The currency used in one country is different from that used in another country or state. For secure international trading, one has to convert money from one currency to another. A currency exchange rate is the equivalent of the money you are supposed to spend to buy foreign currency. The currency exchange rates may fluctuate to balance the imports and exports between countries. Here are the types of exchange rates.
Fixed Exchange Rates
Although exchange rates vary from time to time, it is difficult for the fixed exchange rates to change at all. The stability of a currency is ensured by pegging the money to another unit of currency, for example, gold. It is rare for the value of gold to change, and therefore, the exchange rates for the money linked to it remains stable. The stability associated with fixed exchange rates is desirable to most investors because the risk of getting significant losses is minimized.
Flexible Exchange Rates
Unlike in fixed exchange rates where the value of coinage is dependent on another currency, flexible exchange rates are based on nature. The demand and supply of the currency dictate the exchange rates. Since the demand and supply market is very competitive, the exchange rates tend to change very frequently. Furthermore, if the demand and supply of the currency become unbalanced in a particular country, the central bank will either increase or reduce cash flow to control the situation. Due to the flexibility in management, most countries prefer to use flexible exchange rates for their currency.
In this type of exchange, instead of waiting on the uncertainty of the exchange market, traders make a contract in which they indicate the rates they will use in a future trade. Therefore, when the day comes to make the trade, payments will be made using the price agreed upon initially instead of what the currency exchange market is offering.