Key Concepts and Summary

Key Concepts and Summary

In the foreign exchange market, people and firms exchange one currency to purchase another currency. The demand for dollars comes from those U.S. export firms seeking to convert their earnings in foreign currency back into U.S. dollars; foreign tourists converting their earnings in a foreign currency back into U.S. dollars; and foreign investors seeking to make financial investments in the U.S. economy. On the supply side of the foreign exchange market for the trading of U.S. dollars are foreign firms that have sold imports in the U.S. economy and are seeking to convert their earnings back to their home currency; U.S. tourists abroad; and U.S. investors seeking to make financial investments in foreign economies.

When currency A can buy more of currency B, then currency A has strengthened or appreciated relative to B. When currency A can buy less of currency B, then currency A has weakened or depreciated relative to B. If currency A strengthens or appreciates relative to currency B, then currency B must necessarily weaken or depreciate with regard to currency A. A stronger currency benefits those who are buying with that currency and injures those who are selling. A weaker currency injures those, like importers, who are buying with that currency and benefits those who are selling with it, like exporters.

Glossary

appreciating

when a currency is worth more in terms of other currencies; also called “strengthening”

depreciating

when a currency is worth less in terms of other currencies; also called “weakening”

dollarize

a country that is not the United States uses the U.S. dollar as its currency

foreign direct investment (FDI)

purchasing more than ten percent of a firm or starting a new enterprise in another country

foreign exchange market

the market in which people use one currency to buy another currency

hedge

using a financial transaction as protection against risk

portfolio investment

an investment in another country that is purely financial and does not involve any management responsibility