Do you think that the currency with which you live your life daily is its only use? Do you think that that paper of note is only limited to buy you comfort?
Well, you are partially right. But, adding to its charms is its another side, that is its commodity value. When the currencies are traded as commodities there is created a market called foreign exchange market. The rates at which the currencies are traded are called currency exchange rates and they are highly dependent upon currency rates of the respective countries. Therefore, it is the value of another country’s currency compared to that of the currency of one’s own country. For example, the foreign exchange rates for U.S. dollars 1:5.5 Egyptian pounds, this means that for every U.S. dollar, you can buy five and a half Egyptian pounds. According to Investopedia, theoretically, identical assets should sell at the same price in different countries, because the exchange rate must maintain the inherent value of one currency against the other.
The price of a currency can be decided by two major ways. One is fixed and another is floating. Fixed rate is a rate the central bank of any government sets and maintains as the official exchange rate. A set price will be determined against a major world currency, usually the U.S. dollar, but also other major currencies such as the euro, the yen or a basket of currencies. In order to maintain the local currency rates, the central bank buys and sells its own currency on the foreign exchange market in return for the currency to which it is pegged. On the other hand, floating rate is decided by the private market via the rules of demand and supply. The economic experts call this rate as “self correcting” because intricacies in demand and supply will be corrected in the market. To put it simply, if demand for a currency is low, its value will decrease, thus making imported goods more expensive and stimulating demand for local goods and services. This in turn will generate more jobs, causing an auto-correction in the market. A floating exchange rate is constantly changing.