Theory Of Topic - Exchange Rate
Exchange rate is also known as foreign exchange rate, forex rate and FX rate of two currencies with each other. In other words, it means the rate at which the currency of one country will be exchanged with the currency of another country.
The exchange rates of currencies are determined in the exchange market which works exactly like how the price of goods and services are set, i.e. at market equilibrium. The market equilibrium strikes where the forces of demand and supply meet. The exchange market is similar to the stock market where different buyers and sellers meet and trade in currencies. The currency market is open 24hours a day unlike stock market. It is only closed during the weekend. The currency market works like a futures market where the currency rate is determined by the spot exchange rate and the delivery is done at a later stage.
The exchange rate of one country means the rate of its currency in terms of a foreign currency. It thus, is made up of two components, the domestic currency and the foreign currency. The exchange rate can be quoted directly and indirectly. In the direct quotation or expression, the foreign currency is expressed and defined in terms of the domestic currency. In the indirect quotation or expression, the domestic currency is expressed in terms of the foreign currency. In case the currencies that are being exchanged does not include at least one domestic currency, the rate then established is known as a cross currency or cross rate.
There are three types of exchange rate in the economies, floating exchange, fixed exchange and pegged float exchange.
Floating exchange rate, also known as fluctuating exchange rate is the type of exchange rate where the currency is subject to float as per the foreign exchange rate. A fixed exchange rate is the type of exchange rate where the rate is fixed by governments who try their best to maintain a consistent currency rate. Pegged Float exchange rate is the type of exchange rate where the currency is floating but is adjusted in a periodical manner.
Exchange Rate or Forex is important as a country's currency is the value against other currencies which plays an important role in the exchange of goods and service via import and export, tourism, debt collection etc. It also shows how functional a country's exchange rate market is. It is a function and result of a country's monetary policies as well.
The exchange rate also shows the purchasing power of one country's currency in relation to the currency of another country. Also, a country's foreign exchange reserves changes its values with fluctuations in exchange rate, thus, impacting its balance of payments, which serves as an important indicator of country's economic position and status. Since, international trade and foreign exchange reserves serve such an important part in a country's economic status, exchange rate becomes extremely important.
Problems Encountered In Solutions To Exchange Rate Problems
Exchange rate is a rate which is heavily dependent upon the foreign exchange markets around the world. The foreign exchange market work on the principle theories of demand and supply of currencies in the market also, the exchange rates are quote up to four decimal points. Taking all this in consideration, one can imagine how difficult exchange rate problems must be. It includes calculations which are in decimal points and since the amounts are usually large and heavy, every decimal point matters which requires time and attention. Complex calculations add up to the difficulty level of the exchange rate problems. The exchange rate equilibrium is already difficult to understand with presence of a large number of users in the market. Banks, financial institutions and High Net worth individuals, (HNIs) are major players and there are several investors involved. The investors around the world use the exchange market as an arbitrage to secure less risk in their transactions when they are doing real time transactions in foreign currencies.
Given all these factors, problems of exchange rates are complex and challenging. They include long calculations which need to be accurate to the point. This makes students face difficulty while solving problems related to exchange rate.
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