Next video:
Loading the player...

A government or central bank using a fixed exchange rate has linked the value of its currency to the value of another country’s currency, or the price of gold.

Exchange rates are the rates at which one currency can be exchanged for another. For example, if the United States dollar has an exchange rate of 1:2 to the Canadian dollar, one U.S. dollar will buy two Canadian dollars.

With a fixed exchange rate, a country determines that the value of a single unit of its currency is worth a certain amount of another country’s currency.

For instance, a small country fixes its currency to the U.S. dollar, saying one unit of its money is worth $2. To maintain the rate, the country’s central bank will buy or sell its own currency on the foreign exchange market in return for U.S. dollars.

This will keep the exchange rate steady. But it requires the small country to maintain a large amount of U.S. dollars in reserve so that it can release or absorb extra dollars when necessary.

Fixed exchange rates enable a currency’s value to remain relatively stable, and can help lower inflation, which encourages investment.

But a fixed exchange rate can also cause problems. A smaller country that fixes its currency to a larger country’s currency loses its monetary independence, and in some instances, its control.

A fixed exchange rate is also known as a pegged exchange rate.

Related Articles
  1. Investing

    Why Countries Keep Reserve Currency

    Central banks and financial institutions hold large amounts of foreign money as their reserve currency.
  2. Investing

    The Pros And Cons Of A Pegged Exchange Rate

    A pegged exchange rate occurs when one country fixes its currency’s value to the value of another country’s currency. But it has both pros and cons.
  3. Trading

    Currency Exchange: Floating Rate Vs. Fixed Rate

    Baffled by exchange rates? Wonder why some currencies fluctuate while others are pegged? This article has the answers.
  4. Trading

    The Pros And Cons Of A Pegged Exchange Rate

    A pegged currency can give a country many advantages, but these advantages come at a price.
  5. Trading

    How to Calculate an Exchange Rate

    Struggling to get a grasp on exchange rates? Here's what you need to know.
  6. Trading

    How Are International Exchange Rates Set?

    International exchange rates show how much one unit of a currency can be exchanged for another currency.
  7. Trading

    Interest Rate and Currency Value And Exchange Rate

    In general, higher interest rates in one country tend to increase the value of its currency.
  8. Trading

    Understanding the Floating Exchange Rate

    Floating exchange rate is the exchange rate between two currencies at any given time.
Hot Definitions
  1. Preferred Stock

    A class of ownership in a corporation that has a higher claim on its assets and earnings than common stock. Preferred shares ...
  2. Net Profit Margin

    Net Margin is the ratio of net profits to revenues for a company or business segment - typically expressed as a percentage ...
  3. Gross Margin

    A company's total sales revenue minus its cost of goods sold, divided by the total sales revenue, expressed as a percentage. ...
  4. Current Ratio

    The current ratio is a liquidity ratio measuring a company's ability to pay short-term and long-term obligations, also known ...
  5. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
  6. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
Trading Center