Exchange Rate

The exchange rate is simply the rate at which one currency is traded for the other. It is the rate at which one currency is placed against another to place a deal. The forex or foreign exchange market, as we know, it began after the establishment of the Bretton Woods System which set the US dollar against gold as a standard for trade. Forty-six different countries attended this conference and agreed on the matter. After the abolishment of the Bretton Woods System in 1973, the world economy started trading currency in exchange for other currency as compared to gold. The foreign exchange market is one of the largest markets in the world with the market cap of more than one trillion US dollars in a day while the traditional stock market stands at a market cap of 200 million dollars in a day. The forex market is relatively new and is not regulated by any central authority, which makes it independent but more prone to fraud. Transactions take place with buyers and sellers who meet via online platforms, and a broker acts as a middle man between them. These currencies keep on fluctuating and are dependent on different exchange rates.

Fixed exchange rate system

The fixed exchange rate is the rate of the currency set by its government. It is not prone to change depending on the market forces of demand and supply. It is rigid and is adopted by the government to maintain an equilibrium in the market and stabilize capital and foreign investments. The idea behind this is that each government wants its currency to remain healthy and to achieve that, they sell the currency when the rate of exchange is high and buy the currency when the rate of exchange falls. To ensure the safety of its currency, the government keeps reserves of foreign currency and trades it during an unstable market to keep the balance maintained.

Foreign Exchange

Flexible exchange rate system

The flexible exchange rate system, also known as the floating exchange rate, is opposite to the fixed exchange rate system. Here the exchange rate is determined by the independent forces of demand and supply, not by the government and its institutions. Although this exchange rate system is supposed to be dynamic, this is only applicable to paper, not practically. Officially the government or the central bank does not interfere with this process. Still, they create laws and policies which indirectly affect the exchange rate by altering the structure of the economy or the trading system. The forces of demand and supply are also not completely independent as they occur from the wants of banks, financial institutions, business corporations, hedge funds and individuals.

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