Report Abuse |
Foreign Exchange Rate: Meaning and Determination 8/19/2011 9:09:31 PM
A country’s economic stability is indicated, among other things, by the stability in its exchange rate. The strength of domestic currency of a country is seen against that of currencies of other countries in the world. Earnings from exports and payments for imports would directly be affected by the exchange rate. Therefore, it is important to know the forces that operate upon the determination of foreign exchange rate and the implications of changes in it for the country concerned. In this chapter we shall explain foreign exchange rate determination.
Meaning
Foreign exchange rate is the price of one currency in terms of another. It is the rate at which exports and imports of a nation are valued at a given point in time. The foreign exchange rates, by linking the currencies of different countries, make the comparisons of international costs and prices. They also govern and are governed by the flow and direction of foreign trade.
Foreign Exchange Market
The foreign exchange market is the market where the national currencies are traded for one another. Foreign exchange market performs, mainly, three functions viz., to transfer the purchasing power between countries (transfer function), to provide credit channels for foreign trade (credit function), and to protect against foreign exchange risks (also known as hedging function).
In view of the above three functions, demand for foreign exchange is the demand for foreign currencies by the residents of a country. When people wish to operate in the foreign exchange market they intend to buy or sell foreign exchange depending on their demand for and supply of foreign exchange.
Transactions in the foreign exchange market are reflected in the balance of payments account. The value of Indian residents’ expenditure abroad represents a supply of rupees to the foreign exchange market. This is because if an Indian buys a Japanese radio from abroad, he will pay for it in rupees. Now this total expenditure also represents the demand for foreign exchange that is Japanese Yen, since the Japanese dealer will expect payment in Yen. So rupees have to be exchanged for Yen in the foreign exchange market.
Similarly, the foreign earnings of Indian residents reflect equal earnings of foreign exchange. For example, Indian exporters will expect to be paid in rupees. So in order to buy our goods, foreigners have to sell their currency and buy rupees in return. Hence, there is inflow of foreign exchange into India.
For More details please download below document.
Balance of payments 2.pdf
|