# Exchange Rate

## Exchange Rate Definition

The exchange rate of a currency is the price a currency expressed in terms of another currency. For example, \$1 is worth €0.82 (07/15/12). The foreign exchange market is a market where people exchange currencies for other currencies. In this market, all buyers are also sellers since they are buying in one currency and selling another.

## Types of Exchange Rate Systems

### 1. Flexible or Floating Rate

A floating exchange rate is one in which currencies are left to float against each other, and the market decides the value of the currency. Most of the currencies are floating; however central banks attempt to influence the value of floating exchange rates.

### 2. Fixed Rate

In a fixed exchange rate, a currency is pegged at a certain value to another currency, or a basket of other currencies or to the value of a commodity like gold. The rate between the currency and its peg does not change based on market conditions.

### 3. Managed Rate

A managed exchange rate is one in which a currency is left to float within a lower and upper levels, in which the central bank can intervene to “decide” the value of the currency. Here, there is a lot more intervention than in a flexible rate.

## Fluctuations in Exchange Rates Explained

### 1. Appreciation

A currency appreciates if it’s price increases or increases in value in a floating exchange rate system. For example, \$1.22 is worth €1 now, if it increases to \$1.30= €1, then the euro has appreciated, a euro can buy more dollars.

### 2. Depreciation

A currency depreciates if it’s price decreases or loses value against other countries in a floating exchange rate system. For example, \$1.22 is worth €1 now, if it decreases to \$1.10= €1, then the euro has depreciated, a euro can buy fewer dollars. When one currency depreciates with respect to another currency, the other currency appreciates.

### 3. Devaluation

A devaluation is a decrease in the official price of a currency in a fixed exchange rate system. The Chinese Yuan was pegged to the dollar, where \$1 = 6.4 Yuan, a devaluation of the Yuan would result in \$1 = 8 Yuan. This is usually done to bring the currency value closer to what the value should be.