<h2>Demanders and Suppliers of Currency in Foreign Exchange Markets</h2>
<p>In foreign exchange markets, demand and supply become closely interrelated, because a person or firm who demands one currency must at the same time supply another currency—and vice versa. To get a sense of this, it is useful to consider four groups of people or firms who participate in the market: (1) <strong>firms</strong> that are involved in international trade of goods and services; (2) tourists visiting other countries; (3) international investors buying ownership (or part-ownership) of a foreign firm; (4) international investors making financial investments that do not involve ownership. Let’s consider these categories in turn.</p>
<p>Firms that buy and sell on international markets find that their costs for workers, suppliers, and investors are measured in the currency of the nation where their production occurs, but their revenues from sales are measured in the currency of the different nation where their sales happened. So, a Chinese firm exporting abroad will earn some other currency—say, U.S. dollars—but will need Chinese yuan to pay the workers, suppliers, and investors who are based in China. In the foreign exchange markets, this firm will be a supplier of U.S. dollars and a demander of Chinese yuan.</p>
<p>International tourists will supply their home currency to receive the currency of the country they are visiting. For example, an American tourist who is visiting China will supply U.S. dollars into the foreign exchange market and demand Chinese yuan.</p>
<p>Financial investments that cross international boundaries, and require exchanging currency, are often divided into two categories. <strong>Foreign direct investment (FDI)</strong> refers to purchasing a firm (at least ten percent) in another country or starting up a new enterprise in a foreign country For example, in 2008 the Belgian beer-brewing company InBev bought the U.S. beer-maker Anheuser-Busch for $52 billion. To make this purchase of a U.S. firm, InBev would have to supply euros (the currency of Belgium) to the foreign exchange market and demand U.S. dollars.</p>
<p>The other kind of international financial investment, <strong>portfolio investment</strong>, involves a purely financial investment that does not entail any management responsibility. An example would be a U.S. financial investor who purchased bonds issued by the government of the United Kingdom, or deposited money in a British bank. To make such investments, the American investor would supply U.S. dollars in the foreign exchange market and demand British pounds.</p>
<p>Portfolio investment is often linked to expectations about how exchange rates will shift. Look at a U.S. financial investor who is considering purchasing bonds issued in the United Kingdom. For simplicity, ignore any interest paid by the bond (which will be small in the short run anyway) and focus on exchange rates. Say that a British pound is currently worth $1.50 in U.S. currency. However, the investor believes that in a month, the British pound will be worth $1.60 in U.S. currency. Thus, as <a href="#CNX_Econ_C29_020">figure (a)</a> shows, this investor would change $24,000 for 16,000 British pounds. In a month, if the pound is indeed worth $1.60, then the portfolio investor can trade back to U.S. dollars at the new exchange rate, and have $25,600—a nice profit. A portfolio investor who believes that the foreign exchange rate for the pound will work in the opposite direction can also invest accordingly. Say that an investor expects that the pound, now worth $1.50 in U.S. currency, will decline to $1.40. Then, as shown in <a href="#CNX_Econ_C29_020">figure (b)</a>, that investor could start off with £20,000 in British currency (borrowing the money if necessary), convert it to $30,000 in U.S. currency, wait a month, and then convert back to approximately £21,429 in British currency—again making a nice profit. Of course, this kind of investing comes without guarantees, and an investor will suffer losses if the exchange rates do not move as predicted.</p>
<div class="fig_container" id="CNX_Econ_C29_020">
<p data-type="title"><strong>A Portfolio Investor Trying to Benefit from Exchange Rate Movements</strong></p>
<img alt="The chart shows the chain of events that investors would hope for based on whether or not they believed currency would appreciate or depreciate." src="https://data.ulearngo.com/assets/ba6dafc1-b035-4ca6-bf77-67e8b4012e9e"/>
<p class="fig_caption">Expectations of the future value of a currency can drive demand and supply of that currency in foreign exchange markets.</p>
</div>
