How Is The Foreign Exchange Rate Determined?

            The rate or the exchange is the price of one national currency in terms of another. For instance, when we say that one rupee of Pakistan is equal to 1 shilling of England, by this is meant that we can get one shilling of England by paying Rs 1 in Pakistan. The rate of foreign exchange is like the price of a commodity, is determined by the reciprocal interplay of the forces of demand for and supply of foreign exchange. The demand for foreign exchange comes: when goods are imported from abroad, goods are carried on foreign ships; tourists go abroad, purchase of foreign securities, etc.

            The supply of foreign exchange arise when goods are exported to other countries, foreign tourists or students come to the country, sale of foreign securities in the foreign markets, repayment of principle and interest foreign countries.

            We see in every country there are people who want to purchase foreign money for making payments abroad and there are person who offers to sell foreign exchange. There is, thus continues demand for and supply of foreign money and supply of it. It is this demand for and supply of foreign money which determines the rate of exchange in a fee market between two countries.