International exchange rates show how much one unit of currency can be exchanged per unit of another currency. Currency exchange rates can be floating, in which case they are constantly changing based on many factors, or they can be tied (or fixed) to another currency, in which case they also float, but they move in tandem with that currency, to which they are attached.
Knowing the value of the national currency in relation to various foreign currencies helps investors analyze assets valued in foreign currency. For example, for an American investor, knowing the rate of the dollar against the euro is valuable when choosing European investments. A depreciation of the US dollar can increase the value of a foreign investment, just as an increase in the value of the US dollar can damage the value of your international investment.
Fixed exchange rate modes are set to a predefined value binding with another currency or basket of currencies.
A floating exchange rate is the exchange rate that is determined by supply and demand in the open market, as well as by macroeconomic factors.
A floating exchange rate does not mean at all that countries are not trying to intervene and manipulate the price of their currency, since governments and central banks regularly try to keep the price of their currency favorable to international trade.
Floating exchange rates have become the most common and popular after the failure of the gold standard and the Bretton Woods agreement.
Floating exchange rates are determined by market forces of supply and demand. For example, if the demand for US dollars from Europeans increases, the supply-demand ratio will increase the price of the US dollar against the euro.
There are countless geopolitical and economic factors that affect exchange rates between the two countries, but some of the most common include changes in interest rates, unemployment rates, inflation reports, gross domestic product and production data of a country.
As a rule, the more country depends on domestic industry, the stronger the correlation between the national currency and the prices of goods in the industry. Some currencies provide good examples of commodity-currency relations.
For example, the Canadian dollar is positively correlated with the price of oil. Therefore, when the price of oil rises, the Canadian dollar tends to rise in relation to other major currencies. This is because Canada is one of the largest oil exporters. When oil prices are high, Canada tends to earn large revenues from its oil exports, giving the Canadian dollar a boost in the foreign exchange market.
Another good example is the Australian dollar, which is positively correlated with gold. As Australia is one of the largest gold producers in the world, its dollar tends to move in unison with changes in gold bullion prices. Thus, when gold prices rise significantly, it is expected that the Australian dollar will strengthen against other major currencies.
Some countries prefer to use a fixed exchange rate, which is set and maintained artificially by the government. This rate will not fluctuate throughout the day and can be reset on certain dates, known as revaluation dates. Emerging-market governments often do this to ensure the stability of the value of their currencies.
To maintain a stable fixed exchange rate, the country's government must have large reserves of the currency to which its national currency is tied to control changes in supply and demand.