Foreign Exchange Rate15/12/2022
Foreign exchange rate is the price at which one currency can be converted into another. It represents the rate at which a firm may exchange one currency for another. Thus, the exchange rate is simply the amount of a nation’s currency that can be bought at a given time for a specified amount of the currency of another country.
The actual amount received in conversion or the effective exchange rate, usually differs from the stated rate because it takes into account all taxes, commissions and other costs that the public must pay to complete the transaction and actually receive the foreign funds.
Types of Foreign Exchange Rate
Fixed and Floating Rates
When Government of a country fixes the rate of exchange for its own currency, it is termed as ‘Fixed Exchange Rate’. This is also known as official rate of exchange. Fixed exchange rates are fixed by the respective Governments from time to time for the betterment of their economy.
In contrast exchange rates move, as in any other market place, depending on the demand and supply pressure and are further influenced by the market forces and economic conditions of the respective countries. Floating exchange rate may be free floating or a managed floating.
A currency is freely floating if there does not exist a system of fixed exchange rates and if the Central Bank of the country in question does not attempt to influence the value of the currency. However, in reality this kind of situation does not exist.
In most of the countries Governments attempt to influence movements of exchange rate either through direct intervention in the exchange market or through a mix of fiscal and monetary policies. Under such circumstances, floating is called as ‘managed’ or ‘dirty float’.
A number of countries use a pegged float as a system of exchange rates. The value of one currency is pegged to the value of another currency that itself floats. In a joint float, currencies in a particular group have a fixed exchange value in terms of each other, but the group of currencies floats in relation to other currencies outside the group.
The fixed exchange rate system has inbuilt ad-vantage of simplifying exchange transactions. It imbibes self-discipline for economic policies by participating countries. In India the exchange rate regime of rupee has evolved over a period of time moving in the direction of less exchange controls and current account accountability. The RBI manages the exchange rate of the rupee.
In recent few years the RBI has been very actively intervening in the market to hold the rupee-dollar rates within tight bounds while rupee rates in relation to other currencies fluctuate in correspondence with the fluctuation of this US dollar against them. In addition, the RBI took several measures to relax exchange control and liberalize foreign trade.
Spot and Forward Rates
Spot rates refer to those rates which are applicable on the day of transaction in which physical delivery is made within two working days after the date of transaction the spot exchange between two currencies should be the same across the various banks engaged in rendering foreign exchange services.
In case of large discrepancy customers or other banks would buy large amounts of a currency from whatever banks quoting relatively low price and sell the same immediately to a bank quoting a relatively high price. This will cause adjustments in the exchange rate quotations that would offset the existing discrepancy.
In Forward rates, exchange rates are fixed in advance for a transaction which matures at some specified future date. The exchange at the date in future will be at the price agreed upon now. Foreign exchange rates are function of forward demand and forward supply of various currencies.
A foreign currency is said to be at a forward premium if its future value exceeds its present value in terms of domestic currency and it is said to be at discount if the reverse is true. For example spot rate between rupees and dollar is S (Rs/$) = Rs. 45.50 and three months forward is F3 (Rs. /$) = Rs. 46.70/$; these rates signify that dollar is at a premium and rupee is at discount in the forward.
Forward exchange rates are quoted on most major currencies for different maturities. Standard maturities quoted by banks are of 1, 3, 6, 9 and 12 months. Maturities beyond one year are now becoming more common. Maturity extending to 5 and beyond 5 years is also possible for good bank customers.