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Define Currency Exchange: How Exchange Rates Can Fluctuate?

Referencing Styles : APA | Pages : 1
  • University: Brock University
  • Country: CA

Define currency exchange:

Currency exchange rate is the nominal amount that would be provided to the buyer or seller of the currency from one country to another. The currency exchange rate is fixed on market conditions, interest rates and other domestic valuation of the country. The value of the exchange rate is determined in the foreign exchange market, which is mainly open to all type of traders, as the currency trading is continuous and occur in 24-hours a day except weekends. Moreover, currency exchange rate is the overall value at which one currency is swapped for another at the market rate. However, the currency exchange rate is mainly determined under two three different measures, such as open market valuation, forward exchange rate valuation and retail currency exchange rate valuation. The derivation of exchange rate is dependent on the user, as general traders can opt for open market trades, while small business can use the forward exchange rate for business purposes and retail investors use the retail currency exchange rate which is greater than the market rates.

Explaining how exchange rates can fluctuate:

There are certain factors that directly have an impact on the exchanges rates of a country, which in increases or decreases their valuation in the international market. The major factors that have a direct impact on the valuation of the country exchange rate are depicted as follows.

Interest rates: One of the major factors that has direct impact on the currency exchange of a country is their interest rates. The central bank of the country is responsible for the interest rates, where higher interest rates makes the currency more valuable in the eyes of the investors. The increment in the overall interest rates will encourage the foreign investors to investment in the country, which will in turn raise demand for the currency in the open market and have direct impact on its overall performance. Central banks use the measures for increasing the valuation of their currency in the international market, which in turn supports the importers of the region. In the similar process, the Central bank could reduce the interest rates, which directly decreases the overall valuation of their exchange rate, as it helps the exporters of the region.

Money supply: The second measures that has a direct impact on the exchange rate of a country is money supply, which is mainly created by the central bank of the country. The money supply in the region is a major concern for the Central Bank, as higher amount of money is printed then there is too much money that will be acquired by currency holders, which lead to inflations. The increment in inflation value in a country directly reduces the overall value of currency exchange. Hence, if too much money is printed by the Central Bank of the region then it causes hyperinflation, which has a direct impact on the currency valuation of the country. Thus, overseas investors do not invest in economy that has high inflation, which in turn will reduce the currency valuation of country.

Economic growth: The Third measure that directly affects the currency valuation is the economic growth and financial stability of the country, as it directly impacts its exchange rate. Thus, country with high economic growth will directly have strong and growing economy, where exports, goods and services of the country will be high. Thus, increment in the demand for the goods or increase in exports will directly raise the order for the country’s currency. Thus, it could be understood that with higher financial stability investors will be keen on investing in the country, which will raise value of the country currency.

However, the above factors directly indicate about the relevant change in the exchange rate that occurs due to the decisions that has been made by the central bank of the country. Moreover, there are two types of exchange rates that relevantly affect the valuation of country’s currency. The two types of exchange rate that occurs in real world practices are flexible exchange rates and fixed exchange rates. The derivations of both exchange rates are depicted as follows.

Fixed exchange rates: There are many countries who have been using fixed change rates, which does not vary in accordance with the forex market. In the particular situation, the country aims in securing a fixed change rate for a particular international currency by selling and buying large quantities of the currency and other currencies for maintaining a fixed value. China is one of the countries, which maintains a fixed exchange rate by using the pegging system, where it directly targets the Dollar against Yuan. Since 2003 the Chinese government has been involved in the dollar pegging scheme, where the continuous buying the Dollar has allow Yuan to remain at similar levels, as the current valuation is at 1USD = 6.88Yuan.

This currency pegging system was also used by the Switzerland, where it intentionally reduced its Frank value in comparison to EUR. The central bank of Switzerland hoarded large quantities of EUR for reducing the valuation of Frank for promoting exports and increasing the competitive edge of the suppliers. However, the decline in the EUR valuation backfired on the valuation condition of their currency, which is now being discontinued by the Central Bank of Switzerland.

Flexible exchange rates: The flexible exchange rate is mainly determined by the foreign exchange market, where the rates directly fluctuate on a moment-by-moment basis. The valuation in the forex market is mainly based on lot of factors, where interest rate, country debt levels and economic strength plays a vital role. One of the major examples of flexible exchange rate conditions is the dollar value which has increased continuously even after the financial crisis, as economic strength of United States is relevantly high. Hence, the flexible exchange rate provides more stability in determining the correct valuation of the currency. The guarantee that is provided by the US Treasury directly allows the US government to determine the USD value, as per the forex market.

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