Exchange rate is the price at which one currency can be exchanged for another. There are several factors that influence the level of an exchange rate, which include:
- Inflation: the currency of a country with low inflation rates would appreciate, due to extra demand for their products because of cheaper prices and vice versa.
- Interest rate: a country which offers high interest rates on deposits will experience increased demand for that currency as persons seek to take advantage of the higher interest rates.
- Political and economic factors: majority of investors are risk-averse and as such will not invest in countries that are politically unstable and have low levels of expected growth. The currency for such a country would depreciate.
- Current account: a country with a trade surplus would experience a high demand for its currency and the exchange rate would increase.
Fixed exchange rate is an exchange rate that is set at a predetermined level and maintained at this level.
Floating exchange rate is an exchange rate that is allowed to be determined by the market forces of supply and demand.
Managed exchange rate is a country’s exchange rate that is not fixed or floating, but is influenced by monetary authorities’ actions in the foreign exchange market.
A currency appreciates when its value increases in respect to other currencies, it depreciates when it losses value in respect to other currencies.