what is exchange rate and factors that determines demand for exchange rate

Expert Solution

Exchange rate refers to the rate at which one currency is exchanged with another currency. It is used in forex market where one currency can be converted into another currency using the exchange rate. There are different factors that determine the exchange rate and demand for the forex. The first factor is the interest rate. A higher interest rate level, will cause the demand for the domestic currency to increase and exchange rate of the domestic currency will appreciate against the other major currencies. It will increase the demand for exchange rates. The second factor is the inflation rate. A higher inflation rate causes the erosion of the purchasing power of the currency and exchange rate of the domestic currency decreases against the other currencies. The third factor is the balance of payment scenario. A trade surplus causes the domestic currency as well as exchange rate to strengthen and exchange rate appreciates. It increases the demand for the exchange rate. The fourth factor is public debt. A bigger volume of public debt, weakens the domestic currency and exchange rate decreases as well as its demand. Besides, the economic scenario in the economy and terms of international trade also affect the exchange rate.

Rahul Sunny answered 2 years ago

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