The
value of two
currencies relative to each other. For example, on a given day, one may
trade one
U.S. dollar for a certain number of
British pounds. A currency's exchange rates may be
floating (that is, they may change from day to day) or they may be
pegged to another currency. A floating exchange rate is dependent on the
supply and
demand of the involved currencies, as well as the amount of the currency held in foreign
reserves. On the other hand, a government may peg its currency to a certain amount in another currency or
currency basket. For example, the
Qatari riyal has been worth 0.274725 dollars since 1980.
An advantage to a floating exchange rate is the fact that it tends to be more
economically efficient. However, floating exchange rates tend to be more volatile, depending on the particular currency. Pegged exchange rates are generally more stable, but, since they are set by government fiat, they may take political rather than economic conditions into account. For example, some countries peg their exchange rates artificially low with respect to a major trading partner to make their
exports to that partner artificially
cheap. See also:
Currency pair,
Eurodollar.