Foreign Exchange Rates: Definition, Functions, Types and Examples of Calculations

Exchange rates and foreign currencies are indicators or parameters used by individuals, agencies and countries in conducting economic transactions. Maybe many people already know and understand what exchange rates and foreign exchange are. However, did you know that there is a term foreign exchange rate?

Foreign exchange rates consist of two different terms, namely exchange rates and foreign exchange. Therefore, before discussing foreign exchange rates, the first thing that needs to be discussed is the meaning of exchange rates, foreign exchange, and foreign exchange rates. Let’s look at an explanation of exchange rates, foreign exchange, and foreign exchange rates.

A. Definition of Exchange Rate

The exchange rate is one of the terms often used in the financial sector and is known as the exchange rate . According to the Big Indonesian Dictionary (KBBI) exchange rate is the value of a country’s currency expressed in the value of another country’s currency.

In general, the exchange rate can be interpreted as the price of currency values ​​that can be measured by the value of foreign currencies and can be purchased or exchanged for other currencies.

B. Definition of Foreign Currency

Foreign currency in the Big Indonesian Dictionary (KBBI) means foreign currency used in international trade. Forex is also included in one part of foreign exchange.

In simple terms, foreign currency or commonly referred to as foreign currency is a foreign currency that is recognized and accepted by other countries. Foreign currency can be used as legal tender when conducting international economic transactions or international trade.

In order to better understand foreign exchange and foreign exchange, Sinaumed’s can read Adler Haymans Manurung’s book entitled Foreign Exchange Reserves & Foreign Exchange Exchange which is below.

C. Currencies Active in Foreign Exchange

The value of foreign currencies will always change from time to time. In general, the currency that has the highest selling value will be traded on forex . What is forex? Forex is an acronym for foreign exchange which means a currency exchange transaction.

Maybe some people don’t know the level of currency that has the highest exchange rate in currency exchange or forex transactions . In order to find out the level of currency values, you can refer to the information from the following table.

Rating Currency Name Code
1 United States Dollar (American Dollar) USD
2 Eurozone Euro (Euro) EUR
3 Japanese Yen (Japanese Yen) JPY
4 British Pound Sterling (British Pound Sterling) GBP
5 Swiss Franc CHF
6 Australian Dollar (Australian Dollar) AUD
7 Canadian Dollar (Canadian Dollar) CAD
8 Deutsche Mark (German Mark) DM/DEM

If based on the table above, the US Dollar currency, namely the United States Dollar, ranks first in currency exchange transactions. However, in general, all currencies in the table are often traded in pairs or known as pairs . For example, EUR/GBP, GBP/USD, EUR/USD, AUD/USD, and GBP/JPY.

The US Dollar currency is the currency most traded in currency exchange transactions. This is because more than half of all currency exchange transactions are controlled or dominated by the US Dollar.

There are several reasons that can cause the US Dollar to control the forex market . Here are some of these reasons.

  1. The United States’ economy is the largest in the world.
  2. The US dollar is the world’s reserve currency.
  3. The political system owned by the United States is quite stable and strong.
  4. The US Dollar is a medium of exchange or payment used in international trade transactions.
  5. The United States has the largest and most liquid financial market in the world.

In order to gain a better understanding of foreign exchange, the Foreign Exchange Market book can be used as a reference for Sinaumed’s who is a foreign exchange market player who discusses theory and practice, from micro to macro foundations, as well as cases surrounding the world foreign exchange market.

D. Foreign Exchange Function

As the world develops, especially in the economic field, the trade sector also develops so that many countries carry out international trade. In international trade, a tool for exchanging world currencies is needed and that tool is foreign exchange.

Foreign exchange has three functions, namely a means of exchange and international payments, a tool for controlling exchange rates, and a tool for facilitating international trade. In order to understand more about these three functions. Check out the explanation as follows.

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1. Means of exchange and international payments

In general, all transactions require a medium of exchange such as money. In international trade, whether in the form of goods or services, the medium of exchange used is foreign exchange. Thus, it can be said that foreign exchange functions as money used as a medium of exchange in international trade in the form of goods or services.