<p>Many portfolio investment decisions are not as simple as betting that the value of the currency will change in one direction or the other. Instead, they involve firms trying to protect themselves from movements in exchange rates. Imagine you are running a U.S. firm that is exporting to France. You have signed a contract to deliver certain products and will receive 1 million euros a year from now. But you do not know how much this contract will be worth in U.S. dollars, because the dollar/euro exchange rate can fluctuate in the next year. Let’s say you want to know for sure what the contract will be worth, and not take a risk that the euro will be worth less in U.S. dollars than it currently is. You can <strong>hedge</strong>, which means using a financial transaction to protect yourself against a risk from one of your investments (in this case, currency risk from the contract). Specifically, you can sign a financial contract and pay a fee that guarantees you a certain exchange rate one year from now—regardless of what the market exchange rate is at that time. Now, it is possible that the euro will be worth more in dollars a year from now, so your hedging contract will be unnecessary, and you will have paid a fee for nothing. But if the value of the euro in dollars declines, then you are protected by the hedge. Financial contracts like hedging, where parties wish to be protected against exchange rate movements, also commonly lead to a series of portfolio investments by the firm that is receiving a fee to provide the hedge.</p>
<p>Both foreign direct investment and portfolio investment involve an investor who supplies domestic currency and demands a foreign currency. With portfolio investment less than ten percent of a company is purchased. As such, portfolio investment is often made with a short term focus. With foreign direct investment more than ten percent of a company is purchased and the investor typically assumes some managerial responsibility; thus foreign direct investment tends to have a more long-run focus. As a practical matter, portfolio investments can be withdrawn from a country much more quickly than foreign direct investments. A U.S. portfolio investor who wants to buy or sell bonds issued by the government of the United Kingdom can do so with a phone call or a few clicks of a computer key. However, a U.S. firm that wants to buy or sell a company, such as one that manufactures automobile parts in the United Kingdom, will find that planning and carrying out the transaction takes a few weeks, even months. The table below summarizes the main categories of demanders and suppliers of currency.</p>
<div>
<p><strong>The Demand and Supply Line-ups in Foreign Exchange Markets</strong></p>
<table id="" summary="This table has two columns and five rows. The first row is a header row, and it labels the columns “Demand for the U.S. Dollar Comes from...” and “Supply of the U.S. Dollar Comes from...”. Under the column “Demand for the U.S. Dollar Comes from...” are four sources: A U.S. exporting firm that earned foreign currency and is trying to pay U.S.-based expenses, Foreign tourists visiting the United States, Foreign investors who wish to make direct investments in the U.S. economy, and Foreign investors who wish to make portfolio investments in the U.S. Under the column “Supply of the U.S. Dollar Comes from...” are the following suppliers: A foreign firm that has sold imported goods in the United States, earned U.S. dollars, and is trying to pay expenses incurred in its home country, U.S. tourists leaving to visit other countries, U.S. investors who want to make foreign direct investments in other countries, and U.S. investors who want to make portfolio investments in other countries.">
<thead>
<tr>
<th>Demand for the U.S. Dollar Comes from…</th>
<th>Supply of the U.S. Dollar Comes from…</th>
</tr>
</thead>
<tbody>
<tr>
<td>A U.S. exporting firm that earned foreign currency and is trying to pay U.S.-based expenses</td>
<td>A foreign firm that has sold imported goods in the United States, earned U.S. dollars, and is trying to pay expenses incurred in its home country</td>
</tr>
<tr>
<td>Foreign tourists visiting the United States</td>
<td>U.S. tourists leaving to visit other countries</td>
</tr>
<tr>
<td>Foreign investors who wish to make direct investments in the U.S. economy</td>
<td>U.S. investors who want to make foreign direct investments in other countries</td>
</tr>
<tr>
<td>Foreign investors who wish to make portfolio investments in the U.S. economy</td>
<td>U.S. investors who want to make portfolio investments in other countries</td>
</tr>
</tbody>
</table>
</div>

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Demanders and Suppliers of Currency in Foreign Exchange Markets

Economics studies social behavior guiding the allocation of scarce resources to meet the unlimited needs and desires of the individual members of a given society, and for the production of goods and services, growth of production and welfare over time, and a great variety of other complex issues of vital concern to society. 

Economics

Discover the inner workings of international currency exchange and learn about the key concepts and principles related to demanders and suppliers of currency, fluctuations in exchange rates, and the macroeconomic effects of exchange rates.


Demanders and Suppliers of Currency in Foreign Exchange Markets

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