Though, the term Foreign exchange reserves strictly were meant to denote foreign currency, a widespread local use of this terminology has been used to denote gold, Special Drawing Rights, and International Monetary Fund reserve positions.

The alternate accurate terminologies used to denote Foreign Exchange Reserves are International Reserves or Official International Reserves.

The central bank holds a reserve of several commonly required foreign currencies for trade like Dollars, Euro, Yen and many others. These reserves are obtained in exchange for issuing the domestic currency or as a part of deposits made by the government, financial institutions or bank reserves, deposited with the central bank.

Traditionally, reserves of gold or silver were considered to be foreign reserves; the US dollars were considered to be a reserve currency per the Bretton Woods System. In the current day world Gold should be purchased in the Gold market like any other product and it is not considered to be currency reserve any more. Regardless, of the inconvertibility of currencies to gold, currencies can still be reserved.

In a variable exchange rate system, the official valued international reserve can be used by the central bank to buy the domestic currency. The purchase of the domestic currency with the international currency is done in a way to stabilize the domestic currency.

Central banks of different nations involve in buying and selling official valued international reserves in a way to influence the applicable exchange rates.

In conditions where a fixed exchange rate is followed, the central bank will be buying or selling foreign currency per the demands in the domestic market.

In situations of mixed exchange rates, the central bank might be involved in buying or selling foreign reserve in a way to maintain the exchange rate of the domestic currency at a targeted range.

Countries which do not have a target exchange rate have a floating exchange rate. To maintain the domestic currency exchange rate near the required targets, the central bank can print new domestic currencies and they will purchase the foreign reserve for the domestic currency.

However, trying to defend the domestic currency with a foreign reserve in an un-sterilized manner (printing more notes) leads to an inflation of the domestic currency with respect to value of goods and services. This can lead to increased foreign reserve accumulation and decreasing demand for domestic currency in the market. This can lead to currency devaluation. Foreign exchange reserves are an indication of the capacity of the Central bank to repay foreign debts, maintain the exchange rate for its domestic currency and also it contributes to the credit rating of a nation. In extreme crisis, the other assets of the government will also be considered for stabilization of their funds.