Reasons for buying and selling foreign currencies: investment in capital goods between countries

Foreign Exchange Rates: Buying & Selling Currencies for Investment

What is a Foreign Exchange Rate? 🤝

A foreign exchange rate tells you how many units of one currency you can get for one unit of another currency. Think of it as a price list for swapping money between countries. For example, if 1 USD = 0.85 EUR, you can trade one US dollar for 0.85 euros. The rate can change every minute, just like the price of a popular snack at a market.

Why Businesses Buy Foreign Currency 💰

• Importing Capital Goods: A UK firm wants a German machine that costs 100 000 EUR. To pay, it must buy euros first.
• Investing Abroad: A Japanese company wants to open a factory in Brazil. It needs Brazilian reais to pay for land, labour, and equipment.
• Future Contracts: A Canadian exporter locks in a rate now to avoid a future rise in the US dollar that would make its products more expensive overseas.
• Currency Hedging: A multinational wants to protect itself against a sudden drop in the currency it uses to pay for overseas suppliers.

Why Businesses Sell Foreign Currency 📉

• Export Revenue: A German exporter receives payment in US dollars and needs euros to pay local suppliers.
• Repatriating Profits: A French company earns profits in yen and wants to bring them back to France.
• Reducing Exposure: A company that has borrowed in a foreign currency sells that currency to pay down debt.
• Speculation: Traders sell a currency they think will fall, hoping to buy it back later at a lower price.

How Exchange Rates Affect Investment Decisions 📈

When a company considers buying a foreign asset, it must think about how the exchange rate will change over time. If the domestic currency weakens, the foreign asset becomes cheaper in local terms, making investment more attractive. Conversely, a strengthening domestic currency can make foreign purchases more expensive.

Example: A UK firm plans to buy a German machine for €100 000. At the current rate of 1 GBP = 1.15 EUR, the cost is about £86 956. If the pound weakens to 1 GBP = 1.10 EUR, the same machine would cost only £90 909, making the investment cheaper. The firm might wait for the weaker pound to get a better deal.

Exchange Rate Formula & Quick Maths

The basic relationship is:

$E_{AB} = \frac{\text{Price of 1 unit of currency A in terms of B}}{1}$

Where $E_{AB}$ is the exchange rate of currency A expressed in currency B. For instance, $E_{\text{USD/EUR}} = 0.85$ means 1 USD = 0.85 EUR.

Illustrative Table of Current Rates (Example)