EXCHANGE RATE

The number of units of a currency from a country that are exchanged for one unit of another currency from another country.

 

Exchange rates are especially important for companies that import and export and for multinational corporations because they are required to make an annual review of the exchange rates of their assets in other currency areas according to international accounting laws.

Furthermore, when these companies make exports or imports, they should express their value in both currencies.

There are two different ways of expressing the exchange rate:
  • Direct form: is taken as reference the value of foreign currency in terms of national currency. For example: 1GBP – 1.35119€
  • Indirect form: is taken as reference the value of national currency in terms of foreign currency. For example: 1€ – 0,73991GBP
Furthermore, the exchange rate can also be expressed in a dual manner, as purchase price or as selling price. For example:

Selling 1 GBP → gets € 1.35119
1 GBP buying → pays € 1.35152

The exchange rate can be classified into two types. On one hand, the nominal exchange rate, and on the other hand the real exchange rate:
  • The nominal exchange rate is the most frequently used and relates the exchange of a currency of a country with another country.
  • The real exchange rate actually determines how much a person can exchange goods and services from one country to another country.

There are several factors that influence the exchange rate,and the most important are:

  • Inflation
  • Interbank interest rates
  • Current account deficit
  • Government debt
  • Terms of trade
  • Political stability and economic growth
  • Speculation
  • Relative value of other currencies
Lastly, the exchange rate can be classified into two types that depend on who established them:
  • Fixed exchange rate: the exchange rate is set by the Central Bank and it is responsible for keeping it under check and for taking appropriate decisions in relation to the exchange rate. The Central Bank decides on a significant currency that will be the exchange rate that is the reference value for other currencies. The measure of value is usually a strong currency such as the dollar, the pound or the euro.
  • Floating exchange rate: this can also be called flexible exchange rate. The Central Bank has less influence on it. It is set by market supply and demand. This exchange system is constantly changing because the supply and demand are self-regulating if the deviations are not too strong. The majority of the economies in the developed the world use this system exchange.