An example of a case where foreign exchange functions as a medium of exchange and international payments is when Indonesia imports vehicles from Japan, then the resident currency that must be paid to the Japanese is Yen.

2. Exchange rate controller

Currency exchange rates owned by a country will continue to change so that it requires a tool to control changes in other countries’ currency exchange rates and that tool is the foreign exchange rate. The use of certain foreign exchange rates in a country, so that country can overcome or control currency exchange rates more easily.

For example, with the Rupiah exchange rate against the United States Dollar, the Rupiah exchange rate can be seen whether it is increasing or decreasing. In other words, the exchange rate becomes a benchmark for maintaining the stability of the value of a country’s currency.

3. A tool to facilitate international trade

In international trade, it requires smoothness in transactions so that it does not require a lot of time. Foreign exchange is a tool that can expedite international trade transactions so that the buying and selling process runs smoothly without being constrained by the currency of each country. Therefore, every country that wants to transact in international trade requires foreign exchange rates.

For example, the foreign currency that is often used in international trade is the United States Dollar because this currency is easily exchanged into the currency of other countries (which make transactions) so that international trade transactions run easily.

E. Types of Foreign Exchange Markets

The foreign exchange market is a market used for currency exchange transactions. For someone who just wants to enter into currency exchange transactions, it is necessary to know the types of currency markets. By knowing the types of foreign exchange markets, beginners will not take the wrong steps in making currency exchange transactions. Check out the types of foreign exchange market as follows:

1. Spot Market

The spot market is a market that facilitates immediate currency exchange transactions at banks and money changers. Transactions on the spot market are usually carried out when you want to go on vacation abroad.

Traders usually play transactions that exist in the spot market . For example, when the school holidays begin, the demand for Singapore Dollars will increase because many families will go to Singapore.

2. Forward Market

The forward market is a market that serves the purchase of foreign currency with a contract. Usually, the value of currency purchase contracts in this market can reach millions of US dollars.

Forward transactions are usually carried out by individuals or institutions, either from banks or non-banks, who already have a special contract with a bank, so that these transactions can be said to be transactions that occur between banks.

3. Currency Futures Market

The Currency Futures Market is a market that provides Currency Futures contract trading . One type of Currency Futures contract can ensure a standard volume of a certain currency that can be exchanged at a certain settlement date in the future.

In the Currency Futures market, there are two types of transaction objects, namely foreign exchange ( financial futures market ) and commodities ( commodity futures market ). The benefits of this market are limiting risk ( hedging ) and speculative purposes.

4. Currency Options Market

The Currency Option market is a market that provides trading or buying and selling of Currency Option contracts . Currency Option contracts are divided into two groups, namely Currency Call and Currency Put .

F. Types of Foreign Exchange Transactions

There are four types of foreign exchange transactions, namely spot transactions , forward transactions , swap transactions and option transactions . See an explanation of the types of foreign exchange as follows.

1. Spot transactions

Spot transactions are transactions in the form of buying and selling foreign currencies (forex) or currencies by way of handover and payment between banks which are immediately completed within two working days.

There are several ways to use when handing over funds in a spot transaction , viz

2. Value today (Value tod or Cash)

Value today is the transfer of funds made on the same date or day as the date or day a transaction is made. This method is also known as same day settlement .

3. Value tomorrow (Value tom)

Value tomorrow is the delivery of funds made on the next working day or the working day after the contract is made. This method is commonly known as one day settlement .

4. Spot values

Spot value is the transfer of funds made within two working days after the transaction date. Usually this way is done in international transactions.

4. Forward transactions

A forward transaction is a transaction in the form of a contract that is agreed on the same day, but the settlement will be carried out in the future (the agreed date). Because of that, this transaction is also called a futures transaction.

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In simple terms, when carrying out a forward transaction, the rate will be fixed at the time the contract is made, but payment and delivery will be made when the contract is due.

