Exchange Rates

Foreign Exchange Rates Student Name Institution Course Professor Date Foreign Exchange Rates: Determination and Business Implications Exchange rates are the most critical aspects of international businesses and finance, and they move trade, capital investments, and economic relationships between foreign countries. They represent the rate at which two currencies are exchanged, and these rates are in a continuous state of fluctuation due to different causes. Businesses that engage in international operations need to have a solid grasp of how exchange rates are configured and the consequences for their companies because exchange rate fluctuations may considerably influence profits, competitiveness, and financial performance. Determination of Exchange Rates Exchange rates are typically determined by two principal models: the “floating and fixed exchange rates.” Each model has its characteristics and, hence, influences. In a floating exchange rate system, the market regulates the value of a currency through the forces of supply and demand. A flexible exchange rate system lets the currency's value fluctuate with interest rates, inflation, and capital flows. The US, Japan, and the Eurozone are the countries that have adopted floating exchange rates. If the country's economy is booming, the demand for the currency will be on the rise. Thus, the currency's value will be higher. On the other hand, the market for the currency will be lower; hence, depreciation will result if economic indicators point to weakness (Mwange, 2022). For instance, a situation may arise when a country has high interest rates, making foreign investors prefer its assets. Hence, the “demand for the currency” will hike, and so will its appreciation. Instead, the fixed exchange rate system pegs a country's currency to another currency or basket of currencies to ensure currency stability and reduce uncertainty from currency fluctuations (Mwange, 2022). Governments control the pegged value by buying and selling currencies in foreign exchange markets to match the fixed rate. While this system creates stability, the need for extensive foreign exchange reserves and constant intervention, which can be expensive and even strain the economy, makes it more difficult. Countries with fixed exchange rates, such as Saudi Arabia and China, often use this system to create a competitive export sector and avoid high inflation. Factors Affecting Exchange Rates Exchange rates are determined by several critical factors, regardless of the system in place. One of the most significant factors is interest rates. Higher interest rates in a country usually lead to an appreciation of the value of that country's currency. The higher return on investments attracts foreign investors. The capital inflow that drives the exchange rate up causes the currency to become stronger. On the other hand, when interest rates are low, the currency tends to depreciate because foreign investment is not so attractive (Ha et al., 2020). For instance, the US dollar often strengthens when the Federal Reserve raises interest rates due to increased demand for dollar-denominated assets. Another critical factor is inflation. Countries with low inflation rates generally have a strengthenin...