You hear about Forex, foreign exchange market, FX, exchange rates everyday on the television, radio. You even see them on the Internet and read about them in the newspapers. But you don’t know what these are and how they work.
An exchange rate is a term used to describe the value of one currency relative to another. It means, there is a set value of one currency if it is converted to another currency. Such value is measured by the present foreign exchange that fluctuates from time to time.
Here is a simplified way which will allow you to better understand such terms:
The first thing a foreign exchange trader must know and ask is: what exactly is an exchange rate? An exchange rate is described as a rate for exchanging one currency for another. Like every product or service has its own value or price, the exchange rate is the price of a currency.
This means that a currency of a certain country has its own specific value as compared to the currency of another. Forex traders need to have a firm grasp of the different exchange rates whenever they attempt to trade. Understanding the value of each currency pair and how the movement in value of one currency effects a vast amount of currency pairs is vital when trading Forex.
Exchange Rate on Foreign Shores
If you are from the United States, for example, and you are traveling to the Philippines and the exchange rate is 43 pesos to one US dollar, this means that you have a better purchasing power with one dollar against the peso.
This is one of the reasons why the influx of American tourists to most Asian countries double, especially during the winter time, or when the dollar is particularly stronger than most other currencies in the global market, the Philippine peso included.
A strong dollar gives foreign visitors more buying power and privilege, thus making their travel or vacation more enjoyable. The presence of foreigners also boosts the country’s tourism and economic revenues thus enhancing its exchange rate market.
There is really no need to worry about how much a trader or vacationer can buy for their currency in another country because most prices of products are usually the same. If there are prices increases these are relatively low. This is because exchange rates tend to keep the same value of the currency at its own moderate level.
Calculating Exchange Rate
There are two ways to calculate exchange rate:
The first one is the so-called “fixed rate”. A fixed rate is set and kept by the central bank of one’s country and it is considered to be the official exchange rate for that certain country. The country’s price currency level is measured by comparing it to another major currency, like the Euro or the US dollar. Being the world’s No.1 reserve currency, the USD is used as a base currency when denoting the value of any other currency.
Another method for determining a country’s currency exchange rate is through the “floating” method. This process measures the exchange rate by applying a supply and demand balance check for that currency on the financial market. This is the most commonly used method nowadays, particularly in the developed world.
Exchange Rate Supply and Demand
The term “self-correcting” is sometimes referred to this form of exchange rate because the market automatically sets right or corrects the changes between the supply and the demand for the currency. This is type of exchange rate is continuously being reconstructed based on the supply and demand situations.
It will look like the floating exchange rate is near the actual value of a currency due to the price that is being measured by the supply and demand for that currency. This is not totally precise as this type of exchange rate is so sensible to market speculations.
Meanwhile, the black market may persistently sway developments in the financial market especially in the exchange rate for the currency. A steady and sound system must be set in place and should be applied to allow the market to put pressure on the exchange rate.
Finally, some exchange rates are not determined exclusively on a steady or floating method. A combination of these two methods may be applied to set the price for a certain currency for its accurate and appropriate value.