How are international exchange rates set?

By Ayton MacEachern AAA
A:

International currency exchange rates display how much one unit of a currency can be exchanged for another currency. Currency exchange rates can be floating, in which case they change continually based on a multitude of factors, or they can be pegged (or fixed) to another currency, in which case they still float, but they move in tandem with the currency to which they are pegged.

Knowing the value of your home currency in relation to different foreign currencies helps investors to analyze investments priced in foreign dollars. For example, for a U.S. investor, knowing the dollar to euro exchange rate is valuable when selecting European investments. A declining U.S. dollar could increase the value of foreign investments, just as an increasing U.S. dollar value could hurt the value of your foreign investments.

Factors That Influence Exchange Rates
Floating rates are determined by the market forces of supply and demand. How much demand there is in relation to supply of a currency will determine that currency's value in relation to another currency. For example, if the demand for U.S. dollars by Europeans increases, the supply-demand relationship will cause an increase in price of the U.S. dollar in relation to the euro. There are countless geopolitical and economic announcements that affect the exchange rates between two countries, but a few of the most popular include: interest rate decisions, unemployment rates, inflation reports, gross domestic product numbers and manufacturing information.

Some countries may decide to use a pegged exchange rate that is set and maintained artificially by the government. This rate will not fluctuate intraday, and may be reset on particular dates known as revaluation dates. Governments of emerging market countries often do this to create stability in the value of their currencies. In order to keep the pegged foreign exchange rate stable, the government of the country must hold large reserves of the currency to which its currency is pegged in order to control changes in supply and demand.

For more, see our Forex Market Tutorial.

RELATED FAQS

  1. What is the difference between pips, points, and ticks?

    Learn the differences between points, ticks and pips and how each are used by investors to measure price changes in stocks, ...
  2. What legal privileges do residents of special administrative regions (SAR) have that ...

    Citizens of SARs enjoy the autonomy of a capitalist and free society that is outside the influence of the socialist regime ...
  3. Are Chinese special administrative regions (SAR) special status permanent?

    Find out whether the special status of China's special administrative regions, Hong Kong and Macau, is intended to be a permanent ...
  4. Does China have the equivalent of other special administrative regions (SAR) outside ...

    Find out about the special administrative regions of Hong Kong and Macau and other places in China that offer tax incentives ...
RELATED TERMS
  1. ICE LIBOR

    See LIBOR
  2. WM/Reuters Benchmark Rates

    Spot and forward foreign exchange rates that are used as standard ...
  3. Heckscher-Ohlin Model

    An economic theory that states that countries export what they ...
  4. Balassa-Samuelson Effect

    Countries with high productivity growth also experience high ...
  5. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  6. Financial Account

    A component of a country’s balance of payments that outlines ...

You May Also Like

Related Articles
  1. Chart Advisor

    Is Now the Time to Invest in North America?

  2. Investing

    How To Trade Foreign Stocks

  3. Investing Basics

    Here's How To Tap International Markets

  4. Stock Analysis

    3 Things I Learned From lululemon Athletica's ...

  5. Stock Analysis

    Energy Transfer Partners' Mexican Ambitions

Trading Center