Exchange Rate

Exchange rate is a price of a country’s currency which is expressed in the currency of another country as well as in precious metals or securities.

The notion "currency exchange" is inextricably connected with convertibility being its characteristic. The degree of currency convertibility is determined by the mechanism of state regulation of monetary operations. A currency is called freely convertible when there are no restrictions for citizens and non-citizens to carry out monetary transactions using this currency. A currency is called nonconvertible if there are legal restrictions on all types of operations with it. Partly convertible is a currency in the country of which there are limitations and restrictions on certain types of exchange operations or for certain participants in such operations. Freedom to convert a currency must be governed by the economic stability of a country, i.e. the legal permission to convert a currency is not enough. What is also needed is the trust in the currency and the assessment of the country’s economic viability. So the convertibility is an ability of a currency to be freely exchanged for other currencies and vice versa for the national currency on forex.

The exchange rate is based on purchasing power parity. To disclose its sense they use the law of one price: the price of some goods in one country must be equal to the price of the same goods in another country. As long as these prices are expressed in different currencies their correlation determines the exchange rate.

Exchange rates almost never coincide with their purchasing power parity. In the context of international trade and other foreign economic campaigns the correlation of incomes and payments in a foreign currency and, correspondingly, the supply and demand for a foreign currency are not in balance. When there exists an active pay balance the exchange rates of foreign currencies drop while the rate of a national currency rises. When the pay balance is passive the national currency rate, on the contrary, drops. That is why many countries exploit not only the official national currency rate but also a floating one.

The official purchasing power parity functions to fulfill payments by the central banks and other financial institutions between different countries and international corporations. As for the payments between individuals and organizations, they are performed according to the floating rate.

The rate fixing is achieved according to either gold parity or to the international contract. Fixing the national currency in a foreign one is called an exchange quotation. The quotation is divided into a direct quotation and a reverse quotation. A direct quotation shows the index of the foreign monetary unit represented in the unit of the national currency. A reverse quotation shows the index of a national currency expressed in the unit of the foreign currency.

The rate of one currency in relation to another can be fixed with the help of the third currency. The phenomenon is called cross rate which is applied to when the volume of direct exchange operations between two currencies is relatively small. Consequently, there cannot be formed reliable direct quotations. Even if it turns out to be reliable the cross rate can influence establishing a different exchange rate.

When observing the levels of exchange rates the main emphasis is laid upon the offered rate and the buying rate. The offered rate is the rate according to which a bank sells a currency. The buying rate is the rate on the basis of which a bank purchases a currency. They differ from each other since the monetary transactions in this case are considered to be the means of generating profits. The difference between these rates makes the margin.

At present exchange rates are floating. That happens so because the exchange rates are fixed with account of purchasing parity, pay balance conditions, the level of inflation, interstate migrations of short term credits, political factors and so on. In its turn, the exchange rate exerts a great impact on export competiveness of goods on the global markets. If an exchange rate is too high it decreases the export effectiveness but if the rate is too low it will lead to additional benefits.