Often called forex rates, FX rates or Foreign exchange rates, the exchange rates between two currencies are indicators of the worth of a currency in comparison with the other. More precisely, they indicate the value of a foreign country’s currency through comparison with that of the home country. Each of these conversion rates is subjected to frequent fluctuations as a result of the market’s dynamics of demand and supply for one or the other currency.
If you are curious about the way in which this exchange rate is being determined, you need to understand the two main methods that are being applied for this purpose. The very first method is the fixed rate. This fixed rate is often established and maintained by a nation’s central bank making it an official exchange rate for that particular currency. The price for the currency is ascertained by its comparison with a major currency such as the US dollar or Euro. The central bank is trading its currency so as to keep the exchange rate at the level previously set.
An alternative method of setting the currency exchange rate is the ‘floating’ method. Using this method the exchange rate is determined through the use of the demand and supply balance for that particular currency on the private market. This exchange rate is typically termed as ‘self-correcting’ since the forex market automatically corrects the differences between the demand and supply of the currency. The exchange rate here is regularly being modified in response to the demand and supply levels.
Changes in exchange rates
In the international market, the exchange rate is always fluctuating. Whenever the demand for currency in the market exceeds its supply, that particular currency becomes more worthy. In the same way, when demand is lesser than the supply the currency will be less worthy.
The central bank of a country is saddled with the responsibility of observing the exchange rate and is in charge of fixing it. The Central bank can alter supply and demand of currency in the international market by utilizing trades, GDP, keeping up with the employment level in the nation and modifying the rates of interest.
A good number of countries around the world devalue their currency in the international market with the sole aim of gaining trade and inflow of payments. Going this way implies that the commodities of the local country will become cheaper in the international market. Devaluing the local currency over a longer period is suicidal for the overall economy of the country.