How Currency Is Valued In International Markets

The strength of a particular currency in international market is determined by its demand and supply. The Central Banks usually allow the currency to fluctuate within a narrow band, and intervene when this band is being broken, However, there are times, when the capability of Central Banks is not enough to stop the market forces. As in all asset markets, expectations and speculation invariably govern the outcomes.
How Currency is Valued in International Markets
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A currency is a store of market as well as the medium of exchange for consumers and suppliers. It allows people to exchange goods at their convenience in the market. The value of a currency is assured in some way by a Central Monetary Authority, usually a Central Bank, but its actual value, as perceived by the market, depends on the credibility of that monetary authority to actually ensure such value and the likelihood of other market players accepting it.

How currency is valued in international markets

The strength of the currency is nothing but the price of that currency in

terms of other currencies. In international markets, this price is decided just like the price of any other commodity in the market, by the relative demand and supply. If there are more buyers wanting to buy the currency relative to the amount of the currency available for supply by the suppliers of that currency, the price of that currency will rise, meaning thereby that the currency will strengthen. If, on the other hand, the supply of the currency exceeds what the buyers are willing to buy, then the currency will weaken, meaning its price will reduce.

A currency can either be fixed or floating. A fixed currency links the currency with either another widely accepted asset, like gold, or fixes it in respect of another widely accepted international currency, like the US dollar. In such cases, the monetary authority assures that it will accept and exchange its currency with the standard asset or currency in the pre-determined fixed ratio.

In case of a floating currency, on the other hand, the monetary authority assures to exchange it with other currencies only in accordance with the prevailing exchange rate. This means that a floating currency can possibly have a fluctuating rate in the currency markets. In reality, most currencies are allowed to float by the monetary authority within a limited range, but this range itself can be changed if the demand – supply mismatch becomes difficult to handle for the monetary authority.

Demand for Currency

The demand for a currency is created by two factors, its exports that the others want to buy, or the investments that

people want to make in that currency or assets denominated in that currency. So rising exports lead to rising demand of that currency and consequent strengthening of that currency. Greater capital inflows and investments within from outside have the same effect of increasing demand and strengthening the currency. The effects of falling exports or rising imports are the reverse - they reduce its demand and weaken the currency. Outflow of capital has the same effect.

Role of Expectations in Currency Markets

The currency market is sensitive to both future expectations and speculators. If the economy of a country is not doing well, fewer people will wish to invest there, so the currency of that country will fall. On the other hand if, for some reason, people expect that the currency will fall, they will take their investments out, and so actually make the currency fall.

But the market is seldom allowed to operate freely by the governments, who keep sure that the value of their currencies in the international market do not fluctuate too much. Generally they decide a band in which they want their currencies to remain, and then, through their central banks or monetary authorities, they intervene in the market to ensure price remains where they want it to be. So if on a particular day, the value of the currency is falling more than what is acceptable, the concerned central bank starts buying the currency. If the currency is appreciating too much, it starts selling it.

Controlling the Currency Markets : The Role of Central Banks

In the end, most Central Banks ensure that their currency keeps within a particular band. When there are massive economic changes, like the on-going events in case of Europe, this band needs to be adjusted on a frequent basis by the Monetary agencies. In cases, the force of market sentiment becomes far overpowering than the ability of the Monetary agencies to control the value of their currency.

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