How Do Exchange Rates Work?

by **Ponee** Sat Apr 23, 2016 12:46 pm

Exchange rates tell you how much your currency is worth in another currency. They are the price being charged to purchase that currency. However, these prices are likely to change constantly.

Who decides how many euros, yens or pesos you can buy for a dollar? Foreign exchange traders. You would think that something with so much impact on international trade would be more tightly regulated, but it isn't for most currencies. That's because most countries use flexible exchange rates.

Some countries have enough money in their foreign currency reserves that they can control how much their currency is worth. They used fixed exchange rates that only change when the government says so. These rates are usually pegged to the U.S. dollar. To keep the exchange rate fixed, the central bank must buy and hold a large amount of dollars. If the value of the country's currency rises, the bank must release large amounts of it to keep the price low. If demand for its currency falls, the bank must buy up large amounts of its currency.

Some of these most well-known currencies are the Chinese yuan and the Saudi Arabian riyal.

What Affects Exchange Rates?

The demand for a country's currency depends on what is happening in that country. First, the interest rate paid by a country's central bank is a big factor. The higher interest rate makes that currency more valuable. Investors will want to exchange their currency for the higher-paying one, and save it in that country's bank to receive the higher interest rate.

Second, the money supply created by the country's central bank. If the government prints too much currency, then there's too many dollars, euros or yen chasing too few goods. Currency holders will bid up the prices of goods and services. That creates inflation. If way too much money is printed, as usually happens to pay off war debts, then it causes hyperinflation. See more about types of inflation.

Some cash holders will want to invest overseas, where there isn't inflation. However, they'll find that there isn't as much demand for their currency, since there's so much of it. That's why inflation will push the value of a currency down.

Third, a country's economic growth and financial stability impact a exchange rates. If the country has a strong, growing economy, then investors will want to buy goods and services in that country, and will need more of its currency to do so. It the financial stability looks bad, they will be less willing to invest in that country. They want to be sure they will get paid back if they hold government bonds in that currency. Article updated March 10, 2015.

http://useconomy.about.com/od/inflation/f/How_Exch_Rate.htm

by **RamblerNash** Sat Dec 10, 2016 10:13 pm

How Do Exchange Rates Work?

How Do Exchange Rates Work?

What Affects Exchange Rates?

Re: How Do Exchange Rates Work?