Exchange Rate of a Country: Meaning and Types of Exchange Rate

Read this article to learn about Exchange Rate of a Country: Meaning and Types of Exchange Rate!

Meaning:

Exchange rate between the countries is the price at which residents of two countries trade with each other or the rate at which one currency is exchanged for another.

For example:

Exchange Rate between US $ and Indian Rupee is Rs. 48 /$. It means 1 $ can be exchanged for Rs. 48 in the world market for foreign currency.

If an Indian wants to buy $ he will have to pay Rs. 48 for each $ he has bought. If an American wants to buy Rs. he will get Rs. 48 for each $ he has paid.

Exchange Rate can be explained in two ways:

1 $ can buy Rs. 48

or 1 Re. can buy $ 1/48

Exchange rate is 48 Rs./$

or 1/48 $/Rs.

Both the ways of expressing the Exchange rate are equivalent.

If Exchange rate decreases from 48 Rs./$ to 45 Rs./$ then it is called depreciation of $.

A rise in exchange rate is called an appreciation.

When the domestic currency depreciates it buys less of the foreign currency and when it appreciates it buys more.

Types of Exchange Rate:

1. Nominal Exchange Rate (NER)

2. Real Exchange Rate (RER)

Nominal Exchange Rate is the relative price of the currency of 2 countries.

Or, It is the price of foreign currency in terms of domestic currency.

It is the rate at which goods of one country can be traded for goods of another country, also known as terms of trade.

e.g. 1 $ = Rs. 40

It means 1 $ can be exchanged for Rs. 40

Real Exchange Rate sometimes called as the terms of trade is the relative price of the goods of 2 countries. It tells us the rate at which we can trade the goods of one country for the goods of other country.