What is the rate of foreign exchange? How it is determined under different monetary standards?
What is the rate of foreign exchange? How it is determined under different monetary standards?
Tuesday, June 2, 2020
What is the rate of foreign exchange? How it is determined under different monetary standards?
RATE OF FOREIGN EXCHANGE
RATE OF FOREIGN EXCHANGE
The rate of exchange is the ratio at which one country’s currency can be exchanged for another.
EXAMPLE If one American dollar can buy Pakistan’s fifty rupees, the rate of exchange for a dollar and a rupee would be:
1 US Dollar = Pak Rs.90.9 1 Pak Rs. = $ .0110
DETERMINATION OF RATE OF FOREIGN EXCHANGE UNDER DIFFERENT MONETARY STANDARDS
EXAMPLE If one American dollar can buy Pakistan’s fifty rupees, the rate of exchange for a dollar and a rupee would be:
1 US Dollar = Pak Rs.90.9 1 Pak Rs. = $ .0110
DETERMINATION OF RATE OF FOREIGN EXCHANGE UNDER DIFFERENT MONETARY STANDARDS
The rate of foreign exchange can be determined under different monetary standards.
WHEN BOTH COUNTRIES ADOPT GOLD STANDARD
WHEN BOTH COUNTRIES ADOPT GOLD STANDARD
When two trading nations are on gold standard or their paper currencies are convertible into gold and silver, the exchange rate between their currencies would depend on the weight of gold contained in the coin.
EXAMPLE If a Pakistan coin contains two grams of gold and India’s coin one gram, the exchange rate would be:
I Pakistani Coin = 2 Indian Coins or 1 Indian Coin = 0.50 Pakistani coin Exchange rate thus determined is called as “mint par of exchange”. Gold standards allow free flow of coins among countries with it.
WHEN ONE CURRENCY IS ON GOLD STANDARD, AND THE OTHER ON NON- CONVERTIBLE
EXAMPLE If a Pakistan coin contains two grams of gold and India’s coin one gram, the exchange rate would be:
I Pakistani Coin = 2 Indian Coins or 1 Indian Coin = 0.50 Pakistani coin Exchange rate thus determined is called as “mint par of exchange”. Gold standards allow free flow of coins among countries with it.
WHEN ONE CURRENCY IS ON GOLD STANDARD, AND THE OTHER ON NON- CONVERTIBLE
In such a case currencies of two trading countries cannot freely flow. They will settle their foreign debts through the bills of exchange. The rate will be determined on the demand and supply of their bills, whose demand depends on that of goods and services. High demand will put the rate of currency at a high level and vice versa.
WHEN BOTH COUNTRIES ARE ON NON-CONVERTIBLE PAPER CURRENCIES
WHEN BOTH COUNTRIES ARE ON NON-CONVERTIBLE PAPER CURRENCIES
Here also above method involving bill of exchange is used. In this modern world all countries run non-convertible paper currency system. Under it payment in foreign trade is made through bill of exchange. If the goods and services have a good demand abroad, the demand for bill of exchange will consequently be high. High demand for the bill will fetch a high exchange rate for the currency.