5. Swap transactions

A swap transaction is a transaction involving a contract to buy and sell foreign currency using a spot price that has been combined with a buy and sell transaction of foreign currency that is the same as the forward price. Thus, this transaction is a combination of spot transactions and forward transactions.

Briefly, this transaction is executed by a market maker ( dealer ) by buying a currency with a spot transaction and paying the same amount, but with a forward transaction .

6. Option transactions

An option transaction is a contract that is used to obtain the right to buy or sell a certain amount of foreign currency at a certain price, timeframe and end date.

Sinaumed’s can also read learning related to the basics of buying and selling foreign exchange online, through analysis of movements, and much more in the Foreign Exchange Investment book below.

G. Definition of Foreign Exchange Rates

After knowing the meaning of exchange rates and foreign currencies, foreign exchange rates can be interpreted as a ratio/comparison of the value of domestic currency and foreign currency.

Foreign exchange rates are often used in international trade so that a country before carrying out transactions in international trade will see and observe developments in foreign exchange rates.

H. Foreign Exchange Exchange System

Foreign exchange has several systems in its use. These systems are divided into three, namely a fixed exchange rate system, a free or floating exchange rate system, and a controlled floating exchange rate system. Check out the explanation of the three courses.

1. Fixed exchange rate system ( fixed exchange rate )

Fixed exchange rate system is a currency exchange rate system that is fixed or must follow the rules that have been made by the central bank (government).

In this exchange rate system, the central bank or government has a role in the foreign exchange market by buying or selling foreign currency if the exchange rate does not comply with predetermined standards or rules.

2. Floating exchange rate system

A free or floating exchange rate system is a system in which the currency exchange rate is influenced or determined by market forces. The supply and demand for foreign currency will determine the currency’s value.

This system is free or will always change so that foreign exchange market participants must continue to observe developments that occur in foreign currency exchange rates.

3. Controlled floating exchange rate system ( floating exchange rate )

A controlled floating exchange rate system is a foreign exchange rate system in which both the government and the market have the right to determine foreign exchange rates.

I. Types of Foreign Exchange Rates

After knowing the meaning and system of foreign exchange rates, it’s not complete if you don’t discuss the types of foreign exchange rates. Foreign exchange rates are divided into three groups, namely selling rates, buying rates and middle rates. The following describes the three types of exchange rates.

1. Selling rate

The selling rate is the price of a foreign currency given or determined by a bank or money changer to someone who wants to sell foreign currency or exchange Rupiah for foreign currency.

2. Buying rate

The buying rate is the price of a foreign currency given or determined by a bank or money changer to someone who wants to buy foreign currency or exchange foreign currency for Rupiah.

3. Middle rate

The middle rate is the rate given by a bank or money changer between the selling rate and the buying rate (the selling and buying rates are added up and then divided by two).

J. Example of Foreign Exchange Rate Calculation

One day Putri was being given a job abroad and she got paid for the trip of IDR 45,000,000.00.

At the time of carrying out his work, the applicable exchange rate is as follows.

The selling rate is IDR 15,000.00 per US$ 1

Buying rate IDR 14,500.00 per US$ 1

How much will Putri get paid in United States Dollars?

Putri will exchange Rupiah for United States Dollars, here’s how to calculate the selling rate.

Rp. 45,000,000.00 : IDR 15,000 = US $ 3,000

So, the money that Putri has in the form of US Dollars is US$3,000

K. Conclusion

For a country that wants to carry out transactions in international trade, be it imports or exports, it is necessary to pay attention to foreign exchange rates. Meanwhile, for individuals if they want to carry out currency exchange transactions on forex , they need to know the types of foreign exchange markets.

The United States Dollar is the currency that has the highest value in foreign currency. One of the causes of the United States currency being the highest value in currency exchange transactions is that the United States has the largest and most liquid money market in the world.

Such is the brief explanation of the foreign exchange rate for Sinaumed’s which is useful for a country in making transactions.

Sinaumed’s can also learn about transactions in this international trade through the books available at sinaumedia as #Friends Without Borders who accompany your free walk and your learning process. Buy the book right now!

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