Exchange Rates

You hear about foreign exchange market, foreign exchange, FX, forex, exchange rates etc daily but did you understand it clearly? There is some information which will surely help you to understand these confusing terms.

The 1st thing you must know is what an exactly an exchange rate is. An easy definition of the exchange rate is: a rate need for exchanging one currency for another. An exchange rate is the cost of a currency, such as each product or service has its own cost. Thus each country’s currency has a certain value compared to another one.

You should know different exchange rates whenever you go to another country and you have to purchase that country’s currency. e.g. if you are properly from France and you take a trip to USA and rate of exchange is 1.10D for Euro, this means you can purchase more than a dollar for your currency - Euro.

If you are bothered about how much you can purchase for your own currency in other country, you must know that price of one product should tentatively stay the same; despite of the currency it is utilized to calculate its value. It is because the rate of exchange is maintaining the currency value at its own level.

If you are surprising about the way this rate of exchange is being calculated, you must know there are 2-methods that are being used for this. The 1st method is the fixed rate. This fixed rate is being set and handle by a central bank of country and it is assumed to be an official one for that country.

The cost level for currency is being calculated by comparing it to the main currency such as euro or US dollar. The central bank is purchasing and selling its own currency in order to maintain the exchange rate at the level which has been set before.

Second method for exchange rate setting is the “floating” method. This method is deciding the rate of exchange by using the demand and supply balance for that currency on the market. Sometime this method is called “self correcting” because the market is automatically correcting the differences between the demand and supply for a currency.

Finally, no exchange rate is being calculated entirely on a floating or fixed method. A mixture of both is generally used to set the cost for a certain currency for a correct value of the currency.