View Full Version : What is a fixed exchange rate??
11-28-2009, 05:02 PM
A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime wherein a currency's value is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as gold.
A fixed exchange rate is usually used to stabilize the value of a currency, against the currency it is pegged to. This makes trade and investments between the two countries easier and more predictable, and is especially useful for small economies where external trade forms a large part of their GDP.
It can also be used as a means to control inflation. However, as the reference value rises and falls, so does the currency pegged to it. In addition, according to the Mundell-Fleming model, with perfect capital mobility, a fixed exchange rate prevents a government from using domestic monetary policy in order to achieve macroeconomic stability.
Description of a Fixed Currency
Fixing value of the domestic currency relative to that of a low-inflation country is one approach central banks have used to pursue price stability. The advantage of an exchange rate target is its clarity, which makes it easily understood by the public. In practice, it obliges the central bank to limit money creation to levels comparable to those of the country to whose currency it is pegged. When credibly maintained, an exchange rate target can lower inflation expectations to the level prevailing in the anchor country. Experiences with fixed exchange rates, however, point to a number of drawbacks. A country that fixes its exchange rate surrenders control of its domestic monetary policy.
11-28-2009, 05:06 PM
Maintaining a fixed exchange rate
Typically, a government wanting to maintain a fixed exchange rate does so by either buying or selling its own currency on the open market. This is one reason governments maintain reserves of foreign currencies. If the exchange rate drifts too far below the desired rate, the government buys its own currency off the market using its reserves. This places greater demand on the market and pushes up the price of the currency. If the exchange rate drifts too far above the desired rate, the opposite measures are taken.
Another, less used means of maintaining a fixed exchange rate is by simply making it illegal to trade currency at any other rate. This is difficult to enforce and often leads to a black market in foreign currency. Nonetheless, some countries are highly successful at using this method due to government monopolies over all money conversion. This is the method employed by the Chinese government to maintain a currency peg or tightly banded float against the US dollar. Throughout the 1990s, China was highly successful at maintaining a currency peg using a government monopoly over all currency conversion between the yuan and other currencies.
11-28-2009, 05:11 PM
Floating exchange rate
A floating exchange rate or fluctuating exchange rate is a type of exchange rate regime (http://dinarspeculator.com/wiki/Exchange_rate_regime) wherein a currency (http://dinarspeculator.com/wiki/Currency)'s value is allowed to fluctuate according to the foreign exchange market (http://dinarspeculator.com/wiki/Foreign_exchange_market). A currency that uses a floating exchange rate is known as a floating currency (http://dinarspeculator.com/wiki/Floating_currency). It is not possible for a developing country to maintain the stability in the rate of exchange for its currency in the exchange market. There are two options open for them-  Let the exchange rate be allowed to fluctuate in the open market according to the market conditions, or  An equilibrium rate may be fixed to be adopted and attempts should be made to maintain it as far as possible. But, if there is a fundamental change in the circumstances, the rate should be changed accordingly. The rate of exchange under the first alternative is know as fluctuating rate of exchange and under second alternative, it is called flexible rate of exchange. In the modern economic conditions, the flexible rate of exchange system is more appropriate as it does not hamper the foreign trade. There are economists (http://dinarspeculator.com/wiki/Economist) who think that, in most circumstances, floating exchange rates are preferable to fixed exchange rates. As floating exchange rates automatically adjust, they enable a country to dampen the impact of shocks (http://dinarspeculator.com/wiki/Shock_(economics)) and foreign business cycles (http://dinarspeculator.com/wiki/Business_cycles), and to preempt the possibility of having a balance of payments crisis. However, in certain situations, fixed exchange rates may be preferable for their greater stability and certainty. This may not necessarily be true, considering the results of countries that attempt to keep the prices of their currency "strong" or "high" relative to others, such as the UK or the Southeast Asia countries before the Asian currency crisis (http://dinarspeculator.com/wiki/Asian_currency_crisis). The debate of making a choice between fixed and floating exchange rate regimes is set forth by the Mundell-Fleming model (http://dinarspeculator.com/wiki/Mundell-Fleming_model), which argues that an economy cannot simultaneously maintain a fixed exchange rate, free capital movement, and an independent monetary policy. It can choose any two for control, and leave third to the market forces.
In cases of extreme appreciation or depreciation, a central bank (http://dinarspeculator.com/wiki/Central_bank) will normally intervene to stabilize the currency. Thus, the exchange rate regimes of floating currencies may more technically be known as a managed float. A central bank might, for instance, allow a currency price to float freely between an upper and lower bound, a price "ceiling" and "floor". Management by the central bank may take the form of buying or selling large lots in order to provide price support or resistance, or, in the case of some national currencies, there may be legal penalties for trading outside these bounds.
