In finance, the exchange rate is the rate at which one currency will be redeemed in another. It is also considered a currency value of one country in relation to other currencies. For example, the interbank exchange rate of 114 Japanese yen to US dollar means that ¥ 114 will be exchanged for every US $ 1 or that US $ 1 will be redeemed for respectively  ¥ 114. In this case it is said that the price of one dollar in relation to the yen is ¥ 114, or the equivalent of that the yen price in relation to the dollar is $ 1/114.
The exchange rate is determined on the foreign exchange market, which is open to different types of buyers and sellers, and where currency trading is sustainable: 24 hours a day except weekends, ie trading from 20:15 GMT on Sundays to 22:00 GMT Friday. The spot rate refers to the current exchange rate. The advanced exchange rate refers to the exchange rates quoted and traded today but for deliveries and payments on a certain date in the future.
In the retail currency exchange market, different levels of purchases and sales will be quoted by the seller of money. Mostly trade to or from local currency. The purchase rate is the rate at which the money dealers will buy foreign currency, and the selling rate is the rate at which they will sell the currency. The quoted interest rate will combine the allowance for dealer margin (or profit) in trading, or the margin can be recovered in commission or otherwise. Different prices may also be quoted for cash, documentary form or electronically. A higher level on documentary transactions has been justified as compensation for additional time and document clearing fees. On the other hand, cash is available for immediate resale, but brings security, storage, and transportation costs, and capital-binding costs in the stock of banknotes.
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Currencies for international travel and cross border payments are mostly purchased from banks, currency brokers and various forms of bureau changes. The source of this retail currency comes from the interbank market, which is rated by the Bank for International Settlements of 5.3 trillion US dollars per day. Purchases are made at the spot contract rate. Retail customers will be charged, commissionable or otherwise, to cover provider fees and make a profit. One form of cost is the use of a less favorable exchange rate than the wholesale spot rate. The difference between a retail purchase and a selling price is called a bid-ask spread.
Maps Exchange rate
Quote
In the foreign exchange market, currency pairs are quotes of the relative value of the unit of currency against other units of the currency. The EUR/USD quotation of 1.3225 means that 1 Euro will buy 1.3225 US dollars. In other words, this is the price of one Euro unit in US dollars. Here, the EUR is called "Fixed currency", while USD is called "Currency Variable".
There is a decisive market convention which is a fixed currency and which is a variable currency. In most parts of the world, orders are: EUR - GBP - AUD - NZD - USD - more. Thus, in the conversion from EUR to AUD, EUR is a fixed currency, AUD is a variable currency and the exchange rate indicates how much Australian dollars will be paid or received for 1 Euro. Cyprus and Malta, cited as a base to the USD and others, were recently removed from this list when they joined the Euro Zone.
In some European regions and in the retail market in the United Kingdom, EUR and GBP are reversed so that GBP is quoted as a fixed currency against the euro. To determine which currency remains when both currencies are not on the list above (ie "other"), the market convention is to use a fixed currency that gives an exchange rate greater than 1,000. This reduces rounding issues and the need to use excessive decimal places. There are some exceptions to this rule: for example, Japanese often quotes their currencies as the basis of other currencies.
Quotes using the currency of a country's country as a price currency (for example, EUR 0.8989 = USD 1.00 in Euro Zone) are known as direct quotes or price quotes (from a country perspective) and are used in most countries.
Quotes using the currency of a country's country as unit currency (for example, USD 1.11 = EUR 1.00 in Eurozone) are known as indirect quotes or quantity quotes and are used in British newspapers; it's also common in Australia, New Zealand and the Euro Zone.
By using a direct quote, if the home currency strengthens (ie, appreciates, or becomes more valuable) then the exchange rate decreases. Conversely, if the foreign currency strengthens and the domestic currency depreciates, the exchange rate increases.
The market convention from the early 1980s to 2006 was that most currency pairs were quoted to four decimal places for spot deals and up to six decimal places for forward outrights or swaps. (The fourth decimal place is usually referred to as "pip"). An exception to this is an exchange rate of less than 1,000 that is usually quoted to five or six decimal places. Although there is no fixed rule, the exchange rate numerically greater than about 20 is usually quoted to three decimal places and an exchange rate greater than 80 quoted to two decimal places. Currencies above 5000 are usually quoted without a decimal place (for example, a former Turkish Lira). eg (GBPOMR: 0.765432 - Ã,: 1.4436 - EURJPY: 165.29). In other words, the quotation is given with five digits. Where rates are below 1, quotes often include five decimal places.
