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Fixed Vs Floating (Free) Exchange Rates

This document discusses fixed and floating exchange rate systems. A floating exchange rate is determined by market forces of supply and demand, so the rates fluctuate randomly over time. In a fixed exchange rate system, a government sets and maintains an official exchange rate against a major currency like the US dollar. To maintain a fixed rate, a central bank will buy or sell its own currency on the open market to influence the exchange rate if it drifts above or below the fixed benchmark.

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Raahim Najmi
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26 views

Fixed Vs Floating (Free) Exchange Rates

This document discusses fixed and floating exchange rate systems. A floating exchange rate is determined by market forces of supply and demand, so the rates fluctuate randomly over time. In a fixed exchange rate system, a government sets and maintains an official exchange rate against a major currency like the US dollar. To maintain a fixed rate, a central bank will buy or sell its own currency on the open market to influence the exchange rate if it drifts above or below the fixed benchmark.

Uploaded by

Raahim Najmi
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Exchange Rates

Fixed vs Floating (Free) Exchange Rates


Exchange rate definitions
• The price of one currency expressed in terms of another currency.
• U.S. dollar buys 1.40 Canadian dollars, the exchange rate is 1.4 to 1. Also
called foreign exchange rate.

• The exchange rate is the price at which the currency of one country
can be converted to the currency of another

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EXCHANGE RATE SYSTEMS 1
• Freely floating or flexible exchange rate

• Market forces of supply and demand determine rates.

• Rates fluctuate over time randomly.

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Freely floating system

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EXCHANGE RATE SYSTEMS 2
• Fixed Exchange Rate

• A fixed, or pegged, rate is a rate the government (central bank) sets and
maintains as the official exchange rate.
• A set price will be determined against a major world currency (usually the
U.S. dollar, but also other major currencies such as the euro, the yen or
a basket of currencies)

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How does it work?


• The government maintains a fixed exchange rate by either buying or selling its own
currency on the open market. This is one reason governments maintain reserves of
foreign currencies.
• If the exchange rate drifts too far above the fixed benchmark rate (it is stronger than
required), the government sells its own currency and buys foreign currency. This
causes the price of the currency to decrease in value. Also, if they buy the currency it is
pegged to, then the price of that currency will increase, causing the relative value of
the currencies to be closer to the intended relative value
• If the exchange rate drifts too far below the desired rate, the government buys its own
currency in the market by selling its reserves. This places greater demand on the
market and causes the local currency to become stronger, hopefully back to its
intended value. The reserves they sell may be the currency it is pegged to, in which
case the value of that currency will fall.

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