Exchange rate

Definition

The exchange rate is the value at which one currency can be exchanged for another currency. It plays a crucial role in international trade, investments, and economic stability.

5 Must Know Facts For Your Next Test

1. Exchange rates can fluctuate due to changes in interest rates, inflation, and economic stability.
2. A strong domestic currency makes imports cheaper but exports more expensive.
3. Exchange rate risk affects businesses involved in international trade by impacting the cost of transactions.
4. Hedging strategies like forward contracts and options are used to manage exchange rate risk.
5. Central banks may intervene in foreign exchange markets to stabilize or influence their currency's value.

Review Questions

• What factors primarily cause fluctuations in exchange rates?
• How does a strong domestic currency affect a country’s imports and exports?
• What are some common methods used by financial managers to hedge against exchange rate risk?

Related terms

Forward Contract: A financial contract obligating the buyer to purchase an asset at a predetermined future date and price.

Currency Hedging: Strategies used by investors and companies to protect against potential losses from fluctuations in exchange rates.

Interest Rate Parity:

The theory that the difference in interest rates between two countries is equal to the expected change in their exchange rates over time.