Guide To Foreign Exchange Rate

The foreign exchange rate definition refers to the value of the domestic currency in relation to other currencies. Moreover, in currency exchange, there are two types of rates: fixed and floating. Fixed-rate exchanges are determined by the central bank while floating exchanges are determined by the market. 

Banks and other small businesses that are legally allowed to convert one currency to another usually provide currency exchange services. During your overseas trip, most banks offer currency notes in various denominations to meet your small to medium expenses. In this article, let's understand what is the exchange rate, the factors that affect exchange rates and its impacts. Also, you can learn how exchange rate is determined in flexible exchange rates and fixed exchange rates.

What is the Exchange Rate?

In currency trading, the foreign exchange rate meaning refers to how much the domestic currency is worth compared to other currencies. To compare two currencies, foreign exchange shows their relative values by comparing them.

A forex exchange rate definition refers to the rate at which one currency is exchanged for another or as the price of one currency expressed in terms of another. There are two types of exchange rates for currencies: fixed and floating. In a fixed-rate exchange, the central bank determines the rate, while in a floating exchange, the market determines the rate.

Open Demat Account

Your first step to enter share market

Get Started

* By signing up you agree to our Terms and Conditions

Types Of Exchange Rates

The following are the types of exchange rates:

Fixed Exchange Rates

Under this system, the government sets the exchange rate. So, it's the government's responsibility to keep the exchange rate stable. Moreover, every country maintains its currency's value against some 'external standard' like gold, silver, or another currency. 

Fixing the exchange rate keeps foreign trade and capital flows stable. Moreover, to keep the exchange rate stable, the central bank or government buys and sells foreign exchange when the rate rises and falls. The government has to keep large reserves of foreign currencies to keep the exchange rate fixed.

As one currency (domestic) is pegged to another and that's why the fixed exchange rate system is also called the pegged exchange rate system. Whenever a currency's value is fixed in terms of another or in terms of gold, it's called parity value.

Flexible Exchange Rate System

In this system, the exchange rate is fixed by demand and supply on the foreign exchange market. It's also called a floating rate of exchange or a free rate of exchange. This is because supply and demand forces determine it on the international money market.

Additionally, the Flexible Exchange Rate system doesn't involve government intervention. Since the rate changes with the market, it's called flexible. The foreign exchange market determines the exchange rate by interacting with banks, firms, and other institutions.

Factors Affecting Foreign Exchange Rate

After understanding what is the exchange rate and its types, let's learn the factors that affect the exchange rate. The exchange rate can be influenced by a variety of factors, including economic, political, and psychological factors.

Economic Factors

Inflation, trade balances, and government policies are known to affect foreign exchange rates.

Political Factors

Unrest in the country and political conflict can cause the foreign exchange rate to change.

Psychological Factors

In terms of psychological factors, the psychology of the participants involved in foreign exchange affects the foreign exchange rate.

Features of Foreign Exchange Rate

To understand foreign exchange rates it is crucial to know features associated with it. The following are the key features of foreign exchange rates.

Comparative Values

The foreign exchange rate shows the comparative value of the currency. The countries can make transactions with international partners more efficiently with the help of exchange rates. Thus, foreign exchange rates play an essential role in terms of function.

Fixing Rates

The economist determines the well-being of a country through exchange rate monitoring. Whenever currency exchange rates fluctuate too much, the authorities must act to fix them. This also promotes stability in the economy and prevents an economic downturn from occurring.

Demand Grows and Export Increases

A country's exchange rate usually rises when import demand increases. This increases the price of imported goods in that country. A country's currency becomes cheaper when imports become more expensive, causing demand to decrease. Due to this, global buyers are more likely to purchase products from that country, increasing demand and exports.

The Impact Of Currency Conversions

A nation's economy is often determined by its currency exchange rate. Even though the rate fluctuates every day, it's important to understand how it can affect a nation's socioeconomic situation.

Impact on Travellers

Say you are planning to visit the US next month. However, your currency has depreciated more than expected due to market tensions. If this is the case, you might want to rethink your travel plans and wait until the currency's value improves.

Impact on Businesses

In businesses dealing with overseas clients, wire transfers or foreign currency demand drafts are often used for transactions or money transfers. In many cases, businesses pay more or receive less money due to fluctuations in the exchange rate or currency depreciation.

Impact on Consumers

Let's say you want to order a $40 electric gadget from the US. During the time you viewed the product, the Indian rupee was worth Rs.65 against the USD. However, due to market swings, INR is now worth Rs.75 against USD. In other words, if you go ahead with your order, you'll end up paying more in your currency even though the price didn't change. In the same way, exchange rate fluctuations make consumers pay more.

Conclusion
To manage the overall economic position of the country, foreign exchange rates are an important aspect for the government. Therefore, it is given utmost importance in domestic policies as well as in managing geopolitical relationships. Also, at the micro level, they form an important aspect of the accounting and reporting provisions of a company. Hence, they have to be adhered to as per the provisions of the Companies Act 2013 along with the accounting standards issued in this regard from time to time. You can trade various foreign currencies on a reliable stock market app.