In 2005, Barclays Capital decided by convention by quoting spot rates with five or six decimal places on their electronic trading platform. Contraction spread (the difference between bid and ask prices) arguably necessitates lower prices and gives the bank the ability to try and win transactions on a multi-bank trading platform where all banks may have quoted the same price. A number of other banks have now followed this system.
exchange rate regime
Each country determines the exchange rate regime that will apply to its currency. For example, the currency may be free-floating, pegged (fixed), or hybrid.
If the free currency is floating, the rate is allowed to vary against the other currencies and is determined by the market forces of demand and supply. The exchange rate tends to change almost constantly as quoted in the financial markets, especially by banks, worldwide.
An adjustable fitting or peg system is a fixed exchange rate system, but with provisions for revaluation (usually devaluation) of currency. For example, between 1994 and 2005, the Chinese renminbi yuan (RMB) was pegged to the US dollar at RMB 8.2768 to $ 1. China was not the only country that did this; from the end of World War II to 1967, Western European countries maintained a fixed exchange rate with the US dollar under the Bretton Woods system. [1] But the system must be abandoned for a floating, market-based regime due to market pressure and speculation, according to President Richard M. Nixon in a speech on August 15, 1971, in what is known as the Nixon Shock..
However, some governments are trying to keep their currencies within a narrow range. As a result, the currency becomes too valuable or less valuable, leading to an excessive trade deficit or surplus.
Exchange rate classification
1.From the perspective of foreign exchange trading bank (1) purchase rate: Also known as the purchase price, it is the price used by foreign exchange banks to buy foreign currency from customers. In general, the exchange rate at which foreign currency is converted to a smaller number of domestic currencies is the rate of purchase, which indicates how much of the country's currency is required to purchase a certain amount of foreign exchange. (2) Sales rate: Also known as the selling price of foreign currency, this refers to the exchange rate used by banks to sell foreign exchange to customers. This shows how much the country's currency needs to be recovered if the bank sells a certain amount of foreign exchange. (3) Middle value: This is the average of the offer price and the demand price. Usually used in newspapers, magazines or economic analysis.
2.According to the length of delivery after the foreign exchange transaction (1) the spot rate: This refers to the spot rate of spot exchange transactions. That is, once the foreign exchange transaction is completed, the exchange rate is within Delivery within two business days. Exchange rates that are generally registered in the foreign exchange market are generally referred to as the spot rate unless specifically indicate the forward exchange rate. (2) Forward exchange rate: It will be shipped within a certain period of time in the future, but beforehand, buyer and seller will make contract to reach agreement. When the delivery date is reached, both parties will send the transaction with the exchange rate and the amount of the order. Forward foreign exchange trading is a transaction based on an appointment, which is caused by the different times the buyer needs foreign exchange for foreign exchange funds and the introduction of foreign exchange risk. The forward exchange rate is based on the spot rate, which is represented by the "premium", "discount", and "parity" spot rates.
3.According to the exchange rate setting method (1) base rate: Usually chooses the most common key conversion currency used in international economic transactions and accounts for the largest proportion of foreign exchange reserves. Compare with the country's currency and set the exchange rate. This exchange rate is the basic exchange rate. Major currencies generally refer to the world currency, which is widely used for pricing, settlement, reserve currency, free conversion, and internationally accepted currencies. (2) Cross Rate: Once the basic exchange rate succeeds, the exchange rate of the local currency against other foreign currencies can be calculated through the basic exchange rate. The resulting exchange rate is the cross exchange rate.
Other Classifications: 1. In accordance with payment methods in foreign exchange transactions: Telegraphic exchange rate, Letter transfer rate, Request draft rate
2.According to the level of foreign exchange control (1) overseas value: The official exchange rate is the exchange rate announced by the foreign exchange administration of a country. Usually used by countries with strict foreign exchange controls. (2) Market interest rate: The market exchange rate refers to the real exchange rate for foreign exchange trading on the free market. This fluctuates with changes in supply and demand conditions of foreign exchange.
