Foreign Exchange Risk Mitigation Techniques/Types of Rates of Exchange
Types of Rates of Exchange
Fixed rate of exchange
A fixed rate of exchange is a ratio established by the government at which foreign currencies can be exchanged. The value of the national currency is based on parity with other currencies. Sustaining the parity is the question: if other factors force a market change to a floating rate, the impact could negatively impact the country.
Floating rate of exchange
A floating rate of exchange allows open market conditions to determine the value of the currency in relationship to other currencies. Open market exchange rates are highly volatile and change every 5 seconds or 18,000 times per day. Any given currency typically fluctuates 1% during a 24- hour period. The volatility of the market is influenced by political, economic and technical conditions that come into play and cause fluctuations that may exceed the typical movement. This volatility translates into the need to manage the risk of rising or falling exchange rates.
Managed rate of exchange
A managed rate of exchange allows a central bank to intervene to adjust for market conditions. It controls wide valuation swings that may occur due to adverse market conditions.