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Foreign Exchange 101

For many years, if you as a business or as an individual wanted to send money overseas you instructed your bank to carry out the transaction. With no competition at all the banks were able to charge high fees and offer poor exchange rates. But this was seen as a necessary evil to get a payment to its destination. Then in the late 1980s and early 1990s we started to see competition as Currency houses started to appear. Initially these were typically Bureau de Change that started springing up on London streets and then in airports. Eventually offices were opened and these currency houses started offering a service for corporate clients and individuals. Reducing or completely scrapping transaction fees and offering competitive rates of exchange.

These companies were able to offer a bespoke service compared to the banks, for the banks foreign exchange was just part of its core products. In the early days currency houses were able to offer much better rates because their overheads were much lower than the banks. But overtime even some of the bigger currency houses have had to widen their margins where they can because of ever increasing overheads. 

The basics are straight forward. A currency provider makes profit from the difference between the price they buy the currency for and what they sell it to you for. This is the margin. The bigger the margin, the bigger the profit. On the internet, on TV, in the financial press you will be able to see what is called the interbank rate. This is the rate that banks trade at when making huge transfers, this is seen as the mid-market price and what most of the currency houses work from. For the client they ideally want to be as close to that price as possible. For the currency house they want to win your business AND make a profit.

In general the larger the amount you are looking to transfer the closer you would expect to get to the interbank rate. Unlike most banks a currency provider will give you an upfront quote. So you know in advance how much you are receiving before you make the decision to go ahead. 

So what do you need to know? Firstly, that who you are dealing with are regulated, most important. Secondly, have an idea of where the interbank rate is so that when you are quoted you know whether that seems a fair price or not.

Foreign Exchange can be as simple or as complicated as suits the situation, currency houses and brokerages have a vast array of tools to hand to help minimise risk in the ever fluctuating currency world.