Foreign Exchange Rate – It is a rate at which the currency of one country is exchanged with the currency of other country e.g., $1 = 48 or one Indian rupee 1/48th $.
Determination of the FER – The rate is determined in the foreign exchange market by the interaction of the demand for and supply of foreign exchange.
Demand for Foreign exchange comes from - Domestic residents purchase goods and services from other countries (imports), for sending gifts to foreigners, by the domestic residents to purchase financial assets in other country, speculative purpose and tourists going abroad etc. There is inverse relationship between foreign exchange rate and demand for foreign exchange. So demand curve for foreign exchange is downward sloping.
Supply of Foreign exchange comes from - The foreigner’ purchasing goods and services (exports), the foreigners who invest in home country through **** ventures, remittances from abroad, foreign tourists come to visit a country. There is direct relationship between foreign exchange rate and supply of foreign exchange. So supply curve of foreign exchange is upward sloping.
In diagram, Df Df is demand and Sf Sf is supply curve of foreign exchange .They are equal at point E, so E is equilibrium point. At this point OR is determined as equilibrium foreign exchange rate.
