What Is Foreign Exchange And Write Down The Determination Of Rates Of Exchange.

Meaning: The term foreign exchange may be used in different senses (a) the rate of exchange i.e. the amount of money of a foreign country that a unit of money of the home country will purchase or (b) the foreign exchange operations or transactions i.e. converting one currency into another or the machinery by which foreign payments are made or (c) the fund of foreign exchange at the deposit of a country.

Rate of exchange: Different countries of the world have their different units of money and the currency of one of one country is not legal tender in another country. So one country will not be prepared to accept payments in the currency of another country, hence, a definite rate of exchange between the different currencies of various countries must be established. Thus the rate of exchange is the ratio between the currencies of different countries for the value of local currency in terms of another. For example, if one US dollar can be exchanged for Rs.60 of Pakistan then, the rate of exchange between the currencies of USA and Pakistan is 1:60.

Determination of rates of exchange: In a free market, the rate of exchange is determined by the supply of and demand for foreign currency. Just as the market price of the commodities is determined by the forces of demand and supply, we also know that if demand for and supply of foreign currency is equal, the rate of exchange is said to be at par. If the supply of foreign currency is greater than demand, the value of foreign currency falls below the par. Conversely if the demand for foreign currency is greater than supply the value of foreign currency rises above the par. Up to what limits can the exchange rate rise above or fall below the par? These limits are determined differently under different conditions.