Page 1 :
Foreign Exchange Rate, It refers to foreign currencies and claims on them in the form of bank deposits, cheques, etc., payable in those currencies or in other words, foreign exchange is the reserve of foreign, currencies with the country., , Terms of trade, The ‘Term of Trade’ refers to the rate at which country’s exports are exchanged against its, imports. It relates to the quantity of imported goods, that can be obtained per unit of goods, exported or quantity of country’s exports that must be given in exchange of per unit of, imported goods., , Meaning of Foreign exchange rate, Foreign exchange rate refers to the rate at which one unit of currency of a country can be, exchanged for the number of units of currency of another country. In other words, it is the, price paid in domestic currency in order to get one unit of foreign currency, e.g., 1$ = ₹ 60, , or, , ₹1 = 1/60$, , Types of Exchange Rate, 1., Fixed Exchange Rate, This system is handled by the Central Bank of, the country and it is entrusted with the task of buying and selling of foreign currency., The Central Bank buys currency at the fix exchange rate and sells it when there is, excess demand of foreign exchange., It is the rate which is officially fixed by the monetary authority on daily or monthly, basis. It has two important variants., i. Gold standard system of exchange rate, Under this system, each country, was to define value of its currency in terms of gold. Accordingly, value of its, currency in terms of gold. Accordingly, value of one currency in terms of the, other currency was fixed considering gold value of each currency., For example 1 UK Pound = 4 gm of gold, 1 US Dollar = 2 gm of gold, 1 UK Pond = 2 US Dollar, Therefore, exchange rate between UK pound and US Dollar = 1:2, ii. Bretton Woods system of exchange rate or adjustable peg system of, exchange rate, Bretton Woods is named after United Nations, Monetary Financial Conference held at Bretton Woods (USA) in 1944. Bretton, Woods system, even when it was fixed system of exchange rate, allowed, some adjustments. So, it was called “adjustable peg system of exchange, rate.’

Page 2 :
2., Flexible exchange rate / Floating rate, Flexible exchange rate is determined by the demand and supply of foreign currency., In this system the Central Bank allows the exchange rate to adjust, to equate the, supply and demand for foreign exchange. It is also known as Floating exchange rate., ➢ Pure floating rate – Under this, Central Bank stands aside completely and, allows exchange rate to be freely determined in the open market., ➢ Managed Floating Rate – Under this, Central Bank intervenes from time to, time to buy and sell foreign currency in an attempt to influence the exchange, rate., , Difference between Fixed exchange rate and Flexible/Floating rate: Basis, Meaning, , Fixed Exchange Rate, It refers to the rate of exchange as, fixed by the Central Bank, , Determination, , Gold exchange rate and adjustable, peg system of exchange rate are the, two types of determining fixed, exchange rate, There is complete RBI (Reserve, Bank of India) intervention, , Intervention, , Flexible/Floating exchange Rate, It is determined by the demand and, supply of different currencies in the, foreign exchange rate, It is determined by the market force, of demand and supply like the, prices of other commodity, There is no or partial RBI, intervention., , Determination of exchange rate in a free market, The exchange rate of a currency is determined by forces of demand and supply of foreign, exchange in the foreign exchange market. Exchange rate is determined at a level, where, demand and supply of foreign exchange are equal., The factors determining the foreign exchange rate can be grouped under: ➢ Factors determining demand of foreign exchange are: • Payment of international loans, • Investment in rest of the world, • Direct purchase abroad as well as imports from rest of the world., • Speculative trading in foreign exchange by own resident., • Foreign tour, ➢ Factors determining supply for foreign exchange., • Export of the country to the rest of the world, • Direct Investment like installation of Wall mart stores in the domestic country., • Direct purchase of goods and services by non-residents in the domestic, country.

Page 3 :
•, •, , Remittance by the non-residents living in foreign countries., Foreigners visit to the domestic country., , Equilibrium Rate of exchange, At any particular time, the price at which demand for foreign currency equals to its supply is, called equilibrium Rate of exchange. As shown is the diagram below: 1) Depreciation – (In case of flexible exchange Rate), It means fall in the value of domestic currency in terms of foreign currency. For, example, say from ₹ 65 to ₹ 72 a dollar, it will be a case of depreciation of Indian, rupees because more rupees are required now to buy 1US Dollar., 2) Appreciation – (In case of flexible exchange Rate)., In this case the value of domestic currency increases in terms of foreign currency. It, makes the domestic currency more valuable indicating the less of it is required to buy, foreign currency., 3) Devaluation – (In case of fixed exchange rate)., It means reduction in the external value of a country’s currency as a conscious policy, measures adopted by the Central Bank of our country. In other words, we make our, currency cheaper in terms of foreign currency. This makes our goods cheaper for, foreign buyers and makes foreign goods costlier to our buyers. Hence, export, increases, import falls, reducing the deficit in Balance of Payment., 4) Revaluation – (In case of fixed exchange rate), It refers to an action undertaken by the Central Bank to raise the value of domestic, currency relative to other foreign currency. In this case import increases and export, decreases.