a financial expert, like a currency broker, handle their transaction.
Leading brokers will keep you updated on the latest market movements so that you have all the information you need to be able to trade when the rate is favourable. They also have a range of tools available to help you get the most from your money and protect you from changes in the market.
The difference an exchange rate goes through in a day can mean that when you choose to transfer can drastically affect how much money you receive. For instance, £150,000 at a GBP/EUR exchange rate of 1.3364 would buy you €200,460, while an exchange rate of 1.3577 gets you €203,655. Those exchange rates were experienced in the same day, meaning that a few hours made a difference of €3,195 to the amount of money someone trading £150,000 would have received.
Currency exchange providers can offer you a better deal
How does a foreign currency transfer work?
Banks and foreign currency brokers handle the majority of domestic foreign currency transactions. People often choose a bank as the first port of call, without really considering the other options available to them. However, other accredited currency exchange providers can often offer you a better deal than a high street bank.
There are several reasons why a reputable currency broker is a better alternative to a high street bank when it comes to foreign exchange. For starters, currency brokers are forex specialists, often employing currency experts to provide an unrivalled level of insight into the markets. Currency exchange is just one of the many services that a bank offers, meaning they cannot provide the same level of care and attention as a currency broker can.
Banks also tend to charge more for currency transfers, giving you a worse rate than if you were to use a currency broker.
Some brokers can actually undercut the exchange rates offered by banks by as much as 90% while not charging the transfer fees most banks add on.
Trading with a currency broker should be straightforward, with the option to register online or over the phone and no obligation to trade. Once registered, you’ll have access to a range of transfer options. Smaller transfers can often be conducted 24/7 online, but if you prefer the human touch you can talk through your requirements with your own Account Manager. After going through your options and helping you pick a good time to make a transfer, your Account Manager will ‘book’ the trade once you are happy with the mode of transfer and the rate you have secured. The broker will need the details of the beneficiary account the money needs to be transferred to and then you will need to send them your funds. They will then conduct the trade and electronically wire your new currency into the account you have provided.
There are several factors which can influence how long it takes to conduct the trade, including the currencies being traded and where in the world the destination account is located. Usually you can expect a trade to be completed within one to two working days
Reputable brokers could actually save you money.
How much does it cost to exchange currency?
How much a foreign currency exchange will cost you depends on who you use to transfer your funds. With a reputable broker you could actually save money.
Financial institutions involved in currency transfers, including banks and brokers, buy currency on the private Interbank Market. Their profit comes from the mark-up they put on the currency they purchase. The difference between the rate the institution buys currency for and the higher cost they sell it on for is known as ‘the spread’.
Brokers usually work on smaller margins and pass the saving on to their clients, allowing them to undercut the exchange rates offered by banks by up to 90%.
By using a currency broker you are able to get a much more competitive exchange rate for your currency transfers.
As we’ve seen above, securing the best rate could make a difference of thousands to the final sum you receive.
Are there different ways of conducting a currency transfer?
Banks usually only offer what are known as ‘Spot Contracts’, which is where you buy currency immediately, paying the current market price and receiving your money as soon as possible.
However, a currency broker can offer several other ways of buying currency which might prove to be more
convenient and save you more money. One of these is a forward contract, which allows you to fix an exchange rate in advance for up to two years, meaning you can buy currency in the future at the current market price. This is very useful if you are planning a large purchase overseas, as you can budget effectively and know exactly how much money you will need, even if the exchange rate moves against you.
There are other ways of managing risk when trading currency. If you are more concerned about getting the best rate than you are about how quickly you get the money, a ‘limit order’ or ‘stop loss order’ could be useful. A limit order sets a target rate that you want to exchange your currency at: your funds will only be exchanged once the market hits this rate. This, in a similar fashion to a forward contract, means you know exactly how much money you will receive.
A ‘stop loss order’ gives you the ability to set a minimum threshold exchange rate. This way you can hold out for the best exchange rate, but should the market move against you your money is automatically sold when the minimum level is met, meaning you are protected from making a loss.
