In the Forex market, an exchange rate refers to the rate at which one currency can be exchanged for another currency. For example, the $1.0600 exchange rate for the EUR/USD means that one has to pay 1.0600 dollars to purchase one Euro.
The exchange rate comes directly into play to decide the quantity of the home currency that is necessary to meet the price of the supplier currency. Exchange rates are inherently volatile and prone to risk.
Types of Exchange Rates
There are two types of exchange rates:
What are fixed exchange rates?
This helps the central bank maintain low-interest rates and thus, low inflation rates.
The aim is to stimulate trade and the overall economy.
For example, many African nations have pegged their currencies to the euro. And many Latin American countries have pegged their currencies to the U.S. dollar.
What are floating exchange rates?
Free-floating currencies are the most widely used in global commerce.
They are used almost everywhere in the “developed” world.
For example, if interest rates are increased substantially, in Japan, demand for Japanese yen will increase as people will invest money in the Japanese currency to take advantage of the interest rate increase and make money. If interest rates fall, the opposite consequence is highly likely to occur.
Therefore, governments attempt to control various factors to ensure exchange rates are at a level that will help their respective economies grow. A delicate balance often has to be struck.
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