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  4. What Is the Importance of Foreign Exchange?

What Is the Importance of Foreign Exchange?

By: Sam Grover
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Foreign exchange is important for one major reason: it determines the value of foreign investment. A volatile exchange rate discourages foreign investment, as does a high, stable one. A low, stable exchange rate, however, encourages foreign investment, but at the price of the low-valued currency's economy.

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Currency is essentially a commodity.

Volatile Exchange Rate

If an exchange rate is volatile, foreign investors cannot accurately predict their investment returns. Even if they invest in holdings that give stable, consistent returns in a foreign currency, if that foreign currency is liable to dramatically change its value, then the investment is similarly volatile.

Stable, High Value

A high value currency encourages import markets while discouraging export markets. This is because foreign investors can increase their return on investment (ROI) by making money in a currency that goes far in their country. Exports, however, are harmed, as they are not worth as much overseas as they are at home.

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Stable, Low Value

A currency that has a low value encourages exports and discourages imports. This is because goods sold overseas for higher-value currencies are worth even more than their face value solely because of the currency value. Conversely, there is little incentive for importers to bring goods into a country, and if they do, importers must mark these goods up in order to recoup their losses due to the low currency rate.

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