Exchange Rate, the word itself conveys the meaning of itself. It mean rate of exchange of one thing with another. In forex market this word is often used to determine the rate of exchange of one currency with another. This simple means that how much of one currency is needed to purchase another currency. For example, in order to buy 1 US dollar you need to 54 Indian rupees, that is, the value of one USD in terms of INR is 54. Exchange rates are always relative to the currency pair in which currencies are traded, like USD/EURO or RMB/SGD. One requires to know the exchange rate when travelling between countries, performing Forex Trading and also in doing International Business. Countries may decide to keep their exchange rate fixed through their monetary policies or let the Forex market determine the rate of their currencies.
Exchange rate fluctuates every day. This fluctuation depends on the demand and supply of currencies in Forex Market. This works more or less like a stock market. As per the investors projections and the performance of a company, the value/demand of its stock changes. Similarly the performance of a country in terms of its monetary and fiscal policy, financial stability, its inflations, it international trade determine the exchange rate of its currency. This means poor performance may lead to lowering of exchange rate.
Types of Exchange Rates
There can be two types of exchange rates : Spot and Forward. A spot rate is the current rate of the currency. When you look at a currency converter or ask a broker the rate of currency they generally tell you the spot rate. The rate at which you can buy the currency now. A forward rate is the rate at which you enter into trading a currency pair but the delivery and payment of the currency is done on a future date. For example, you have made a bulk order of Televisions from China to be sold in US. The delivery will take place in next 1 month’s time and payment will be done on delivery. To finalise the order you need to prepare all the documentation required and plan shipment. For this generally current rate is taken to fixed as the total cost of the contract for which the payment will be paid on the shipment. This is a forward rate because this is fixed today, quoted today but this transaction’s delivery and payment will be done on a future date.