It is conversion from one currency to other that determines the profits that traders receive while trading; however, it is important for them to understand that when one currency is converted into another, there must be some basis in determining the conversion. This blog is trying to elaborate the factors that determine the exchange value of a currency.
Firstly, the basis by which the currency unit of one country gets converted into currency units of another country is known as foreign exchange rate. Now it is important to understand that foreign exchange rate is therefore the price of one currency in terms of another. Also, it is well understood that the rate of exchange for a currency varies a lot depending upon various factors.
Factors Affecting Exchange Rates
It is a globalization era where in the globalized economic environment of today, economic activity is globally unified to an unprecedented degree and one economy is well-knitted with other. Inter-dependency of one economy on the other has gone up many folds. Also, changes in one nation’s economy are rapidly transmitted to that nation’s trading partners.
Thus, the first factor is that the economic activities tend to have a lot of impact on the exchange value of the currency. Nonetheless, fluctuations in economic activity are reflected, almost immediately as fluctuations in currency values and that is why traders are expected to have a tab on the economic activities that are taking place.
Another important factor that plays vital role in determining the exchange value of a currency is balance of payments as here the flow of economic transactions between residents of a given country and the residents of other countries during a certain period of time are of vital importance. Better balance of payment means higher value for the currency.
Nonetheless, it is important to understand that balance of payments represents the demand and supply of foreign exchange which ultimately determine the value of the currency. It plays important role in the national economy as well as when the balance of payments of a country is continuously deficit, it implies that the demand for the currency of the country is lesser than its supply.
Factors That Determine the Forex Market
Third factor is relative inflation rates wherein the supply of a currency increases relative to its demand. This is quite a problem for an economy and currency when its excess growth in the money supplies in an economy causes inflation which in turn weakens the exchange value vis-à-vis other currencies.