Method of Determining Foreign Exchange Rate.

In which ratio the currencies between two countries are changed each other is called exchange rate. The exchange rate is fluctuated due to the difference of value standard of currency. Generally exchange rate is determined depending on the  demand & supply of currency. The determined methods of foreign  exchange rate are different according to the variation and differentiation of currencies. The methods of determining foreign exchange rate are divided into two categories are given below with detail :

1. Gold standard method.

2. Paper currency method.

1. Gold standard method :

The equal amount of golds are reserved or mixed gold in making currency against circulation or running the currencies of which countries are called gold standard area. The exchange rate in the countries of gold standard areas is determined by gold standard method or according to the ratio of consigned gold against the currencies between the two countries. In the ancient time the exchanged rate was determined by this method but at present this method isn't used to determine the exchange rate. The another name of this exchange rate determined by this method is called 'Mint per exchange ' also. It was a difficult method. Because every county itself determined gold standard according to its benefit and as a result the controlled of exchange faced the high difficulties.

2. Paper currency method :

There is running and continuing paper currency at about every county in the present world. The exchange rate is determined by the paper currency method in the paper currencies issuing countries. There are two theories of determining exchange rate according to the paper currency method. Such as-

i) Purchasing power parity theory.

ii) Balance of demand & supply theory.

I) Purchasing power parity theory :

By definition the PPP states that utilizing a unit of a coin, let us say one euro, which is the obtaining power that can buy  the same  merchandise around the world. The hypothesis is in view of the 'law of one value', which contends that ought to an euro cost of a decent be duplicated by  the conversion standard (€/US$) then  it will bring about an equivalent cost of  the positive qualities in US dollars. As it were, if  we expect  that  the trade  rate between the € and US $ states at 1/1.2, then  products that cost € 10  in the EU ought to cost US$ 12 in the United States. Something else, arbitrage 11 benefits will happen. Nonetheless, it is at long last  the business sector that through supply and interest will drive in like manner the euro and US dollar costs to  the harmony  point. Along these lines, the law  of one cost will be re-established, and additionally the  buy power equality between the euro and US dollar. Swelling differentials between nations will likewise be dispensed with regarding their impact on the costs of the products in light of the fact that the PPP will  acclimate to equivalent the  proportion of their cost levels 12. All the more particularly, as expressed in  their book (Lumby S. & Jones C. 1999) "the money of the nation with  the higher rate of swelling  will deteriorate against the other nation's coin by roughly the expansion respectful". All in all, it can  be contended that the hypothesis, despite the fact that it depicts in a sufficient manner the determination of the trade rates,  is not of good esteem, for the most part as a result of the accompanying two impediments. Firstly, not  all products are exchanged  universally (for instance, structures) and also, the transportation expense ought to speak to a little measure of the good worth.

ii) Balance of demand & supply theory :

This theory is modern & the most acceptable. In this theory exchange rate is determined at the balance point of demand & supply of currencies. The supply of foreign currency is increased through export of commodities. Because of increasing the supply of foreign currencies the demand of it is lessened and its value is drawn back more than indigenous currencies. As a result with the help of same amount of money more foreign currencies are gained than previous time and vice Versailles. On which point the demand & supply of foreign currencies of two countries are equal is called balanced point and on this point currency exchange rate is determined. It is also called balanced theory. In this theory, the exports imports of tangible & intangible goods are considered and the surplus of transaction is considered as balanced condition. But if the balanced condition of transaction is not controllable then the difficulties are seen in the determination of foreign exchange rate.