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  • Writer's pictureVirtus Prosperity

Exchange Rates: A Simple Explanation

The exchange rate is the value of the currency of one country expressed in terms of the currency of another country. For example, the exchange rate of USD on October 6, 2023 is 24,385 VND. This means that 1 USD can be exchanged for 24,385 VND.

When you visit exchange counters at banks, you will always see two types of exchange rates: buying rate and selling rate. The buying rate is always higher than the selling rate by a certain amount. This means that banks always buy foreign currency at a lower price than they sell.

For example, the exchange rate of USD on October 6, 2023 has a buying rate of 24,500 VND and a selling rate of 24,800 VND. So, if you sell 1 USD to the bank, you will receive 24,500 VND (according to the buying rate). Conversely, if you buy 1 USD from the bank, you will have to pay 24,800 VND (according to the selling rate). The difference of 300 VND is the profit earned by the bank.

To understand the relationship between exchange rates and import-export, let's consider the following example:

From the example above, we can see that with a stronger currency like USD, a barista in the United States can afford all three types of goods in one hour, while a barista in Vietnam cannot. This implies that a stronger VND would stimulate Vietnam's imports, as Vietnam can afford to buy more goods from the international market. Conversely, a weaker VND would promote exports, as it would make Vietnamese goods cheaper for foreign customers.

There are 3 exchange rate regimes:

Floating exchange rate: This is a rate entirely determined by the currency market based on the supply and demand rules, without any intervention from the government. Currently, no country uses this regime, as most governments intervene to limit fluctuations that may affect their economy.

Fixed exchange rate: This rate is established and managed by the government. The use of fixed exchange rates helps stabilize the foreign investment environment, control inflation, and maintain market stability. However, long-term application of fixed exchange rates may lead to inflexibility in management and trade imbalances.

Managed float exchange rate: This is a combination of the above two regimes, where the rate is allowed to fluctuate according to the market's supply and demand rules, but still under the supervision and regulation of the government. Most countries around the world use this type to ensure economic stability, and promote import-export development, while still maintaining the independence of each currency.

Other factors influencing exchange rates include inflation, foreign exchange supply and demand, interest rates, income, public debt, and balance of international payments.

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