The advantages of fixed and floating exchange rates

Advantages of fixed exchange rates

Fixed rates provide greater certainty for exporters and importers and, under normal circumstances, there is less speculative activity – though this depends on whether dealers in foreign exchange markets regard a given fixed exchange rate as appropriate and credible.

Advantages of floating exchange rates

Fluctuations in the exchange rate can provide an automatic adjustment for countries with a large balance of payments deficit. A second key advantage of floating exchange rates is that it allows the government/monetary authority flexibility in determining interest rates as they do not need to be used to influence the exchange rate.

Who are the participants in today’s Forex market?

In general, there are two main groups in the Forex marketplace:

Hedgers account for less than 5% of the market, but are the key reason futures and other such financial instruments exist. The group using these hedging tools is primarily businesses and other organizations participating in international trade. Their goal is to diminish or neutralize the impact of currency fluctuations.

Types of Exchange rate Systems

An exchange can operate under one of four main types of exchange rate systems

Fully fixed exchange rates

In a fixed exchange rate system, the government (or the central bank acting on its behalf) intervenes in the currency market in order to keep the exchange rate close to a fixed target. It is co

The basic theories underlying the US dollar to euro exchange rate

Law of one price: In competitive markets, free of transportation cost barriers to trade, identical products sold in different countries must sell at the same price when the prices are stated in terms of the same currency.

Interest rate effects: If capital is allowed to flow freely, exchange rates become stable at a point where equality of interest is established.

The dual forces of supply and demand

These two reciprocal forces determine euro vs. US dollar exchange rates. Various factors affect these two forces, which in turn affect the exchange rates

The business environment: Positive indications (in terms of government policy, competitive advantages, market size, etc.) increase the demand for the currency, as more and more enterprises want to invest in its place of origin.

Stock Market: The major stock indices also have a correlation with the currency rates, providing a daily read of the mood of the business environment.

Political factors: All exchange rates are susceptible to political instability and anticipation about new governments. For example, political instability in Russia is also a flag for the euro to US dollar exchange, because of the substantial amount of German investment in Russia.

Economic data: Economic data such as labour reports (payrolls, unemployment rate and average hourly earnings), consumer price indices (CPI), producer price indices (PPI), gross domestic product (GDP), international trade, productivity, industrial production, consumer confidence etc., also affect currency exchange rates.

Euro Dollar currency exchange

The euro to US dollar exchange rate is the price at which the world demand for US dollars equals the world supply of euro. Regardless of geographical origin, a rise in the world demand for euros leads to an appreciation of the euro.

Factors affecting the Euro to US dollar exchange rate
Four factors are identified as fundamental determinants of the real euro to US dollar exchange rate:

  • The international real interest rate differential between the Federal Reserve and European Central Bank
  • Relative prices in the traded and non traded goods sectors
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