How Currencies are Pegged (Fixed Foreign Exchange Rates)

This is a continuation of my initial entry to address questions posed by Fariehaz in an earlier article on FOREX trading.

As usual, I’ll keep it simple. I won’t get into too much details.

First of all, currency peg means fixing the exchange rate of one currency against the other (contrast with floating exchange rates). For example, the Malaysian Ringgit (MYR) was pegged with the US Dollars (USD) at 3.800, after the Asian financial crisis.

So, how is a currency pegged?

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What Determines Foreign Exchange (Currency) Rates

Fariehaz, in my original entry on FOREX trading, asked me a couple of questions. They were:

1. What determines Foreign Exchange rates.
2. How currencies are pegged.

In this entry, I will address the 1st question. I will keep it as simple as possible. Only basic explanations will be provided. No in depth explanations will be done in this entry.

There are number of factors that contribute to changes in Forex rates. Below are some of them.

1. Interest rate movements

A rational investor will often look for the best place, in terms of returns, to park their money. If interest rates were high and outlook for the stock market is grim for example, then currency might be the better option (more attractive). Then, currency becomes more expensive due to the high demand..

Also, if you look at two countries. For example, the United States of America and Australia. Australia, at the present moment, has a higher interest rate than the US of A. Thus it makes more sense to park money here in Australia than in the US, thus earning a higher interest. Again, this will drive US Dollars down and push the Aussie Dollars up. This is what you call as… CARRY TRADE.

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