Sources of Foreign Exchange

Sources of foreign exchange are areas in which economic and financial transactions between countries affect exchange rate levels. These sources comprise monetary payments and receipts whose respective levels are driven by supply and demand for goods and services, investments and currency.

The trade of goods and services between countries requires each to purchase the currency of the other in order to make payments. Therefore, the international demand for a country's output (exports) directly affects the demand, and consequently the price, of its currency.

When foreign investors buy and sell capital investments or securities (ex. stocks and bonds) issued in a given country, they must engage in foreign exchange in order to complete transactions. Similar to trade, the international demand for a country's capital investments has a direct effect on the demand for and price of its currency. Following a decline in a country's currency value, all things being equal, foreign investors may be inclined to invest in that country's securities, taking advantage of the exchange rate-reduced prices.

In addition to global demand for a country's securities and exports, a country's currency is affected by day-to-day movements in prices driven heavily by speculative trading activity, such as day trading. Unlike international trade and investment, price movements driven by speculation are less indicative of economic conditions and more indicative of the perceptions of those engaged in speculative trading.