Currency is a medium of exchange issued by the national government or a central bank to measure the price of a commodity. Currencies of various countries differ in liquidity or in ability to maintain its nominal value.
Currencies can be classified in many ways. Any characteristic can be a basis of classification, for example:
The issuing country:
- national currency is a currency issued by a government or a central bank to use it within the country;
- foreign currency is a currency note (banknotes, treasuries, coins) in circulation, a legal instrument of payment in certain foreign nations or groups of nations, and withdrawn or being withdrawn from circulation, but exchangeable currency notes;
- holdings in monetary units of foreign countries and international monetary and payment units in accounts;
- collective currency is a currency used for settlements between international economic organizations, for instance, the SDR. The previous European currency - ECU, now - the euro.
Currency convertibility:
- fully convertible currency. It is a currency with no limits to operations in it;
- partially convertible currency is a currency that has certain restrictions on its exchange for other currencies;
- nonconvertible currency.
Exchange rates:
- strong/steady currency (i.e. stable against its nominal rate and other currencies);
- weak/soft currency.
Validity period:
- constant currency (an exchange rate that eliminates effects of exchange rate fluctuations and that is used for calculation of financial performance figures);
- temporary currency. It is a currency of a certain country, and its validity period is limited. It is also a monetary unit that is used for payments within agreements and contracts during the validity period of these agreements).
Efficiency:
- reserve currency is a foreign currency, in which central banks accumulate and keep reserves for international payments on external trade operations and foreign investments;
- the major currencies. There are seven major fully convertible currencies that mostly often used in international payments: the US dollar, the euro, the Swiss franc, the pound, the Japanese yen, the Canadian dollar, the Australian dollar.
Real existence:
- real currency acting directly as money;
- quasi-currency, for example, the ECU.
Currency functions:
- as monetary unit indicating the value of commodities and services;
- as medium of exchange acting as an intermediary in exchnage, which is executed by the following formula: commodity-money-commodity;
- as saving and accumulation mean. It can transform from monetary unit to real estate (property) or securities (stocks, bonds, etc.).
From the definition of currency, classification and functions we can conclude that currencies of different countries have diverse value that is indicated in the exchange rate.
Exchange rate is a price (quote) of a monetary unit of a nation expressed in the monetary units of another country, precious metals or securities.
Exchange rates are constantly changing being influenced by the following factors:
- purchasing power parity of exchange rates. It means that purchasing power of a certain amount on one market should equal the same amount on another market. If the amount is exchanged at a current rate for a foreign currency, the higher the price of a commodity and cost of its domestic production compared to the similar product abroad is, the more the import volume compared to the export one is. It will likely lead to the higher domestic price for the same product as abroad, and it will push the price of a foreign currency up as demand for it increases;
- capital flow. The increase of demand for foreign securities, bank credits, and cash leads to the rise of a foreign currency value;
- economic performance of nations, currency of which is quoted on the market. It is negative or positive news about economic situation in a country that influence the currency rate;
- operations of large financial funds. They can exert significant influence on the long-term trends of exchange rates by investing funds into currency reserves;
- activity of exporters and importers. Their influence on the market is short-term and cannot cause global changes in exchange rates, as exporters and importers make external trade deals the volume of which is insignificant compared to overall volume of operations on the currency market;
- political speeches can effect exchange rates during reports, meetings, summits, press conferences, etc. (for example, press conference after the interest rates discussion), and sometimes they can determine long-term trends if the speech is about long-term outlook (for example, possibility of changing interest rates, forming government budget). As a rule, forecasts about what will be said and how the market will act after, appear ahead of such statements as date and time for a speech are known in advance. Sometimes unexpected events take place and they lead to strong and unpredictable movements on the market;
- activity of central banks. Government can influence the currency market through central banks, and central banks enter the currency market via commercial banks. Government can use direct and indirect regulations to boost production and increase consumption. The direct regulation includes the discount policy and currency investments on the external currency markets (related to abrupt injections or withholding large currency volumes from the international market); the indirect regulation is introduced through the money volume in circulation, inflation rate, and others. Central banks entry to the market is usually followed by the significant movements of exchange rates because of large volume of investments. Also central banks of different countries can make joint operations on the currency market.
