How Currency Exchange Rates Affect Global Business

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An exchange-rate system is the set of rules established by a nation to govern the value of its currency relative to other foreign currencies. The exchange-rate system evolves from the nation's monetary order, which is the set of laws and rules that establishes the monetary framework in which transactions are conducted. When one currency is traded for another, a foreign exchange market is established. Multinational corporations are one of the participants in the foreign exchange market. The business world relies on the foreign exchange market. When buying foreign goods and services or investing in other countries, companies need to purchase the currency of the country where they are transacting business. Currencies are traded everyday in the FX market to be used for direct foreign investments, import and export needs of companies, purchases of foreign instruments, and managing existing positions. The exchange rates are set based on several basic factors that are consistently applied in all situations. These fixed factors that impact currency exchange rates are generally identified as inflation, interest rates, and trade value. Trade value has to do with the ratio of business and service trading that takes place between the two countries that issue the currency. In the event that one country purchases more goods and services from a given country than it imports to that same country, the value of the each country will reflect that difference. In effect, the country that gains the most from the sale of goods and services between the two countries will have a currency that is rated higher in value. Political turnovers and natural disasters also impact the economic nature of a country and the exchange rates subsequently. Inflation and recession are economic factors that directly impact the ability of a country to purchase goods and services, both within the country and on the world market. High inflation will mean that the country will be less capable of purchasing goods and services. Decreased purchasing power will lead to the currency of that country being considered less desirable. Since the idea of exchanging currency is to maximize the worth of the investment in currency, inflation will directly lead to a depreciation of the worth of that nation’s currency in comparison to that of a country that is not currently experiencing inflation. Thus the currency exchange rate between the two countries shifts, until the period of inflation passes. Directly related to inflation is the matter of interest rates. Also an important economic indicator, high interest rates mean less circulation of money through loans. Less money in circulation means less purchasing on the world market. This means that currency exchange rates for that country will also drop in value. These three main factors in evaluating exchange rates can change in a matter of hours. In today’s market, countries should keep a close eye on the recent sharp fluctuations in exchange rates so as to identify possible implications for financial and macroeconomic stability in global businesses. Central Banks are setting a monetary policy and they are adjusting interest rates in order to prevent sharp volatility in the exchange rates and to achieve the objective of price stability. If the exchange rate can freely move, assuming any value that private demand and supply jointly establish, it is called freely floating exchange rate. In floating exchange rate regime, currency values fluctuate depending on how much supply is being demanded from that country in comparison to the other country with which it is doing business. It is also called flexible exchange rate. If the central bank timely and significantly intervenes on the currency market, a managed floating exchange rate regime takes place. In freely and managed floating regimes, a loss in currency value is called depreciation, whereas an increase of currency's international value will be called appreciation. Changes in...
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