foreign exchange

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foreign exchange

foreign exchange, methods and instruments used to adjust the payment of debts between two nations that employ different currency systems. A nation's balance of payments has an important effect on the exchange rate of its currency. Bills of exchange, drafts, checks, and telegraphic orders are the principal means of payment in international transactions. The rate of exchange is the price in local currency of one unit of foreign currency and is determined by the relative supply and demand of the currencies in the foreign exchange market. Buying or selling foreign currency in order to profit from sudden changes in the rate of exchange is known as arbitrage. The chief demand for foreign exchange within a country comes from importers of foreign goods, purchasers of foreign securities, government agencies purchasing goods and services abroad, and travelers. Exchange rates were traditionally fixed under the gold standard and later by international agreements, but in 1973 the major industrial nations of the West adopted a system of “floating” rates that allowed for fluctuation within a limited range. The currencies of Western nations are generally allowed to fluctuate freely, although central banks will intervene in the foreign exchange markets in an attempt to control excessive or undesirable appreciation or depreciation.


See S. W. Arndt et al., ed., Exchange Rates, Trade and the U.S. Economy (1985); N. Abuaf and S. Schoess, Foreign-Exchange Exposure Management (1988).

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References in periodicals archive ?
(6) That is, for a general equilibrium to exist under standard economic analysis, it must not be possible for markets to be arbitraged. Because we do not observe significant levels of arbitrage, it is generally assumed that markets operate in a fashion that prevents arbitrage opportunities from arising.
One consequence of this theorem is that, if one can find a way to allocate probabilities in a manner which follows the standard rules described above, then a set of prices derived from a risk-neutral valuation based on these probabilities is not capable of being arbitraged and, conversely, if the market is not capable of being arbitraged, there is at least one set of probabilities (although there may be possibly infinitely many if the market is incomplete) that one could use that would give the observed prices via a risk-neutral valuation.
Clearly, adequate care must be taken to prevent unallowable arbitraged on government funds.