A system in which there is no official intervention in the determination of foreign exchange rate. The exchange rate is determined by the interaction of demand and supply of the foreign exchange market. It is known as flexible rate because it tends to change with the change in demand and supply of different currencies in foreign exchange market.
Demand of Foreign Exchange : Demand of foreign exchange means demand of foreign currencies. The demand curve of foreign exchange is downward sloping due to negative relationship between foreign exchange rate and demand of foreign exchange. The foreign exchange is demanded due to following reasons :
(a) To purchase goods and services from other countries.
(b) To send gifts or transfers to abroad.
(c) To invest in other countries.
(d) To speculate on the value of foreign currencies.
Supply of Foreign Exchange : Supply of foreign exchange means inflow of foreign currency from rest of the world. The supply curve of foreign exchange is upward sloping due to positive relationship between foreign exchange rate and supply of foriegn exchange. The foriegn exchange is supplied due to following reasons :
(a) Foreigners purchasing home country’s goods and services through exports.
(b) Gifts or transfers received from abroad.
(c) Investment by non resident inside the domestic territory (Foreign Investment) .
(d) To speculate on the value of domestic currencies.
Foreign Exchange Rate is determined at the rate where demand and supply of foreign exchange are equal. In the present graph amount of foreign exchange is shown on X axis and foreign exchange rate is shown on Y axis. D and S curve respectively represents demand and supply of foreign exchange. At ‘OR’ exchange rate demand and supply of foreign exchange are equal (which is shown by OM). Therefore this exchange rate will be determined in the market. If demand and supply of foreign exchange changes then this exchange rate will also changes.
