foreign exchange rates
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Foreign exchange rates

In a lot of ways, you need to think about foreign exchange rates and currency the same as any other product. Every provider of foreign exchange services will acquire money from a supplier (the markets), add a value to it, and then charge the consumer (you) a small margin over the original expense to make profit - the foreign exchange rates you see on the high street or in the papers.

So with foreign exchange, there is nothing different, especially when you are going abroad for holiday.

However, it happens that if large amounts are exchanged, such as in big business, a cheaper price is available. This is the same as a wholesale price in domestic UK markets. The rationale is that the seller is prepared to make a lower profit margin on a greater turnover, while the buyer purchases a large amount for a discounted price.

How does Foreign Exchange actually work?

Within the foreign exchange market companies trade in 'tiers'. Volume attracts volume, and so the largest market participants will trade with each other, and the prices they trade at are the prices that are published to the world. Smaller participants, even though they exchange a large amount, are also forced to trade with each other. There can be many tiers within the market at any one time, and the prices that transactions occur at can also vary dramatically. This is the very nature of a global, dynamic, 24 hour market. If it is the case that a small amount needs to be exchanged and there is only a large participant available, that smaller trade will have to pay a premium to what is known as the 'spot' rate (or benchmark exchange rate).

As a general rule, the greater the risk, or the smaller the amount, the greater the price will be.

If for instance, a traveler wants to exchange pounds for the currency of a politically and economically unstable country that is under siege, or with its currency and economy precariously close to collapse, or trade sanctions being imposed to cause enormous instability in that country, there would be few people who would desire to hold the currency of that nation (due to the risk). So, the UK citizen travelling there would find it very easy and cheap to exchange pounds for that currency. It is when they want to recover their pounds on their return that they will experience great difficulty in finding a similar rate of exchange (because no one wants to hold that currency).

Similarly, if a traveler wants to exchange 1000, they will invariably be offered an exchange rate 2-3cents (or units) below the spot market rate, simply because they are in the retail 'tier' of the market. The margin represents profit to the seller of the currency, who can now offset their transaction at a profit. This means that they will receive less foreign currency in exchange for their pounds. If a larger amount needs to be exchanged, a much better price will be attainable, but comparisons between the various providers will need to be made, in order to receive the best price.

Foreign exchange providers often charge a fee in addition to the exchange rate they offer, which can vary between 4 -6 per transaction (so it pays to exchange large amounts as opposed to small ones). However, make no mistake; this in reality is a double service charge, comprising of the margin on the exchange rate, and also the monetary fee, so this needs to be considered when making comparisons of the alternatives available.

Numerous providers of foreign exchange abound in the UK. They range from banks to post offices, licensed exchange merchants and other financial institutions. In addition, providers such a PayPal, Monyebookers and POli also provide foreign exchange facilities, albeit through the individual's bank account.

Most of these establishments in the UK are reputable and regulated, with professional standards that they adhere to. If on the other hand, the traveler needs to exchange currency overseas, some countries are not as regulated as others, and it will be found that while some financial institutions may exist, most of the currency vendors will be available in shop fronts or on the street. This is not to say that value is absent in these transactions, but only that it is more unlikely.

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-- Additional useful articles --
»  Credit card currency for cash abroad
»  Travelers cheques an option?
»  Using debit cards abroad for currency
»  Comparing currency exchange options
»  Background on travelers cheques

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