Floating currency and pegged currency are the two most prominent ways to determine the exchange rate for a particular currency. A floating currency rate is determined by the fluctuation of the stock and exchange markets. A pegged currency rate is set by the country or region where the currency originates.Continue Reading
In a floating exchange rate, the worth of currency varies based on what consumers pay for it. Supply and demand, foreign investment, import and export ratios, and inflation are the factors that affect the market. This system is used by countries that have mature economic markets, and it is considered a more efficient system because the market reflects current money values. The downside of the system is that any economic downturn causes major market swings in inflation and rates. When money is changed from one currency to another, the floating exchange rate determines how much of one currency equals the other based on each country's current market.
In a pegged currency rate, the rate does not fluctuate from one day to the next. A country's national bank holds foreign currency reserves to handle supply and demand. When a particular currency is suddenly in demand, the bank releases that currency. When a currency has a lower exchange rate, the bank buys more of it to store in reserves. This system is very unstable, especially if the people of the country realize that their currency is not actually worth what the fixed rate indicates; however, this system keeps inflation rates under control.Learn more about Currency & Conversions