Exchange Rates As An Unbiased Indicator

BSE Training Institute Ltd. – Group 6

Exchange Rate, what is it?

An exchange rate is the rate at which one currency can be exchanged for another. It is also regarded as the value of one country’s currency in terms of another currency.

Floating

EXCHANGE RATE REGIME

Pegged Floating

Fixed

Dollarization

Floating Exchange Rate A country's exchange rate regime where its currency is set by the

foreign-exchange market through supply and demand for that particular currency relative to other currencies. Thus, floating exchange rates change freely and are determined by trading in the forex market.

Generally, countries with mature, stable economic markets will use a floating system.

Fixed Exchange Rate A country's exchange rate regime under which the

government or central bank ties the official exchange rate to another country's currency (or the price of gold).

This helps the government maintain low inflation, which in the long run should keep interest rates down and stimulate increased trade and investment.

Pegged Floating Exchange Rate Pegged floating currencies are pegged to some band or value,

either fixed or periodically adjusted. Pegged floats are: Crawling bands: the rate is allowed to fluctuate in a band around a

central value, which is adjusted periodically. This is done at a preannounced rate or in a controlled way following economic indicators.

Crawling pegs: Here, the rate itself is fixed, and adjusted as above. Pegged with horizontal bands: The currency is allowed to fluctuate

in a fixed band (bigger than 1%) around a central rate.

Dollarization Citizens of a country officially or unofficially use a foreign country’s

currency to conduct transactions. The main reason a country would do this is to reduce its country

risk, thereby providing a stable and secure economic and investment climate. Countries seeking full dollarization tend to be developing or transitional economies, particularly those with high inflation.