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I was recently on holidays in Turkey and had two experiences changing money.

The first was a currency exchange office in the city center. The staff there had computer monitors and were hooked into some electronic trading system. When they change dollars or euros to local currency, I can see that they can book a trade electronically.

The second experience was a jewellery shop in a local town. The shop owner traded currency (dollars, euros, pounds for local currency). Whilst he checked rates on his phone, I could not see that he used an electronic trading system. He just took cash, and gave cash in local currency.

Question - how does he make money? And how does he avoid risk of currency fluctuation (turkish lira has been quite volatile in recent years).

He was giving very similar rates to the "proper" exchance office in the city center.

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    IMHO, this question is should be posted under econmics SE board. – mootmoot Aug 13 at 10:59
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how does he make money?

Such currency exchange kiosks usually either take a fee or provide a worse exchange rate than banks do. They later go to a regular bank and exchange their foreign currency into local currency at the usual exchange rate and keep the difference.

The exchange rates banks offer to tourists will often be worse than those they offer to local businesspeople. The latter arrive with counted money in bulk, the proper paperwork on hand and can articulate themselves properly in the local language, so dealing with the professionals means a lot less work for the bank.

In some countries it might also be very difficult for locals to acquire foreign currency from an official bank. In that case, the black market exchange rate from local currency to € or US$ might be far higher than the official one. People who are in a position to acquire foreign currency from tourists can profit quite a lot in such an environment.

And how does he avoid risk of currency fluctuation

That's a risk of doing business. Risk-averse currency traders would make frequent trips to the bank. More adventurous currency traders might monitor the exchange rate trends and international news. When they expect that a certain currency will soon raise in value, then they will hold on to it and exchange it at a more opportune moment.

  • Thanks for great answer! I was a bit puzzled that he could offer the same exchange rate as the bank (to tourists) and still be able to make money. – vikingsteve Aug 13 at 13:41
  • A system like Hawala (which use by some prominent online exchange trader now) with online confirmation is able to minimize typical currency transfer volatility. – mootmoot Aug 13 at 13:57
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There are three ways the currency dealer could be making money providing the foreign exchange (forex) conversion:

1) Spread markups: the difference between the bid/ask price (i.e. the rate where you can buy and the rate you can sell), compared to the underlying spot rate (not the bank rate which is already marked-up from the real interbank spot price. In other words, the rate banks offer consumers are usually not indicative of the real underlying interbank spot price, as they will add a spread. So if the mid-point between the Euro for example against the Turkish Lira, also known as the EUR/TRY pair was trading at 6.20714 TRY for every 1 euro, the underlying interbank spot rate might be 6.20707/6.20721, but the price offered by a bank or local kiosk (at airport etc..) could be far worse such as 5.4100/7.1200, and therefore both the bank and local provider are earning considerable spread compared to the true spot rate.

2) Commission: many services might add a fixed commission rate which could be expressed as a percentage of the base currency (Euro, in above example) or counter currency (Turkish Lira, in above example), depending on whether you are buying or selling. Or there could be other commission models, such as in the interbank markets commissions could be $10 per 10,000 (i.e. $100 per 100,0000) or might not scale, such as $10 regardless of size up to a certain limit.

3) Market-maker risk: In terms of avoiding/dealing with currency fluctuations, the dealer is either acting as an agency broker which means it is earning from the commission only and not the spread, as the trade is executed through a 3rd party the dealer uses, although I should note how that third party could rebate a portion of the spread back to the dealer. However, the dealer would have no market-maker risk in this setup as an agency broker, as that risk would be mitigated. If however, the dealer was taking the risk on the other side of each trade, they would need to be able to offset and manage that risk through a combination of hedging and settling their exposure (such as if it reaches a certain Value at Risk (VaR) threshold). If the dealer handles other currencies this risk management becomes more complex and would be akin to how online forex brokers manage their risk. The Global FX Code are new standards that banks and interdealer brokers are adapting in terms of best practices, and in some cases, these practices are trickling down to the smaller banks and local dealers to help bring more integrity to the market and avoid price gouging: https://www.globalfxc.org/docs/fx_global.pdf)

And since the dealer is handling physical currency, there is likely a delay between how the risk is managed and when an exchange is made, unless it is managed in real-time when providing the service to the client (which would require an electronic trading platform or voice-broking system). Given the rise of financial technology payment's application, it would be pretty easy for the dealer to manage such risk with the right system in place, otherwise, they could have substantial end-of-day risk if they handled a sufficient number of transactions and if the market moved against them adversely (or profit if it moved in their favor).

  • Undisclosed affiliation with one of the links listed. Please see money.stackexchange.com/help/behavior. In particular: "The community tends to vote down overt self-promotion and flag it as spam. Post good, relevant answers, and if some (but not all) happen to be about your product or website, that’s okay. However, you must disclose your affiliation in your answers." – Chris W. Rea Aug 17 at 22:54
  • Thanks @ChrisW.Rea, I wasn't aware of that requirement. I am affiliated with ForexBrokers.com and added the link as a reference to the types of brokers I was referring to that have lower spreads compared to local banks and kiosk dealers. I'll be sure to disclose any affiliation again in the future with related answers. – Steven Hatzakis Aug 19 at 5:42

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