What Are The Terminologies Used For Exchange Rate System?

Foreign exchange markets have a special vocabulary. By definition, a fall in the price of one currency in terms of one or all others is called depreciation. A rise in the price of a currency in terms of another currency is called an appreciation. In our example above, when the price of the dollar rose from yen 100/$ to yen 200/$, the dollar appreciated. We also know that the yen depreciated.

The term devaluation is often confused with the term depreciation. Devaluation is confined to situations in which a country has officially set its exchange rate relative to one or more other currencies. In this case, devaluation occurs when lowering the price of the currency changes the set rate. A revaluation occurs when the official price is raised.

For example, in December 1994 Mexico devalued its currency when it lowered the official price at which it was defending the peso from 3.5 pesos per dollar to 3.8 pesos per dollar. Mexico soon found it could not define the new parity and floated its exchange rate. At that point the peso fell or depreciated even further.

When a country's currency falls in value relative to that of another country, we say that the domestic currency has undergone depreciation while the foreign currency has undergone an appreciation.