This Blog Entry is Requested by my friend Kunal Kaushal and is moderated by Payal Jain
A market based exchange rate will change whenever the values of either of the two component currencies change. A currency will tend to become more valuable whenever demand for it is greater than the available supply. It will become less valuable whenever demand is less than available supply (this does not mean people no longer want money, it just means they prefer holding their wealth in some other form, possibly another currency).
Increased demand for a currency is due to either an increased transaction demand for money, or an increased speculative demand for money. The transaction demand for money is highly correlated to the country’s level of business activity, gross domestic product (GDP), and employment levels. The more people there are out of work, the less the public as a whole will spend on goods and services. Central banks typically have little difficulty adjusting the available money supply to accommodate changes in the demand for money due to business transactions.
The speculative demand for money is much harder for a central bank to accommodate but they try to do this by adjusting interest rates. An investor may choose to buy a currency if the return (that is the interest rate) is high enough. The higher a country’s interest rates, the greater the demand for that currency. It has been argued that currency speculation can undermine real economic growth, in particular since large currency speculators may deliberately create downward pressure on a currency in order to force that central bank to sell their currency to keep it stable (once this happens, the speculator can buy the currency back from the bank at a lower price, close out their position, and thereby take a profit).
In choosing what type of asset to hold, people are also concerned that the asset will retain its value in the future. Most people will not be interested in a currency if they think it will devalue. A currency will tend to lose value, relative to other currencies, if the country’s level of inflation is relatively higher, if the country’s level of output is expected to decline, or if a country is troubled by political uncertainty. For example, when Russian President Vladimir Putin dismissed his Government on February 24, 2004, the price of the ruble dropped. When China announced plans for its first manned space mission, synthetic futures on Chinese yuan jumped (since China’s currency is officially pegged, synthetic markets have emerged that can behave as if the yuan were floating).
Basis Of currency rate decision:
If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. Exchange rates for such currencies are likely to change almost constantly as quoted on financial markets, mainly by banks, around the world. A movable or adjustable peg system is a system of fixed exchange rates, but with a provision for the devaluation of a currency. For example, between 1994 and 2005, the Chinese yuan renminbi (CNY, Â¥) was pegged to the United States dollar at Â¥8.2768 to $1.
Please leave your comments !!
kaushal217February 28, 2008 at 4:42 pm
Its good work friend and really beneficial. Thanks a lot.
KevinMay 28, 2008 at 11:25 pm
i was looking for a answer to this question for a long time. not many people know how the currency is valued. nice explanation. keep it up 🙂
HamzaSeptember 15, 2008 at 11:19 pm
well put, but kindly can u explain to me how the forces of demand and supply decide the exchange rate of a country in easier terms. as i’am a student of o’levels so its hard for me too understand.
deepa SSeptember 19, 2008 at 9:49 pm
An interesting article to read,this clears a lot of doubts and clears the fundamentals of a layman..
The RealinOctober 9, 2008 at 8:15 am
thanks a lot for your comments 🙂
SheenaDecember 7, 2008 at 9:07 pm
Hey this is nice.
Even most of my profs dont know abt this.. or they r too bad at explaining..
sangeethJanuary 8, 2009 at 12:05 pm
i got it tks
SagarJanuary 18, 2009 at 11:54 am
dude, finally somthin that i was lookin for from quite sometime..
Would like to understand this in detail as had lots of doubts..
waise… found eggzactly da same article at Wiki.. 🙂
How Currency rate is decided Currency Fluctuation Realin Blog | debt solutionsJune 16, 2009 at 5:47 am
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samarjeetAugust 3, 2010 at 3:36 pm
I think currency fluctuation more depend upon Expor/ Import
one thing which strike my mind is that the interest rates in India is much higher with respect to U.S. & U.K. still currency of both is much stronger than INR .
SUNIL VERMASeptember 4, 2010 at 8:22 pm
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