Foreign exchange rate

In foreign exchange trading, one currency is traded for another. The currency which the purchasing party needs to buy is known as the base currency, whereas the currency to be used to make the purchase is referred to as the counter currency. The relationship between these two, which is made concrete by the amount of counter currency necessary to purchase one unit of the base currency is known as a foreign exchange rate. This figure, depending on the category under which the specific currency rate falls, may change on a daily basis.

Currencies whose exchange rates fluctuate daily are said to have floating rates. Changes mainly come about as a result of movements in demand and supply. Entities dealing with floating currencies, especially those who engage in trade for profit, would do well to monitor changes in the market in order to make sound decisions. In certain cases, it may be advisable to wait things out before purchasing a specific currency, since doing so may cause losses if rates are not favorable.

On the other hand, there are currencies for which exchange rates remain stable despite constant changes in the market. This is otherwise called a pegged exchange rate, mainly due to the fact that currencies which work under this system are pegged to another currency. The currency to which the original is pegged should be a much stronger one. Examples of these are the US dollar and the euro. A fixed exchange rate presents the trading party with the benefit of knowing exactly how much of the base currency is to be received for each transaction. Despite the apparent stability of fixed exchange rates, though, they can still be changed or completely removed under certain conditions.

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