The fluctuations in the value of the rupee with respect to the dollar are part of everyday news. The value of the rupee just like any other currency changes almost on a daily basis. This concept of currency fluctuation is part of the larger Foreign exchange market. To understand the concept and process of the value of a currency one has to have a look at Foreign Exchange Market.
What is Foreign Exchange Market?
Foreign Exchange Market is simply a global market where the trading of currencies takes place. This market is decentralized in nature.
In simple words, one currency is traded with another currency at a particular rate. The rate at which two particular currencies are exchanged is called the exchange rate.
The exchange rate is the value of one country’s currency in relation to another country’s currency.
The exchange rate of any country’s currency does not remain constant but rather keeps changing. Hence, the changing value of rupee remains a constant part of our everyday news.
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For Example, the exchange rate of the Indian rupee in terms of the US dollar is approximately is 1 US dollar = 74.12 Indian Rupee. This means that if you want to buy a dollar from Foreign Exchange Market using Indian Rupee, you will need 74.12 rupees.
How the value of a currency is determined?
In most countries of the world, the currency’s value is determined by floating exchange rates. In this system, the value of a currency is determined by the basic economic concept of Demand and Supply.
A currency with more demand has a higher value. As the exchange of different currencies takes place in the Exchange market, the demand of each currency in the market determines its value.
In this process of value determination, the government or authority of a country exercises no or little control. Even though government or the central bank of the respective country does intervene when the currency destabilises or performs poorly.
But overall it is the mechanism of demand for a particular currency that determines its value.
There is another system of value determination of currencies, even though not as prevalent as the above one. It is called pegged exchange system.
Here, the value of a currency of a country is fixed with a particular currency.
For Example, a country decides to fix their currency value with relation to the US dollar and determines their currency at ⅕ of a dollar.
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How do currencies move?
Most exchange of currencies takes place at banks. Currencies issued by different countries move through banks and it is here that most of the transactions take place.
A person in Delhi having legal US dollar bills can get them converted to the Indian rupee at a particular exchange rate at a bank. This bank represents a small unit in the huge Foreign Exchange Market.
The central bank of a country (RBI in India) also maintains a large reserve of foreign currency to deal with any kind of problems for…
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