In ancient times, the trading of goods and services was by barter system where in goods were exchanged for each other.
Such system had its difficulties primarily because of non‐divisibility of certain goods, cost in transporting such goods for trading and difficulty in valuing of services.
Therefore the need to have a common medium of exchange resulted in the innovation of money.
People tried various commodities as the medium of exchange ranging from food items to metals. Gradually metals became more prominent medium of exchange because of their ease of transportation, divisibility, certainty of quality and universal acceptance.
People started using metal coins as medium of exchange. Amongst metals, gold and silver coins were most prominent and finally gold coins became the standard means of exchange.
The process of evolution of medium of exchange further progressed into development of paper currency. People would deposit gold/ silver coins with bank and get a paper promising that value of that paper at any point of time would be equal to certain number of gold coins. This system of book entry of coins against paper was the start of paper currency.
With time, countries started trading across borders as they realized that everything cannot be produced in each country or cost of production of certain goods is cheaper in certain countries than others. The growth in international trade resulted in evolution of foreign exchange (FX) i.e., value of one currency of one country versus value of currency of other country. Each country has its own “brand” alongside its flag. When money is branded it is called “currency”. Whenever there is a cross‐border trade, there is need to exchange one brand of money for another, and this exchange of two currencies is called
“foreign exchange” or simply “forex” (FX).
At First, The value of each currency against another currency was derived from gold exchange rate. Then it shifted from gold standard to floating exchange rates. Then to Bretton Woods System, which made USD the dominant currency of the world.
Finally Bretton Woods system was suspended and countries adopted system of free floating or managed float method of valuing the currency.
Being a pegged system, the value of currency is pegged to another currency or basket of currencies.
Currencies which acts Majorly in this system : Euro (EUR), US Dollar (USD), Japanese Yen (JPY), Pound Sterling (GBP), Australian Dollar (AUD), Canadian Dollar (CAD), and the Swiss Franc (CHF).
These currencies follow free floating method of valuation. They work in a pegged system like : EURUSD, USDJPY, GBPUSD, AUDUSD, CADUSD and USDCHF.
Unlike any other traded asset class, the most significant part of currency market is the concept of currency pairs. In currency market, while initiating a trade you buy one currency and sell another currency. Therefore same currency will have very different value against every other currency.
This peculiarity makes currency market interesting and relatively complex.
For major currency pairs, economic development in each of the underlying country would impact value of each of the currency, although in varying degree. The currency dealers have to keep abreast with latest happening in each of the country.
Every trade in FX market is a currency pair: one currency is bought with or sold for another currency. We need to identify the two currencies in a trade by giving them a name. The names cannot be “foreign currency” and “domestic currency” because what is foreign currency in one country is the domestic currency in the other. The two currencies are called “base currency” (BC) and “quoting currency” (QC). The BC is the currency that is priced and its amount is fixed at one unit. The other currency is the QC, which prices the BC, and its amount varies as the price of BC varies in the market. What is quoted throughout the FX market anywhere in the world is the price of BC expressed in QC. There is no exception to this rule.
Exchange rates are constantly changing, which means that the value of one currency in terms of the other is constantly in flux. Changes in rates are expressed as strengthening or weakening of one currency vis‐à‐vis the other currency. Changes are also expressed as appreciation or depreciation of one currency in terms of the other currency. Whenever the base currency buys more of the quotation currency, the base currency has strengthened / appreciated and the quotation currency has weakened / depreciated.
For example, if USDINR has moved from 68.00 to 68.25, the USD has appreciated and the INR has depreciated. Similarly to say that USD looks strong over next few months would mean that USDINR pair may move towards 69.00 from the current levels of 68.25.
Currency being the face on country’s economy shows how well a country in doing financialy. It is really important to know what one’s currency holds and how they can utilize it when it comes to future of Financial Markets.