Forex Rates, Forex Rate

By: EconomyWatch   Date: 28 July 2009

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Foreign exchange rates, or forex rates, indicate the value of a currency vis-à-vis another currency. These forex rates keep fluctuating, depending upon the economic and financial stature of the respective countries.  

Forex Rates: Types

Broadly speaking, there are two ways of determining forex rates, namely fixed (or pegged) rates and floating rates. Historically, the forex rates of most currencies were fixed by the government of the respective countries. However, this situation has shifted considerably across the world since the emergence of the floating rates concept in 1914.

 

Fixed forex rate: The value of a currency may be set against a key world currency, such as the US dollar, usually by the central bank. Once set, the central bank trades its currency in the forex market against the currency to which it is pegged to maintain the exchange rate. This is why such exchange rates are also known as pegged rates. A fixed forex rate regime is often followed by those countries that have an unsophisticated capital market and a weak regulatory system.

 

The central bank keeps foreign exchange reserves to either infuse or absorb extra funds from the market to ensure appropriate money supply in the economy. Although the exchange rates are fixed by the central bank under this system, the bank may adjust the official exchange rate as and when it deems necessary.

 

Floating forex rates: Under the floating rate system, the private market determines the value of a currency. This system is also called a flexible exchange rate regime, since the value of a currency is allowed to fluctuate according to the demand/supply trends in the forex rate market. A floating rate changes constantly, resulting in uncertainty around the value of the currency. In extreme cases, the central bank may intervene to stabilize the currency, economy and investment into the country. Thus, a floating rate regime is often termed as a managed float system.

 

Usually the countries that have a more mature and stable economy prefer the floating rate system. This system is considered to be efficient as the value of a currency automatically corrects to reflect inflation and other economic variables.

 

 


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