Exchange Rates - Knowing the Basics

Exchange rates are everywhere in society and are necessary in order to maintain an economic balance worldwide. People should learn more about them because of their importance but it is seldom that you meet a person who knows anything about exchange rates in depth. Here is an article that gets you started on the basics and explains how exchange rates are calculated, their use and why floating and fixed rate calculations should be combined.

We hear the term 'exchange rates' used so often that it seems to be devoid of any meaning. Yet few people ever dedicate the time to finding out what it actually means and get lost in a world of figures and jargon. It relates to the worth of one country currency against another. For example, the US Dollar will be valued against the Pound Sterling of the UK. In this instance, the Sterling is stronger than the Dollar which means that if you're traveling from the United States, your Dollar will buy you much less Sterling.

While this news may worry you in terms of how expensive things will be in a foreign country, remember that in theory at least, the price of goods should remain the same in relative terms because exchange rates keep the value of currencies at a level which should ensure that prices work out the same. Of course, you cannot legislate for a country cost of living. A loaf of bread bought in Manila will be much cheaper than one bought in London because of the relative weakness of the Philippines' economy compared to the UK.

Exchange rates are usually calculated by either a floating method or a fixed rate. As the name suggests, the fixed rate is the considered to be the official rate for a country because it has been set by that nation's Central Bank. Countries such as India which use neither the Euro nor Dollar will compare their currency to those as they are considered to be the benchmark in terms of currency strength. The Central Bank then has to stay busy buying and selling its own currency to ensure that it maintains the level that has been set.

The floating method is dictated by the levels of supply and demand for that currency on the private market. This market automatically corrects the currency depending on what the supply and demand for it is. Yet no government will risk utilizing only one of these methods because of the risky nature of the floating method. Although its supply and demand nature would seem to suggest that it is the ideal way of determining a currency's true value, the truth is that it is vulnerable to black market activities.

Constant speculations on an exchange rate that is dependent on the floating method is extremely risky indeed. These could cause a serious fluctuation which means that there would be criminal groups involved in trying to manipulate the currency for their own ends on a regular basis. Therefore, the fixed rate method also needs to be applied to ensure that exchange rates remain somewhat stable.

Source by Maureen Holland