Currency price. Visitors to our site know that currency can not only be a means of payment, it can also be a product that can be bought or sold. If all the states of the world used one currency, then it would be difficult to talk about its commodity function. But the world works differently. Most countries issue and use their national currency. This is what you can buy with the currency of another country.
But in this case, the question arises of the price at which such a trading operation can be carried out. The exchange rate allows you to determine this price. What is it? How are exchange rates calculated? We will try to answer these questions.
- What is the exchange rate?
- Types of exchange rates
- Currency convertibility
- Types of currency convertibility
- Factors influencing the value of a currency
- Conclusion
What is the exchange rate?
So, what is an exchange rate? It is generally accepted that the exchange rate is the price of the currency of one country expressed in the currency of another.
One of the main criteria when determining the exchange rate is the purchasing power that the currency has. In economic theory there is a law of one price. Based on this law, the basic value of the national currency exchange rate is determined. The calculation is carried out in the following sequence:
The assumption is made that the value of a product remains constant in any country, no matter where it is located.
The product is valued in national currency (Pd).
The same product is valued in foreign currency (Pf).
The ratio of these prices will be the desired value of the exchange rate of the national currency to the foreign currency.
Types of exchange rates
It is important not only to understand what the exchange rate is. Its types are also of great importance for understanding the essence of commodity-money relations. There are the following types of exchange rates:
- Market. The exchange rate formed under the influence of market factors, the main of which are supply and demand, is considered market rate. Investors’ interest in currencies is inconsistent. Therefore, the market rate is in constant motion. A currency rises when there is increased demand for it and there is a lack of supply, and a fall occurs when supply exceeds demand.
- Official. The rate established by the decision of the national regulator is official. It can be set for different time periods. If the official exchange rate does not correspond to the market rate, the regulator must do everything in its power to minimize this discrepancy.
- Exchange. This rate means the price at which currency is currently being purchased or sold on the exchange. For example, when the euro/dollar exchange rate falls on the stock exchange, it is profitable to buy euros at the exchange rate, spending a minimum amount of dollars on it.
- Buyer’s rate. In market conditions, there is a price that a buyer is willing to pay for a particular currency. It is this price that determines the buyer’s rate. It is also considered that at this rate the resident bank makes the purchase of foreign currency.
- Seller’s course. There are different interpretations of this exchange rate, but the essence comes down to the following – this is the lowest price at which the currency seller is ready to make a transaction.
- Exchange rate. This rate allows you to find out how many units of national currency you need to have on hand to purchase a unit of foreign currency. Typically, the exchange rate consists of two prices – the purchase price of the currency and the sale price.
The exchange rate and its types can operate in a certain mode. There are two such modes:
- Floating. In this mode, the state does not have a decisive influence on the exchange rate. Its formation is influenced only by market factors, and exchange rate movements occur as a result of changing supply and demand.
- Fixed. The state, through its financial regulatory authorities, sets a fixed value for the national currency exchange rate. It can be established for a certain period or operate continuously.
Currency convertibility
Speaking about exchange rates, one cannot fail to mention such a concept as convertibility, which determines the ability of a currency to be freely exchanged for one another. The degree of convertibility of a particular currency depends on the decision of the relevant government body entrusted with the function of currency regulation.
It is generally accepted that the convertibility of currency issued by a state is one of the main indicators of the openness of the economy of this state, its ability to compete on equal terms in the global labor and capital markets.
Types of currency convertibility
In practical application, currency convertibility is divided into types, the main ones being the following:
Full convertibility. This type of convertibility implies free access for all residents and non-residents to unlimited exchange of national currency for foreign currency. Only countries with developed economies can afford this type of conversion. The only freely convertible currencies include the US dollar, British pound, Japanese yen and euro.
Partial convertibility. In conditions of partial convertibility, transactions with the national currency are subject to restrictions by the issuing state, allowing it to be exchanged only for a certain list of foreign currencies.
Internal convertibility. Under the conditions of this type of convertibility, only residents are given the right to purchase foreign currency for making foreign economic payments.
External convertibility. This type of convertibility allows only foreign citizens and companies to bring their capital into the country and exchange it for the national currency.
Closed currency. If there is a ban on the part of the issuing state on the exchange of national currency for foreign currency, this currency will be considered inconvertible (closed). It can function only in a limited territory of the state that issued this currency into circulation.
Factors influencing the value of a currency
Macroeconomic indicators of the state
- Foreign trade balance of the country. If exports of goods and services exceed imports, this will have a positive effect on the value of the national currency. As the country’s gold and foreign exchange reserves grow, the national currency strengthens and its value becomes higher.
- Inflation rate within the country. The exchange rate of a currency directly depends on its purchasing power. A high inflation rate in a country leads to a decrease in the purchasing power of the national currency, which means that its value falls.
- Dynamics of gross domestic product (GDP). GDP growth has a positive effect on the value of the national currency, since with its growth the inflation rate decreases and, as a rule, the influx of foreign investment increases.
- Budget deficit level. The balance of the state budget, the absence of additional emission of money that is not supported by the gross domestic product, allows the national currency to strengthen.
- Government debt obligations. With an increase in public debt to foreign creditors, the burden on the country’s balance of payments increases. Debt servicing leads to an outflow of foreign currency from the country, as a result of which the demand for it increases and the depreciation of the national currency.
State monetary policy
- Foreign exchange intervention carried out by a national bank. The bank independently enters the market and buys or sells currency, which in the short term affects the value of the national currency and its stability.
- National bank interest rate. The bank’s board can change the level of the discount rate, which affects the value of the currency. Lowering the interest rate contributes to the revival of the national market, GDP growth and the availability of loans for individuals and legal entities. As a result, the national currency rate strengthens. But at the same time, investors are not interested in low interest rates. They withdraw foreign currency from the country, which in the long term negatively affects the value of the national currency.
Socio-political situation in the country. The currency is very sensitive to any events taking place in the state. Its cost is negatively affected by:
- Military conflicts.
- Strikes and civil strife.
- Unconstitutional change of power.
- Violation of the territorial integrity of the state.
- Instability of legislation relating to currency regulation.
The price of a currency depends on many factors. Moreover, this dependence in most cases is ambiguous. The market reacts very sluggishly to some events and the price practically does not change. Other seemingly insignificant events cause panic in the market, and the price of the currency rapidly changes in one direction or another.
