Econ Grapher

Currency

What is Currency?
Currency refers to the generally accepted form of money in circulation in a country, issued by the government or relevant authority. The purpose of currency is to act as a medium of exchange for goods and services. Most countries have their own currency, with the exception of those EU countries that have adopted the Euro as their currency. A country's currency can be traded for other countries' currencies, indeed the international foreign exchange market is the most highly traded market, with volumes in the trillions. When a currency is traded for another currency the rate at which the transaction occurs is referred to as the exchange rate. The exchange rate is an important regulating device in the global economy, left floating, exchange rates will reduce imbalances over time, but when the exchange rate is fixed the regulating function ceases and imbalances can arise.

How does it relate to Markets?
As noted the currency market is one of the most widely traded in the world, also referred to as forex, or foreign exchange trading. Indeed the forex market is an ideal place for taking positions based on views about macro-economic trends e.g. rising interest rates in one currency vs another may create carry trade opportunities and thus cause the currency to appreciate - so a view on increasing interest rates could be leveraged in the forex market. The exchange rate is also an important data point in macro economic analysis, when a country's exchange rate falls its exports will become relatively more competitive because the effective price will be lower, likewise asset prices may also appear cheaper to international investors and thus capital flows may also increase (both factors would cause demand to eventually rise for that currency, which may cause the exchange rate to rise - thus is the regulating force of currencies). The exchange rate will also implicitly include information about interest rates and inflation, as an exchange rate is a function of relative purchasing power.

Currency Code
Currencies all have an ISO 4217 code comprising 3 letters, this is used in quoting exchange rates, or designating which currency a bill or payment is in. For example the United States Dollar is USD, the Euro is EUR, the Chinese Yuan is CNY, New Zealand Dollar is NZD, and so on.

Fixed vs Floating
A currency or more appropriately, the exchange rate is said to be floating if the exchange rate is determined by market forces. For example the USD is a floating currency, because it is freely traded and the government does not control the level of the exchange rate. A pure float is most suitable for a well functioning global financial and economic system. A fixed exchange rate is one where the government of one of the currencies controls the level of the exchange rate with another currency e.g. the USD, examples of fixed rates include Hong Kong, and formerly China; however China recently announced further flexibility and reforms. A managed float is something between a fixed and floating rate, for example the exchange rate may trade within a band. A dirty float is a floating exchange rate, but where unofficial government interventions take place periodically.

Sources and further reading:
Wikinvest - Currency
Investopedia - Currency
ISO - Currency Codes
CNNMoney.com - Currencies

Graph Library:
Metric - Currency

Original Source: http://www.econgrapher.com/encyclopedia-currency.html

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