The foreign exchange market is the largest market in the world with current estimates approximating the daily volume at $3 trillion. Currencies are traded around the clock throughout the world. The spot rate is the price of a currency purchased for immediately delivery (settlement occurs in not more than two business days). Most buying and selling occurs in the interbank market, and the minimum transaction size is one million units of a specific currency.  

Spot exchange rates are a function of supply and demand. Quite simply, when foreign countries wish to buy domestic products, they require the domestic currency to do so. If this demand is substantial, it will raise the price of the currency. Countries with a large exporting base generally have relatively stronger currencies.

The supply and demand of a currency is affected by such things as inflation, interest rates, and risk. Each of these items is relative in that the change it has on a currency can only be determined by comparing the relative change to another currency. A country with a relatively high rate of inflation will have a depreciating currency when compared to countries with lower rates of inflation. Interest rates have the opposite effect. High interest rates will attract money to a country boosting its currency relative to countries that have lower interest rates. Additionally, country risk also affects the value and exchange rate of a currency. Countries with high political risk and/or poor economic prospects will generally have a lower exchange rate compared to a country that is more stable.  

There is also considerable currency trading that occurs in black markets around the world. Stable currencies are favored on the black market, and therefore they actually have two immediate trading rates – the spot rate and the black market rate. As an example, the dollar has been depreciating relative to some currencies, such as the euro, but the dollar still dominates the black market. The dollar is the currency of choice in black markets of many developing countries despite the fact its lost value in some cases. Black market trading is popular in countries that have tight currency controls and those that are fraught with exorbitant inflation. The important thing to remember is that the immediate rates of a currency are constantly changing. Forward contracts, where a predetermined price is negotiated, are available for those who are uncomfortable with the constant fluctuation in the spot market.  

Sources:
Carbaugh, Robert. International Economics. Mason, OH: Thomson South-Western, 2007. 
Connors, Will; Darcy Crow; Nguyen Anh Thu. “Globally, the Greenback Remains King.” The Wall Street Journal. 29 October 2009.