Why is the mechanism of Demand and Supply applicable for determinig Prices of currencies in terms of other currencies?
Mihir Manohar (CA Final - Article Assistant) (474 Points)
17 July 2012Why is the mechanism of Demand and Supply applicable for determinig Prices of currencies in terms of other currencies?
CA MOHAMMED IRFAN
(Chartered Accountant)
(136 Points)
Replied 17 July 2012
Dear Mihir, where three concepts are most important to understand the determination of exchange rate of two currencies, viz:-
1) Interest Rate Parity
2) Purchasing Power Parity (Inflation Rate)
3) Fishers Rate
Thses three concepts are very scientific and based on certain asumptions.
However the world market is inefficient and its hardly recognise the rule given by these concepts. In turn the market gives importance to Government policies and the forces of demand and supply. Since, foreign currencies are not freely available the Govt. wants to make its use benificially and price it in such a way that its misuse is reduced and we have a favourable balance of payement in the country. Pricing the currency as per the forces of demand and supply serves this purpose of the Govt.
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