What Factors Cause Exchange Rates to Fluctuate?
The foreign exchange market, or forex, is one of the largest markets in the world, and is in constant flux. When it's night in one part of the world, it's morning in another, and exchange rates fluctuate as currencies are bought and sold. With trillions of dollars' worth of currency trading each day, the currency market is one of the most important in an economy of global trade, and exchange rates fluctuate in response to a variety of factors ranging from economic data to changes in interest rates.
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Identification
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An exchange rate is a ratio that expresses the value of one currency in terms of another. An individual exchange rate is also called a currency cross or pair, and is identified by the abbreviations of the currencies involved. For example, EUR/USD is the number of dollars (USD) that can be purchased by one euro (EUR). Indirect quotation occurs when the home currency is first in the pair. Direct quotation is when a foreign currency is listed first. The major currency pairs are EUR/USD, GBP/USD, USD/JPY, USD/CHF, AUD/USD and USD/CAD.
History
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Originally, currencies were redeemable in gold, silver or some other commodity of value. But demand for currency usually outstrips the available supply of such commodities, and lending institutions historically chased higher profits by lending more currency than they had in reserve. In the 20th century, the United States and other major countries abandoned the gold standard, leaving currencies essentially without intrinsic value other than the gross domestic product of each country.
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Function
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In the most basic sense, currencies fluctuate because of changes in supply and demand. Supply of currency is usually based on the creation of money by national central banks, through a variety of means. The demand for currency can either be transactional, meaning it is needed for actual use in an economy, or speculative, meaning it is purchased simply because it is expected to appreciate in relation to other currencies.
Features
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The transactional demand for a currency is related to the economic growth of a country, its rate of employment, and the velocity of money, which is the rate at which money moves through the economy from one transaction to another. Speculative demand for currency is based on perceptions of the degree to which it will retain its value. This is related in part to expectations of future economic activity, but also to anticipated inflation, which occurs when the supply outstrips demand and sends the value of the currency down.
Considerations
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One of the most direct influences on exchange rates is the interest rate differentials between different countries. Central banks attempt to manipulate demand for their currency by raising or lowering benchmark interest rates, which represent the cost of borrowing in the currency. The variation in interest rates around the world produces a type of speculative demand called a carry trade, where money is borrowed in a low-interest currency and converted and lent in a high-interest currency. The carry trader is able to keep the difference in the rates as profit, but runs the risk that changes in the relative interest rates and exchange rates will erode that profit.
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Comments
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what are the major sources of the supplyof foreign exchang in uganda.
