Essay About Currency Exchange Rates And Floating Exchange Rate

Factors That Determine the Currency Exchange Rates
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Factors that Determine the Currency Exchange Rates
Exchange rate is often referred to as the nominal exchange rate. It is
defined as the rate at which one currency can be converted, or
exchanged, into another currency. For example, the pound is
currently worth about 1.824 US dollars. One pound can be converted
into 1.824 dollars. This is the exchange rate between the pound and
the dollar. There are four types of currencies can be operated, which
are a floating, managed and fixed exchange rate.
Lots of developed industrial nations like US ($), UK (???) and Japan (??￥)
operate floating exchange rates. A floating exchange rate is known as
freely floating and should be self-regulating. It is often determined
by the market demand and supply without any other government or
official interference. As the exchange rate between pound and dollar
for example, the price of pound in terms of dollar would decided by
the demand for pounds from whom hold dollars and the supply of pounds
from sterling holder who want to buy dollars. When people in the UK
try to buy US goods and services they will supply pounds to US,
however, when people from US try to by UK goods and services they will
demand UK pounds. At this time, the price which keeps the demand and
supply force in balance is the exchange rate between pound and dollar.
As it shows in
[IMAGE]Price of ???s in $s S D
(FIGURE 1.1)
0 Q Quantity of???s
figure1.1, when one pound equals one and a half dollars, the price is
in equilibrium.
Although floating exchange rate is mainly affect by market forces,
actually sometimes a nations central bank try to influence the
exchange rate. They can use the way of adjusting the interest rate to
influence the capital flow into or out of the country or directly
buying or selling the currency. The reason central bank try to manage
the exchange rate is to reduce the fluctuations around the equilibrium
exchange rate they believed. The ERM which stands for the exchange
rate mechanism is an example of a managed exchange rate. It is
fundamentally for preventing large fluctuations relative to European
Unions (EU) countries currencies. the member countries of EU have to
keep their currencies value within a permitted band. Country has to
take actions to bring its exchange rate value within the set band when
its currency moves out of it. As it shows in figure1.3 that there is
an increase in demand for imports, then lead the supply curve to shift
right from S to S. In order to lower the price of the currency, the
country may take actions such as raising its domestic interest rates
or buy its own currency. This results demand curve shifts right from D
to D and keep the value of the exchange rate within the band.
Price of currency in Euros
[IMAGE] D
Upper margin
Lower margin