Page 2 - Module 4 - Lesson 4 - Guidelines to the iEvents that effect the USD

EXCHANGE RATE

“ the price of a nation’s An exchange rate has a base currency and a counter Flexible (or floating) Exchange Rates
currency. In a direct quotation, the foreign currency
Exchange rates can be floating or fixed. Most exchange
is the base currency and the domestic currency is the
currency in terms of counter currency. rates are determined by the foreign exchange market,
or forex. That’s called a flexible exchange rate. For this
In an indirect quotation, the domestic currency is the
reason, exchange rates fluctuate on a moment-by-
another currency” base currency and the foreign currency is the counter moment basis.
currency.
The flexible rates follow what forex traders think the
as an Most exchange rates use the US dollar as the base currency is worth. Those judgments depend on a
lot of factors. The three most important are central
currency and other currencies as the counter currency.
ECONOMIC However, there are a few exceptions to this rule, such bank’s interest rates, the country’s debt levels and the
as the euro and Commonwealth currencies like the
strength of its economy.
British pound, Australian dollar and New Zealand
measure dollar. The United States allows its forex market to determine
the U.S. dollar’s value. The U.S. dollar strengthened
Exchange rates for most major currencies are generally against most currencies during the 2008 financial
Exchange rates are one of the most watched and expressed to four places after the decimal, except crisis. When stock markets fell worldwide, traders
analysed economic measures across the world and for currency quotations involving the Japanese yen, flocked to the relative safety of the dollar. But, why
was the dollar safe? After all, the crisis started in the
which are quoted to two places after the decimal.
are a key indicator of a country’s economic health. United States. Here’s more on why the dollar is so
Furthermore, exchange rates can also be categorized strong right now.
Rates are not just important to governments and as the spot rate – which is the current rate – or a Despite this, most investors trusted that the U.S.
forward rate, which is the spot rate adjusted for
large financial institutions. They also matter on a interest rate differentials. Treasury would guarantee the safety of the world’s
smaller scale, having an impact on the real returns of Let’s consider some examples of exchange rates to global currency.
an investor’s portfolio. . enhance understanding of these concepts. The dollar took on that role when it replaced the gold
US$1 = C$1.1050. standard during the 1944 Bretton Woods agreement.
Fixed Exchange Rates
Here the base currency is the US dollar and the
counter currency is the Canadian dollar. In Canada, A fixed exchange rate is when a country’s currency
economic this exchange rate would comprise a direct quotation doesn’t vary according to the forex market. The
of the Canadian dollar. This is easy to understand
country makes sure that its value against the dollar, or
INFLUENCES intuitively, since prices of goods and services in Canada other important currencies, remain the same.
are expressed in Canadian dollars; therefore the price
of a US dollar in Canadian dollars is an example of a It buys and sells large quantities of its currency, and
Strong currencies make a nation’s direct quotation for a Canadian resident. the other currency, to maintain that fixed value.
exports more expensive and imports C$1 = US$ 0.9050 = 90.50 US cents. For example, China maintains a fixed rate. It pegs its
from foreign markets cheaper, Here, since the base currency is the Canadian dollar currency (the yuan), to a targeted value against the
dollar. As of June 19, 2017, one dollar was worth 6.806
whereas weaker currencies make and the counter currency is the US dollar, this would Chinese yuan. Since February 7, 2003, U.S. dollar has
be an indirect quotation of the Canadian dollar in
exports cheaper and imports more Canada. weakened against the yuan. One U.S. dollar could be
exchanged for 8.28 yuan at that time. The U.S. dollar
expensive. Higher exchange rates If US$1 = JPY 105, and US$1 = C$1.1050, it follows has weakened because it can buy fewer yuan today,
adversely affect a country’s balance that C$1.1050 = JPY 105, or C$1 = JPY 95.02. For an than it could in 2003.
of trade but lower exchange rates investor based in Europe, the Canadian dollar to yen That’s because the U.S. government pressured the
exchange rate constitutes a cross currency rate, since
Chinese government to let the yuan rise in value. This
have a positive effect on it neither currency is the domestic currency. allows U.S. exports to be more competitively priced
in China. It also makes Chinese exports to the United
States, more expensive. For more on how this affects
you, see U.S. China Trade Deficit

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