A:

The forex spot rate is determined by supply and demand. Banks all over the world are buying and selling different currencies to accommodate their customers' requirements for trade or to exchange one currency into another.

For example, an American bank receives a deposit from a German bank on behalf of their client who wants to buy something from a company in America. The German client has to pay the American supplier in dollars. The German client has euros and these euros need to be exchanged then for dollars. The German buyer will instruct his bank to exchange the euros to dollars and transfer the money to the U.S. supplier. If the bank doesn't have a supply of dollars, it will buy the dollars from another bank and sell euros.

The sum total of all banks selling dollars and all banks buying dollars creates a supply and demand for U.S. Dollars. If the demand for dollars increases then the dollar will appreciate against other currencies. If the demand drops then the dollar depreciates against the other currencies. The rates are set by all the participating banks bidding and offering currencies all day long amongst each other. This is the interbank system and is the way currencies are traded and the way exchange rates are determined. (For more, see The Foreign Exchange Interbank Market.)

This question was answered by Selwyn Gishen.

RELATED FAQS

  1. Where did the term 'pip' in currency exchange come from?

    Learn the definition of a pip, what it means in the scope of currency exchanges and how to determine its value. Find out ...
  2. How do changes in national interest rates affect a currency's value and exchange ...

    Understand the role that changes in interest rates can play in determining the value and foreign exchange rate of a country's ...
  3. What is the difference between pips, points, and ticks?

    Learn the differences between points, ticks and pips and how each are used by investors to measure price changes in stocks, ...
  4. How does the balance of payments impact currency exchange rates?

    Take a brief look at the relationship between a nation's balance of payments and the exchange rate value of its currency ...
RELATED TERMS
  1. Transfer Risk

    The risk that a local currency cannot be converted into the currency ...
  2. ICE LIBOR

    See LIBOR
  3. WM/Reuters Benchmark Rates

    Spot and forward foreign exchange rates that are used as standard ...
  4. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  5. Open Position Ratio

    The percentage of open positions held for major currency pairs ...
  6. Indirect Quote

    A currency quotation in the foreign exchange markets that expresses ...

You May Also Like

Related Articles
  1. Forex Education

    Trading Forex Options: Process And Strategy

  2. Forex Education

    Understand the Indirect Effects of Exchange ...

  3. Mutual Funds & ETFs

    How To Invest In The Swiss Franc

  4. Economics

    Who Benefits From South Korea's Lowered ...

  5. Fundamental Analysis

    Forex Exotic Currency Trading: Risks ...

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!