3. According to the international exchange rate regime (1) fixed exchange rate: This means that the exchange rate between the currency of a country and the currency of another country is essentially fixed, and the exchange rate fluctuations are very small. (2) Floating exchange rate: This means that a country's monetary authority does not specify the official exchange rate of the country's currency against other currencies, nor does it have the upper or lower limit of exchange rate fluctuations. The local currency is determined by the supply and demand relations of the foreign exchange market, and is free to rise and fall.
4. Is there any inflation (1) nominal exchange rate: an officially announced or marketed exchange rate that does not consider inflation. (2) Real exchange rate: The nominal exchange rate that eliminates inflation
Factors affecting exchange rate changes
1. Payment balance When a country has an international balance of payments deficit or a large trade deficit, it means that its foreign exchange earnings are less than foreign exchange expenditures and its foreign exchange demand exceeds its supply, so its foreign exchange rate rises, and its currency depreciates.
Interest rate 2.Interest rate The interest rate is the cost and profit of loan capital. When a country raises its interest rate or domestic interest rate higher than the foreign interest rate, it will lead to capital inflow, thus increasing the demand for the domestic currency, allowing the currency to appreciate and the foreign currency exchange rate depreciate.
3.Inflation factor The inflation rate of a country increases, purchasing power of money decreases, paper currency depreciates internally, and then foreign currency strengthens. If both countries have inflation, the currency of countries with high inflation will depreciate against those with low inflation. The last is the relative revaluation of the first.
4.Fiscal and Monetary Policy Although the influence of monetary policy on an indirect government exchange rate change is also very important. In general, large fiscal revenues and spending deficits caused by expansive fiscal and monetary policies and inflation will devalue the domestic currency. Fiscal and monetary tightening policies will reduce fiscal expenditure, stabilize the currency, and increase the value of the domestic currency.
Capital 5.Venture If the speculator expects a particular currency to appreciate, they will buy a large amount of the currency, which will cause the currency exchange rate to rise. Conversely, if speculators expect a particular currency to depreciate, they will sell large amounts of currency, generating speculation. Direct currency exchange rate fell. Speculation is an important factor in short-term fluctuations in foreign exchange market exchange rates.
6. Government market interventions When exchange rate fluctuations in the foreign exchange market affect a country's economy, trade, or government needs to achieve certain policy goals through exchange rate adjustments, the monetary authority may participate in currency trading, buying or selling large amounts of local or foreign currency in the market. Foreign exchange supply and demand has caused the exchange rate to change.
7.The economic strength of a country In general, high levels of economic growth are not conducive to local currency performance in the foreign exchange market in the short run, but over the long term they strongly support the local currency's momentum.
Exchange rate fluctuations
The market-based exchange rate will change whenever the value of one of the two component currencies changes. The currency becomes more valuable whenever the demand is greater than the available inventory. It will be less valuable when demand is less than the supply available (this does not mean people no longer want money, it just means they would rather keep their wealth in other forms, maybe other currencies).
Increased demand for currencies may be due to increased demand for money transactions or increased speculative demand for money. Transaction demand is closely related to the level of a country's business activity, gross domestic product (GDP), and employment rate. The more people are unemployed, the less society as a whole will spend on goods and services. Central banks usually have little difficulty adjusting the available money supply to accommodate changes in money demand due to business transactions.
Speculative demand is much more difficult for central banks to accommodate, which they influence by adjusting interest rates. A speculator can buy a currency if the return (ie interest rate) is high enough. In general, the higher the interest rate of a country, the greater the demand for the currency. It has been argued that such speculation may undermine real economic growth, especially as large-currency speculators may intentionally create downward pressure on currencies with shorting to force the central bank to buy its own currency to keep it stable. (When that happens, the speculator can buy the currency back after depreciating, closing its position, and thus making a profit.)
For freight companies delivering goods from one country to another, exchange rates can often be severe. Therefore, most operators have CAF costs to account for these fluctuations.
Purchase currency strength
Real (RER) exchange rate is the purchasing power of the currency relative to other currencies at current rates and prices. This is the ratio of the number of units of a country's currency required to buy a basket of goods markets in another country, having acquired the currency of another country in the foreign exchange market, by the number of units of the given country currency it will be necessary to buy the market basket directly in the country which is determined. There are various ways to measure RER.
