In this video you will learn about how floating exchange rates are determined. You’ll also learn about the difference between currency depreciation and …
An exchange rate represents the price value of one currency expressed in terms of another.
The cost of Money:
National treaties are vitally important to the way modern economics operate. They allow us to consistently express the value of an item across borders of countries, oceans and cultures. We need these values because one nation's money is not accepted in another. You can not walk into a store in Japan and buy a loaf of bread with Swiss francs. First you have to go to a bank and buy some Japanese yen with your Swiss francs. An exchange rate is simply the cost of one form of currency in another form of currency.
Types of Exchange rates:
Spot rate is defined as the one which applies to 'on the spot' delivery of currency. In spot transaction the actual exchange of money for goods takes place with minimum possible delay. The spot rate is the value of currency under consideration at that very moment.
Forward rate is the one applicable to a transaction, which will occur at specified point of time in future. Here, the value is fixed today but the settlement is at some specified date in the future.
The one which applies to future delivery of the currency is known as future rate. Here, the contract is made today. However, the payment is done on some fixed date in the future with the rate-value on that day.
The floating Exchange Rate
The market determinates a floating rate. A currency is worth whatever buyers are willing to pay for it. This is determined by Supply and Demand, which is in turn driven by foreign investment, import / export ratios, inflation and a host of other economic factors. Generally, countries with mature, stable economic markets will use a floating system. Virtually every major nation uses this system, including US, Canada and Great Britain. Floating exchange rates are considered more efficient, because the market will automatically correct the value to reflect inflation and other economic forces.
Pegged Exchange Rate
A pegged, or fixed system, is one in which the value is set and artificially maintained by the government. The rate will be pegged to some other country's dollar, usually the US dollar. The determined value will not fluctuate from day to day.
Hybrid Exchange rates
A few exchange systems are 100% floating, or 11% pegged. Countries using pegged rate can avoid market panics and inflationary disadvantages by using a floating peg. They peg their value to the US dollar, and that unit does not fluctuate from day to day. However, the government periodically reviews their peg, and makes minor adjustment to keep it in line with the true market value.
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