Foreign Exchange, the Foreign Exchange Market and Exchange Rate

Every international transaction eventually requires one currency to be converted into another, because a seller ordinarily wants to be paid in its own home currency while a buyer usually holds a different currency. Foreign exchange refers precisely to this process of converting the currency of one country into the currency of another so that international transactions -- trade in goods and services, cross-border investment, remittances, or travel -- can actually be settled. In everyday usage, the term 'foreign exchange' is also used to refer to foreign currency itself, as in 'the country's foreign exchange reserves.'

This buying and selling of currencies does not happen in one physical building the way, say, shares are traded on a stock exchange. Instead, it takes place across a worldwide network of commercial banks, central banks, currency dealers, and financial institutions that are linked electronically and operate across time zones, so that some part of the foreign exchange market is open at almost any hour of the day. This network, taken together, is called the Foreign Exchange Market. Businesses that need to pay a foreign supplier, or that receive payment in a foreign currency and want to convert it into rupees, go through banks that participate in this market. …