Forex Currency Exchange: An Insight
Foreign exchange market is indisputably the predominant market worldwide with daily currency trading to the tune of about four trillion dollars. Forex exchange rates are the rates at which one currency can be traded or bought against another and identical pair of currencies should necessarily be exchanged at their inherent values against each other anywhere across the globe.
Forex currency exchange can take place either on fixed or floating exchange rates. Fixed rates or pegged rates are the official forex exchange rates which are set and maintained by the Central Bank of any country governed by the fiscal policy of the government.
The set price determination will take place against dominant world currencies, predominantly American dollar, Euro, yen or other influential currencies. The local exchange rate is maintained by the Central bank through buying and selling of its’ own country’s currency against the foreign currency to which pegging is desired on the foreign exchange market.
A better understanding can be scored through an example. If the value of a single unit of domestic currency is pegged at five US dollars, the Central bank has to take initiatives foe ensuring that the market will be supplied with the requisite dollars by it. The rates can be maintained if the central bank keeps a considerable level of foreign reserves.
This reserved amount is utilized by the bank for releasing or absorbing redundant funds into market or out of it. Such a step assures of sustained foreign currency supply in the market, keep a check on the market volatility and inflation and mitigates vulnerabilities to forex currency exchange rates.
In contrast, floating forex exchange rates are determined by the interplay of private market forces of supply and demand. Such rates are self correcting in the sense that the disparity in supply and demand will get automatically addressed by the market.
This essentially implies that a currency in low demand will automatically suffer a diminution in its value which in turn will inflate the prices of imported goods and stimulate demand for indigenous or locally produced goods and services. This will lead to generation of more jobs in the market triggering an auto correction of the currency in the market. A floating exchange rate uniformly is subjected to change.
However the truth is that no currency is completely fixed or floating. Foreign currency exchange rates can suffer changes even in fixed regimes under pressing market influences. At times, when the local currency exhibits the true value of its as compared to fixed currency, a black market that conclusively and comprehensively reflects the actual supply and demand may start taking shape.
The pegged official rate of the currency will then undergo revaluation or devaluation by the Central bank in response to such alterations to ensure check on black market development by aligning the official forex exchange rates with unofficial ones. Even the floating regime may see intervention by central bank to check inflation and insure stability. Forex trade when wisely and consciously executed in an informed manner will bring in rich dividends.