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FOREIGN EXCHANGE
Popularly referred to as "FOREX" The conversion of one country's currency into that of another. It is the minimum number of units of one countries currency required to purchase one unit of the other countries currency.
WHY IT NEEDED???.....
Different countries have different currencies with different values. Example: India - Rupees America -Dollar China - Yuan When trade takes place.. the persons of these countries have to convert their currencies to other countries currencies to make payments
For this purpose the concept of foreign exchange come into operation. Under mechanism of international payments, the currency of a country is converted in to the currency of another country through FOREIGN EXCHANGE MARKET. The effect of globalization and international trade Increased import and export
Advantages It provide the stability of exchange rate. Fixed rates provide greater certainty for exporters and importers.
Disadvantages Too rigid to take care of major upheavals. Need large reserves to defend the fixed exchange rate. May cause destabilizing speculations; most currency crisis took place under a fixed exchange system.
Advantages
Automatic adjustment for countries with a large balance of payments deficit. Flexibility in determining interest rates Allow countries to maintain independent economic policies. Permit a smooth adjustment to external shocks. Don't need to maintain large international reserves.
Disadvantages Flexible exchange rates are highly unstable so that flows of foreign trade and investment may be discouraged. They are inherently inflationary.
i.e the price of a good that is charged in one country should be equal to the one charged for the same good in another country, being exchanged at the current rate.
This rule is also known as the law of one price. It is an economic theory that estimates the amount of adjustment needed on the exchange rate between countries in order for the exchange to be equivalent to each currency's purchasing power.
CURRENT ACCOUNT
export and import of goods &services CAPITAL ACCOUNT Capital transfers FINANCIAL TRANSFERS Foreign direct investment Portfolio investment RESERVEBANK TRANSACTIONS
According to the theory, a deficit in the balance of payments leads to fall or depreciation in the rate of exchange, while a surplus in the balance of payments strengthens the foreign exchange reserves, causing an appreciation in the price of home currency in terms of foreign currency. A deficit balance of payments of a country implies that demand for foreign exchange is exceeding its supply. As a result, the price of foreign money in terms of domestic currency must rise, i.e., the exchange rate of domestic currency must fall. On the other hand, a surplus in the balance of payments of the country implies a greater demand for home currency in a foreign country than the available supply. As a result, the price of home currency in terms of foreign money rises, i.e., the rate of exchange improves.
2. Inflation Rate
when inflation increases there will be less demand for local goods (decreased supply of foreign currency) and more demand for foreign goods (increased demand for foreign currency).
4. Political conditions
Internal, regional and international political conditions and events can have a profound effect on currency market