Thus the real exchange rate is the exchange rate multiplied by the relative price of a basket of goods markets in both countries. For example, the purchasing power of the US dollar relative to the euro is the price of the euro dollar (dollar per euro) multiplied by the euro price of one unit of the market basket (euro/unit of goods) divided by the dollar price of the market basket (dollars per unit of goods), and hence not dimensionless. This is the exchange rate (expressed as dollars per euro) times the relative price of two currencies in terms of their ability to buy unit of market basket (euro per unit of goods divided by dollars per unit of goods). If all goods can be traded freely, and foreigners and domestic buy the same basket of goods, purchasing power parity (PPP) will apply to exchange rate and GDP deflator (price level) of both countries, and the real exchange rate will always be the same. 1
The rate of change in real exchange rates over time for the euro versus the dollar equals the rate of euro appreciation (the positive or negative percentage of changes in the dollar exchange rate per euro) plus the euro inflation rate minus the dollar inflation rate.
Equilibrium real exchange rate and misalignment
The Real Exchange Rate (RER) represents a nominal exchange rate that is adjusted to the relative prices of domestic and foreign goods and services, thus reflecting the competitiveness of a country over the world. More details, currency appreciation or higher domestic inflation rates encourage RER, aggravate the competitiveness of the country and reduce Current Accounts (CA). On the other hand, currency depreciation produces the opposite effect, increasing CA.
There is evidence that RERs generally reach a stable level over the long run, and that this process is faster in a small open economy characterized by a fixed exchange rate. The substantial and continuous deviation of RER from the long-run equilibrium level, the so-called RER misalignment, has been shown to have a negative impact on the balance of payments of a country. A RER that is too high means that the RER is currently above its equilibrium value, while the undervalued RER indicates otherwise. In particular, the prolonged reappraisal of the RER is widely seen as a preliminary sign of the impending crisis, due to the fact that the country is vulnerable to both speculative attacks and currency crises, as happened in Thailand during the 1997 Asian financial crisis. On the other hand , A prolonged RER undervaluation usually results in pressure on domestic prices, changing consumer consumption incentives and, thus, misallocation of resources between tradeable and non-tradable sectors.
Given that RER mismatches and, in particular excessive assessments, could undermine country-oriented export development strategies, the measurement of RER equilibrium is critical to policymakers. Unfortunately, this variable can not be observed. The most common method for estimating RER equilibrium is the universally accepted Purchasing Power Parity (PPP) theory, which states that the RER equilibrium level is assumed to remain constant over time. However, RER equilibrium is not a fixed value because it follows the main economic fundamental trends, such as different monetary and fiscal policies or asymmetric shocks between home and abroad. As a result, the PPP doctrine has been debated for years, given that it may signal a natural RER movement toward a new equilibrium as one of the RER miserignment.
Starting from the 1980s, to overcome the limitations of this approach, many researchers are trying to find some alternative equilibrium RER steps. The two most popular approaches in economic literature are the Fundamental Equilibrium Exchange Rate (FEER), developed by Williamson (1994), and Behavior Equilibrium Exchange Rate (BEER), initially estimated by Clark and MacDonald (1998). FEER focuses on long-term determinants of RER, rather than on short-term cyclical and speculative forces. It represents a RER consistent with macroeconomic balance, characterized by the achievement of internal and external balance at the same time. Internal balance is achieved when output levels are in line with full employment of all available production factors, and low and stable inflation rates. On the other hand, external balance applies when the actual and future CA balance sheet corresponds to a sustainable long-term net capital flow. Nevertheless, FEER is seen as a normative measure of RER because it is based on some "ideal" economic conditions associated with internal and external balance. Specifically, since sustainable CA positions are defined as exogenous values, this approach has been questioned extensively over time. In contrast, BEER requires an econometric analysis of RER behavior, given the significant RER deviations from the PPP equilibrium level as a consequence of changes in key economic fundamentals. According to this method, BEER is the RER generated when all economic fundamentals are at their equilibrium value. Therefore, the total misalignment of RERs is given by the extent to which economic fundamentals differ from their long-term sustainable rates. In short, BEER is a more general approach than FEER, as it is not limited to long-term perspective, able to explain the RER cycle movement.
