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Rate of exchange

Rate of exchange

Rate of exchange is a rate on which one currency can be interchanged for other. In other words, it is a value of currency of one country expressed in monetary units of other country. If you go to other country, you should "purchase" the domestic currency. The same as the price of any asset, the exchange rate is the price on which you can purchase this currency. If you go to Egypt, for example, and the exchange rate for US dollars makes 1: 5,5 Egyptian pounds, it means that for each US dollar, it is possible to purchase five and a half Egyptian pounds. Theoretically, identical assets should be sold under the same price in the different countries because the exchange rate should support the values inherent in one currency against other.

There are two methods on which the rate of one currency against other is defined. The fixed rate is a rate which positions the government (central bank) and supports it as the official exchange rate. The fixed price for world leading world currencies (as a rule, US dollar, euro, yens, etc.) is positioned . With the purposes of maintenance of the positioned exchange rate, the central bank purchases or sells own currency in the currency market in exchange for currency to which it is adhered. For example, if it is positioned that cost of one unit of the native currency is equal 3 US dollars, the central bank should guarantee that can supply the market with these dollars. With the purposes of rate maintenance, the central bank should keep a high level of external reserves. It is the reserved volume of a foreign exchange placed in central bank which it can use for liberation (or absorption) additional means in (or from) the market. It guarantees the corresponding monetary stock, corresponding fluctuations in the market (inflation / deflations), and in the issue, the exchange rate. The central bank can correct also an official rate in case of need.

Unlike the fixed rate, the floating rate of exchange is defined in the private market through a supply and demand. A floating rate often name "self-corrected", and any distinctions in a supply and demand will be automatically corrected in the market. Look at this simplified model: if the demand for currency low, its value decreases that does the import goods more expensive and stimulates demand for the local goods and services. It, in turn, creates additional jobs that result ins automatic correction in the market. The floating rate constantly varies.

Actually, any currency is not completely fixed or floating. In the fixed mode, pressure of the market can influence changes in the exchange rate also. Sometimes, when the domestic currency really reflects the true value against its currency pegged, "kerbs market", because of an actual supply and demand can develop. The central bank more often, can be compelled to overestimate an official rate so that it corresponded informal, thus, stopping kerbs market activity.

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