exchange rate

Examples of exchange rate in the following topics:

• Introducing Exchange Rates

  • In finance, an exchange rate between two currencies is the rate at which one currency will be exchanged for another.
  • In finance, an exchange rate (also known as a foreign-exchange rate, forex rate, or rate) between two currencies is the rate at which one currency will be exchanged for another.
  • The spot exchange rate refers to the current exchange rate.
  • The forward exchange rate refers to an exchange rate that is quoted and traded today, but for delivery and payment on a specific future date.
  • Explain the concept of a foreign exchange market and an exchange rate

• Fixed Exchange Rates

  • A fixed exchange rate is a type of exchange rate regime where a currency's value is fixed to a measure of value, such as gold or another currency.
  • A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime where a currency's value is fixed against the value of another single currency, to a basket of other currencies, or to another measure of value, such as gold.
  • A fixed exchange rate regime should be viewed as a tool in capital control.
  • China is well-known for its fixed exchange rate.
  • Explain the mechanisms by which a country maintains a fixed exchange rate

• Exchange Rate Systems

  • The three major types of exchange rate systems are the float, the fixed rate, and the pegged float.
  • An exchange rate regime is how a nation manages its currency in the foreign exchange market.
  • A floating exchange rate, or fluctuating exchange rate, is a type of exchange rate regime wherein a currency's value is allowed to fluctuate according to the foreign exchange market.
  • Many economists believe floating exchange rates are the best possible exchange rate regime because these regimes automatically adjust to economic circumstances.
  • Crawling pegs:A crawling peg is an exchange rate regime, usually seen as a part of fixed exchange rate regimes, that allows gradual depreciation or appreciation in an exchange rate.

• Real Versus Nominal Rates

  • Real exchange rates are nominal rates adjusted for differences in price levels.
  • An exchange rate between two currencies is defined as the rate at which one currency will be exchanged for another.
  • The real exchange rate is the purchasing power of a currency relative to another at current exchange rates and prices.
  • The real exchange rate is the nominal exchange rate times the relative prices of a market basket of goods in the two countries.
  • In this case, the real A/B exchange rate is 3.

• Managed Float

  • Managed float regimes are where exchange rates fluctuate, but central banks attempt to influence the exchange rates by buying and selling currencies.
  • Managed float regimes, otherwise known as dirty floats, are where exchange rates fluctuate from day to day and central banks attempt to influence their countries' exchange rates by buying and selling currencies.
  • Some economists believe that in most circumstances floating exchange rates are preferable to fixed exchange rates.
  • However, pure floating exchange rates pose some threats.
  • A floating exchange rate is not as stable as a fixed exchange rate.

• Finding an Equilibrium Exchange Rate

  • There are two methods to find the equilibrium exchange rate between currencies; the balance of payment method and the asset market model.
  • Purchasing power parity is a way of determining the value of a product after adjusting for price differences and the exchange rate.
  • The concept of purchasing power parity is important for understanding the two models of equilibrium exchange rates below.
  • The asset market model views currencies as an important element in finding the equilibrium exchange rate.
  • The asset market model of exchange rate determination states that the exchange rate between two currencies represents the price that just balances the relative supplies of, and demand for, assets denominated in those currencies.

• Exchange Rate Policy Choices

  • A free floating exchange rate increases foreign exchange volatility, which can be a significant issue for developing economies .
  • Flexible exchange rates serve to adjust the balance of trade.
  • Under fixed exchange rates, this automatic re-balancing does not occur.
  • The developing countries, marked in light blue, may prefer a fixed or managed exchange rate to a floating exchange rate.
  • Explain the factors countries consider when choosing an exchange rate policy

• The Slope of the Aggregate Demand Curve

  • Due to Pigou's Wealth Effect, the Keynes' Interest Rate Effect, and the Mundell-Fleming Exchange Rate Effect, the AD curve slopes downward.
  • As a result of Keynes' interest rate effect, Pigou's wealth effect, and the Mundell-Fleming exchange rate effect, the AD curve is downward sloping.
  • Perhaps the most complex of the three inputs underlined in deriving aggregate demand is the Mundell-Fleming Exchange Rate Effect.
  • This new factor is the exchange rates, as the name implies.
  • Robert Mundell and Marcus Fleming noted that incorporating the nominal exchange rate into the mix makes it impossible to maintain free capital movement, a fixed exchange rate and independent monetary policy.

• Introduction to Monetary Policy

  • In addition, lower interest rates make a currency worth less in the currency exchange market.
  • This reduces the demand for and increases the supply of dollars in the currency market, reducing the exchange rate (in foreign currency per dollar).
  • A lower exchange rate makes a country's goods relatively more affordable for the rest of the world, stimulating exports and further increasing output.
  • Investment falls as the interest rate rises.
  • Increased demand and decreased supply cause an increase in the exchange rate, which boots imports while reducing exports.

• Open Market Operations

  • These include the discount rate, the fed funds target rate, and the reserve requirement, and open market operations (OMOs).
  • Historically, the Federal Reserve has used OMOs to adjust the supply of reserve balances so as to keep the federal funds rate--the interest rate at which depository institutions lend reserve balances to other depository institutions overnight--around the target established by the FOMC.
  • Therefore, the implementation of contractionary policy will result in the selling of bonds (cash in exchange for debt holding) and an expansionary policy (buy bonds in exchange for cash) will result in an increase in the money supply at a lower interest rate as a means to enhance growth opportunities and revitalize the economy.
  • The interest rate targeted through the OMO manipulation of the money supply is the fed funds target rate or the rate that member Fed banks charge one another for overnight loans.
  • In addition to this direct interest rate channel, the fed funds rate influences many other interest rates in the economy and by so doing contributed to either incentivizing borrowing for growth or disincentivizing the same.