CURRENCY EXCHANGE RATES
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Definition: Currency exchange rate is a ratio that
defines the relative value relationship existing between two currencies
at a given moment in time. Also referred to as foreign exchange
rate, rate of exchange and exchange rate, the
currency exchange rate between two currencies will normally vary over
time (i.e., fluctuate) in response to economic and political
circumstances (free market forces); this variable
relationship is referred to as a floating exchange rate.
A government may choose to lock, or peg, its nation’s currency
exchange rate to the value of another nation’s currency or to the
value of a commodity (e.g., the Gold Standard), usually for purposes of
increasing economic stability during a period of internal crisis or in
order to insure uniformity in foreign trade. Such an arrangement is known
as a fixed exchange rate. Currency exchange rates have often been
pegged to the U.S. Dollar (USD) because the economy of the United States is
widely considered to be one of the most stable and least risky economies in
the world.
Currency exchange rates are essential to facilitate international exchange
of goods and services (foreign trade), foreign
investment and international travel. A currency’s exchange rate
will ordinarily fluctuate slowly and over a narrow range; however,
shocks to the economic or political stability of a country can cause
rapid, large magnitude currency exchange rate fluctuations. Such
shifts in currency values can adversely impact international businesses
and travelers as well as governments. As foreign markets have become more
closely tied to one another in a unified international structure,
techniques such as hedging and sophisticated financial
instruments known as derivatives have been designed to lessen the
impact of currency shocks. Currency traders seek to reap profit
from short-term fluctuations in currency markets; by so doing, they
provide much-needed liquidity to financial markets during periods
of economic stress.
Authored by Kenneth L. Anderson.
Original article published 25 March 2004.
The advent of ecommerce — the ability to effect mercantile
transactions electronically through use of the Internet — has made
it increasingly necessary for currency exchange rates to be both accurate
and timely. Follow links to the right to learn more about currency
exchange rates and exchange rate calculators courtesy of XE.com as
well as additional information about how currency exchange and currency
exchange rates work. Check Related Links at the left margin for
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