11-28-2009, 05:13 PM
Thanks for the lesson Med.
11-28-2009, 05:16 PM
Foreign exchange market
The foreign exchange market (currency, forex, or FX) trades currencies. It lets banks and other institutions easily buy and sell currencies.  (http://dinarspeculator.com/#cite_note-0)
The purpose of the foreign exchange market is to help international trade and investment. A foreign exchange market helps businesses convert one currency to another. For example, it permits a U.S. business to import European goods and pay Euros (http://dinarspeculator.com/wiki/Euros), even though the business's income is in U.S. dollars (http://dinarspeculator.com/wiki/U.S._dollars).
In a typical foreign exchange transaction a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market started forming during the 1970s when countries gradually switched to floating exchange rates (http://dinarspeculator.com/wiki/Floating_exchange_rate) from the previous exchange rate regime (http://dinarspeculator.com/wiki/Exchange_rate_regime), which remained fixed (http://dinarspeculator.com/wiki/Fixed_exchange_rate) as per the Bretton Woods system (http://dinarspeculator.com/wiki/Bretton_Woods_system).
11-28-2009, 05:19 PM
thanks for the explaination Med.
11-28-2009, 05:23 PM
A futures exchange or derivatives exchange is a central financial exchange where people can trade standardized futures contracts (http://dinarspeculator.com/wiki/Futures_contracts); that is, a contract to buy specific quantities of a commodity (http://dinarspeculator.com/wiki/Commodity) or financial instrument (http://dinarspeculator.com/wiki/Financial_instrument) at a specified price with delivery (http://dinarspeculator.com/wiki/Delivery_(commerce)) set at a specified time in the future.
Nature of contracts
Exchange-traded contracts are standardized by the exchanges where they trade. The contract details what asset is to be bought or sold, and how, when, where and in what quantity it is to be delivered. The terms also specify the currency in which the contract will trade, minimum tick value, and the last trading day and expiry or delivery month (http://dinarspeculator.com/wiki/Delivery_month). Standardized commodity futures contracts may also contain provisions for adjusting the contracted price based on deviations from the "standard" commodity, for example, a contract might specify delivery of heavier USDA (http://dinarspeculator.com/wiki/USDA) Number 1 oats at par value but permit delivery of Number 2 oats for a certain seller's penalty per bushel.
Before the market opens on the first day of trading a new futures contract, there is a specification but no actual contracts exist. Futures contracts are not issued like other securities, but are "created" whenever Open interest (http://dinarspeculator.com/wiki/Open_interest) increases; that is, when one party first buys (goes long (http://dinarspeculator.com/wiki/Long_(finance))) a contract from another party (who goes short (http://dinarspeculator.com/wiki/Short_(finance))). Contracts are also "destroyed" in the opposite manner whenever Open interest (http://dinarspeculator.com/wiki/Open_interest) decreases because traders resell to reduce their long positions or rebuy to reduce their short positions.
Speculators on futures price fluctuations who do not intend to make or take ultimate delivery must take care to "zero their positions" prior to the contract's expiry. After expiry, each contract will be settled (http://dinarspeculator.com/wiki/Futures_contract#Settlement) , either by physical delivery (typically for commodity underlyings) or by a cash settlement (typically for financial underlyings). The contracts ultimately are not between the original buyer and the original seller, but between the holders at expiry and the exchange. Because a contract may pass through many hands after it is created by its initial purchase and sale, or even be liquidated, settling parties do not know with whom they have ultimately traded.
Compare this with other securities, in which there is a primary market when an issuer issues the security, and a secondary market where the security is later traded independently of the issuer. Legally, the security represents an obligation of the issuer rather than the buyer and seller; even if the issuer buys back some securities, they still exist. Only if they are legally cancelled can they disappear.
11-28-2009, 05:23 PM
Excellent, thanks Med!
11-28-2009, 05:45 PM
thank alot Med
Thanks medic, i have enjoyed learning so much.
11-28-2009, 05:50 PM
Thanks for yet another lesson Medic.
11-28-2009, 05:56 PM
11-28-2009, 05:57 PM
Excellent post, thanks
11-28-2009, 06:07 PM
11-28-2009, 06:13 PM
Thank You Medic
11-28-2009, 06:18 PM
Thank you Med! :)
11-28-2009, 06:31 PM
needed that information bad....
11-28-2009, 07:23 PM
thank you medic
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