Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Fixed Exchange Rate

What it is:

A fixed exchange rate pegs one country's currency to another country’s currency. It is also known as a pegged exchange rate.

How it works (Example):

There are generally two ways in which countries can value their currency in the world market. They can either fix their currency to gold or to another major currency, like the U.S. dollar or the euro. Alternatively, they can let their currency float in the world market.

If the exchange rate is fixed, the country’s central bank, or its equivalent, will set and maintain an official exchange rate. To keep this local exchange rate tied to the pegged currency, the bank will buy and sell its own currency on the foreign exchange market in order to balance supply and demand.
 

Why it Matters:

In order to maintain this fixed exchange rate, the central bank must maintain a high level of currency reserves.

The existence and argument for these types of fixed rates is that the fixed exchange rate facilitates trade and investment between the two countries with the pegged currencies. It can be especially beneficial for the smaller country, which depends more heavily on international trade.

A fixed exchange rate also has its weaknesses; once pegged to a larger country’s currency, the smaller country can lose some control over its domestic monetary policy.

Related Terms View All
  • Yupcap
    Let's say Jane Doe has a master's degree and is an editorial assistant in San Francisco....
  • Bellwether
    Let's assume XYZ Company is an auto manufacturer. If XYZ Company stock typically falls...
  • Market Performance Committee
    The Market Performance Committee consists of several members of the NYSE who closely...
  • Vault Receipt
    Let's say John Doe purchases gold through a futures contract. The contract expires and...
  • Withholding
    For example, let's say John Doe's salary is $24,000 a year. Though he makes $2,000 a...