Exchange Rates and the Foreign Exchange Market: Introduction and Overview

This chapter provides an overview of foreign exchange markets, their activities, and their products. The foreign exchange markets play an important role within an economy. The Forex market links domestic capital markets to foreign ones. Forex market activity is often a key determinant of liquidity within a capital market. An exchange rate is quite simply a price of one currency in terms of another. Much like the prices of other things, exchange rates reflect the forces of demand and supply. Demand and supply for a currency may in turn be affected by a myriad of factors. Unless one begins with an exchange rate that is one to one, the percentage appreciation of a currency against another will not equal the percentage depreciation of the other. This chapter discusses what exchange rates are, how they are quoted, and how changes are measured. Exchange rate exposure and its management are examined in depth. The chapter also examines Shariah-compliant techniques for managing currency exposure.