Every country has an Exchange Rate at which it Exchange its local currency to a foreign currency. In this article, I hope to explain and show you all how the Exchange Rate works and its importance.
What Does Exchange Rate Mean
Exchange Rate are the relative value or price between a country’s currency and another country’s currency. That means that Exchange Rate are technically used to show us how much my country’s currency will be worth in your own country when it is Exchanged.
Let me give an example, let’s assume that Dr. Mike is a car dealer who buys Ford cars from the United States and ship it to South Africa and he needs to buy 5 cars each which cost $250,000. For Dr Mike to know how much of its own local currency it will cost to buy just one car he will need to know the Exchange Rate of his local currency and the foreign currency.
If the Exchange Rate of the United State Dollar to the South African Rand is USD1=ZAR12, then it means it will require ZAR 3,000,000 to be able to buy one of the car for USD 250,000, and ZAR 15,000,000 to be able to shipped those 5 cars down to South Africa.
We have seen how the Exchange Rate affects business, let’s see how it does affect international travel. Assume you want to on a tour to Japan to see the famous city of Tokyo and you are travelling from Nigeria, in other to use the Japanese currency, the Japanese Yen (JPY). You would need to first convert your local currency at the airport or through your bank and how will you can do that? By using the Exchange Rate for the Nigerian Naira (NGN) and Japanese Yen (JPY).
How Do the Exchange Rate Works
Now, this is a good question. How do the Exchange Rate works? The “Exchange Rate” became widely used after the golden standard was abolished and this came into effect in 1944 during the Bretton Wood Agreement. The United State Dollar(USD) was used as the world reserve currency(don’t worry if you do not understand about the Bretton Wood Agreement as I will discussed that in my next article).
The Exchange Rate are basically used to exchange one’s country currency and this can be found in when trading the Forex market. Each country has way of keeping its Exchange Rate intact.
Type of Exchange Rate?
Exchange Rates are dived into two which are the
- Fixed Exchange Rate
- Floating or Flexible Exchange Rate
Fixed Exchange Rate
Fixed Exchange Rate can be seen in countries where their currency do not fluctuant or varies a lot, the country make sure that the value or Rate between its currency and the USD or other important currencies such as EUR, JPY remains the same.
Many countries such as Nigeria, Switzerland, and China have a fixed Exchange Rate that is peg against the USD at a fixed price or Rate. This done by either selling or buying large quantities of its own currency or the other country’s currency.
For example, Nigeria has been able to maintain a Fixed Exchange Rate of Nigeria Naira ₦ 360 to $1 by the intervention of the Central Bank of Nigeria, who keep pumping Forex currencies to the Forex Market.
Floating or Flexible Exchange Rate
Countries such as the United Kingdom and United State, uses this type of Exchange Rate, where the price of its currency and that of foreign currencies are determined by the forex market. Floating or Flexible Exchange Rate fluctuate a lot and are influenced by factors which affect what people especially huge financial institution think about the country’s economy.
Such factors include the interest Rate, export and import value, debt amount, financial policies etc. For example if the interest Rate of a country is high(positive) this will make people to buy more bonds, stocks, treasury bill even to buy and hold the currency to receive interest . And to buy these things involves converting the individual’s currency to that of the country’s currency. Thus creating a lots of demand d for the currency.
How Are They Calculated?
The Exchange Rate are not calculated but are derived based on various factors too numerous to mention here. They primary get there valued from the United State Dollar (USD) and are quoted on “how a dollar is worth in the foreign currency” when it comes to the EURO (EUR), it is a little difference.
The EUR is a bit different, in its quotation. For example you would hardly hear people converting the EUR to USD rather they will convert the USD to EUR.
Importance of Exchange Rate
Exchange Rates are very important, as we use them all time, ranging from international trade, to banking down to paying for international services. In more article to come, I discuss more about this and other areas of finance and business it can be applied to.
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