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Foreign Exchange Rate

 Foreign Exchange Rate

Meaning of Foreign Exchange

     The Foreign Exchange rate of Overseas Conversion rate is the rate at which one currency of a nation is negotiated for another currency of another nation. It is the price of one currency in terms of another currency. It is habitual to define the conversion rate as the price of one unit of the foreign currency in terms of the domestic currency.

    The conversion rate among dollar and pound denotes to the number of dollars required to purchase a pound. Therefore, the conversion rate among the dollar and the pound from the United States view point is articulated as $1.65 = ₤ 1. The Britishers would articulate it as the number of pounds required to get a dollar and the above conversion rate would be shown as ₤ 0.66 = $1.

Mint Parity Theory of Foreign Exchange Rate – Ascertainment under Gold Standard

  1. This thesis is related with the working of the international gold standard. Under this system, the currency in use was made of gold or was exchangeable into gold at predetermined rate.
  1. The value of the currency unit was denoted in terms of certain standards of gold that is so many grains of gold to the dollar, the pound, the rupee etc. The central bank of the nation was always prepared to purchase and sell gold at the predetermined rate.
  1. The rate at which the measure of money of the nation was exchangeable into gold was termed as the mint price of gold.
  1. If the official British price of gold was ₤ 8 per ounce and the US price of gold $ 40 per ounce they were the mint prices of gold in the corresponding nations.
  1. The conversion rate between the dollar and the pound would be fixed at $40/₤8 = $5. This rate was known as the mint equality or the mint par of conversion for the reason that it was based on the mint price of gold.
  1. Therefore under the gold measure the normal or basic rate of conversion was equal to the ratio of their mint par values.
  1. However the actual rate of exchange could vary above and below the mint parity by the cost of shipping gold among the two nations.
  1. To illustrate this, presume the US has an insufficiency in its balance of payments with Britain. The disparity among the value of imports and exports will have to be paid in gold by US importers for the reason that the demand for pounds surpasses the supply of pounds.
  1. But the transhipment of gold integrates transportation cost and other handling charges, insurance etc.
  1. Presume the shipment of gold cost from the US to Britain is 6 cents. So the US importers will have to spend $5.06 to obtain one pound for the reason that he can purchase $5 worth gold from the US treasury and ship it to Britain at a cost of 6 cents per ounce.
  1. Likewise, the conversion rate of the pound cannot fall beneath $4.94 in the case of an excess in the US balance of payments.
  1. Therefore, the conversion rate of $4.94 to a pound is the US gold import point or lower specie point.

Postulations

This thesis is based on the following postulates.

  1. The price of gold is predetermined by a nation in terms of its currency
  1. It purchases and sells gold in any amount at that price
  1. Its supply of money comprises of gold or paper currency which is reversed by gold
  1. Its price level changes directly with its money supply
  1. There is movement of gold between nations
  1. Capital is mobile within nations
  1. The adjustment automation is mechanical

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