Bilateral vs effective exchange rate
The bilateral exchange rate involves a currency pair, while the effective exchange rate is the weighted average of the foreign currency basket, and can be seen as a measure of the overall external competitiveness of the country. The nominal effective exchange rate (NEER) is weighed by the inverse of asymptotic trading weight. The real effective exchange rate (REER) adjusts the NEER to the corresponding foreign price level and deflates by the price level of the country of origin. Compared with NEER, the weighted effective exchange rate of GRDP may be more appropriate to consider the phenomenon of global investment.
Parallel exchange rate
In many countries there is a difference between the official exchange rate for allowed transactions and parallel exchange rates that respond to excess demand for foreign currency at the official exchange rate. The rate at which the parallel exchange rate exceeds the official exchange rate is known as the parallel premium.
Uncollected interest rate parity
Unveded interest rate parity (UIRP) states that the appreciation or depreciation of one currency against another currency may be neutralized by changes in interest rate differentials. If US interest rates increase while Japanese interest rates remain unchanged then the US dollar should depreciate against the Japanese yen by the amount that prevents arbitrage (in fact, on the contrary, appreciation, quite often in the short term, as described below). Future exchange rates are reflected in the forward rates declared today. In our example, the advanced dollar exchange rate is said to be at a discount because it buys less Japanese yen in advanced levels than in spot rates. The yen is said to be at a premium.
UIRP showed no evidence of work after the 1990s. Contrary to theory, currencies with high interest rates are characteristically rewarded rather than depreciating on prizes of inflation containment and higher yielding currencies.
Payment balance model
The balance of payments model states that foreign exchange rates are at the equilibrium level if they produce a stable current account balance. Countries with trade deficits will experience a reduction in foreign exchange reserves, which ultimately lowers (depreciates) the value of their currencies. A cheaper currency (undervalued) makes the country's goods (exports) more affordable in the global market while making imports more expensive. After the intermediate period, imports will be forced down and exports increase, thus stabilizing the trade balance and bringing the currency into equilibrium.
Like purchasing power parity, the balance of payments model focuses primarily on tradable goods and services, ignoring the increasing role of global capital flows. In other words, money not only pursues goods and services, but to a greater degree, financial assets such as stocks and bonds. Their currents go into the capital account item of the balance of payments, thus balancing the deficit in the current account. Increased capital flows have led to an effective asset market model.
Asset market model
Increased trading volume of financial assets (stocks and bonds) has required rethinking about its impact on exchange rates. Economic variables such as economic growth, inflation and productivity are no longer the only movers of currency movement. The proportion of foreign exchange transactions derived from the cross-border trading of financial assets has dwarfed the extent of currency transactions resulting from the trade in goods and services.
The asset market approach views the currency as the price of assets traded on efficient financial markets. As a result, the currency is increasingly showing a strong correlation with other markets, especially stocks.
Like the stock exchange, money can be made (or lost) in trading by investors and speculators in the foreign exchange market. Currency can be traded in the spot market and foreign currency exchange options. The spot market represents the current exchange rate, while the option is a derivative of the exchange rate.
Exchange rate manipulation
A country can gain an advantage in international trade if it controls the market for its currency to keep its value low, usually by a national central bank involved in open market operations in the foreign exchange market. At the beginning of the twenty-first century, it is widely stated that the People's Republic of China has been doing this for a long time.
Other countries, including Iceland, Japan, Brazil, and others have a policy of maintaining the low value of their currencies in the hope of reducing the cost of exports and thereby strengthening their economies. A lower exchange rate lowers the price of a country's goods to consumers in another country, but increases the price of imported goods and services for consumers in low value countries.
In general, exporters of goods and services will prefer lower value for their currency, while importers will prefer higher value.
See also
- Black Wednesday
- Bureau de change
- Current account
- The strength of the currency
- Dynamic currency conversion
- Effective exchange rate
- Euro calculator
- Foreign exchange fraud
- The foreign exchange market
- Functional currency
- Table of historical rates for USD
- Telegraph transfer
- USD Index
References
External links
Media related to exchange rates on Wikimedia Commons
Source of the article : Wikipedia
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