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Submitted to

Submitted by

Bibhor Jha

Antovna Gyawali

Facilitator, Treasury Management



1. Difference between Pegged Exchange Rate Mechanisms

Fixed Exchange Mechanism
A fixed exchange rate system maintains fixed exchange rates between currencies;
those rates are referred to as official parity. A nation with fixed exchange rates
must enforce those rates. An early form of fixed exchange rates was to specify the
value of a nation's currency in terms of gold (the "gold standard").
The government of a country doesn't let the exchange rate change in response due
supply and demand for the currency which is known as a fixed exchange rage. The
government will buy or sell its currency to keep the exchange rate at a particular
A nation operating under a fixed exchange rate system (pegged to the dollar) that
experiences a balance of payments deficit will be forced to finance the deficit out
of its dollar reserves. As the number of dollars declines, the nation's money supply
is reduced. This causes prices to drop and interest rates to increase. The price
drops make the nation's goods more competitive internationally; the higher
interest rates also cause more capital to flow into the country. These forces help
the nation to achieve equilibrium with its balance of payments.
The advantages of fixed exchange rate systems include the elimination of
exchange rate risk, at least in the short run. They also bring discipline to
government monetary and fiscal policies. Disadvantages include lack of monetary
independence and increases in currency speculation regarding possible
EXAMPLE: Nepal and India have fixed exchange rate mechanism
Saudi Arabia with USA
Pegged exchange rate system
A pegged exchange rate system is a hybrid of fixed and floating exchange rate
regimes. Typically, a country will "peg" its currency to a major currency such as
the U.S. dollar, or to a basket of currencies. The choice of the currency (or basket
of currencies) is affected by the currencies in which the country's external debt is
denominated and the extent to which the country's trade is concentrated with
particular trading partners. The case for pegging to a single currency is made
stronger if the peg is to the currency of a principal trading partner. If much of the
country's debt is denominated in other currencies, the choice of which currency to

peg it to becomes more complicated.

Particularly with a pegged exchange rate, an initial target exchange rate is set and
the actual exchange rate will be allowed to fluctuate in a range around that initial
target rate. Also, given changes in economic fundamentals, the target exchange
rate may be modified.

Pegged exchange rates are generally used by smaller countries. To defend a

particular rate, they may need to resort to central bank intervention, the
imposition of tariffs or quotas, or the placement of restrictions on capital flow. If
the pegged exchange rate is too far from the actual market rate, it will be costly to
defend and it will probably not last. Currency speculators may benefit from such a
Advantages of pegged exchange rates include a reduction in the volatility of the
exchange rate (at least in the short-run) and the imposition of some discipline on
government policies. One disadvantage is that it can introduce currency
EXAMPLE- China and USA have pegged exchange rate mechanism
2. Write short note on WORLD CURRENCY MARKET
In the foreign exchange market and international finance, a world
currency, supranational currency, or global currency refers to a currency that is
transacted internationally, with no set borders.
Currencies are bought and sold, just like other commodities, in markets called
foreign exchange markets. The worlds three most common transactions are
exchanges between the dollar and the euro (30%) the dollar and the yen (20%)
and the dollar and the pound Sterling (12%).
The foreign exchange (or FOREX) market, just like every other market in the
world, is driven by supply and demand. The demand for currencies is derived from
the demand for a countrys exports, and from speculators looking to make a profit
on changes in currency values. The supply of a currency is determined by the
domestic demand for imports from abroad. For example, when the UK imports cars
from Japan it must pay in yen (), and to buy yen it must sell (supply) pounds.
The more it imports the greater the supply of pounds onto the foreign exchange
market. A large proportion of short-term trade in currencies is by dealers who

work for financial institutions. The London foreign exchange market is the Worlds
single largest international exchange market.
The foreign exchange market (FOREX, FX, or currency market) is a global
decentralized market for the trading of currencies. The main participants in this
market are the larger international banks. Financial centers around the world
function as anchors of trading between a wide range of multiple types of buyers
and sellers around the clock, with the exception of weekends. The foreign
exchange market determines the relative values of different currencies.
The foreign exchange market works through financial institutions, and it operates
on several levels. Behind the scenes banks turn to a smaller number of financial
firms known as dealers, who are actively involved in large quantities of foreign
exchange trading. Most foreign exchange dealers are banks, so this behind-thescenes market is sometimes called the interbank market, although a few
insurance companies and other kinds of financial firms are involved. Trades
between foreign exchange dealers can be very large, involving hundreds of
millions of dollars. Because of the sovereignty issue when involving two
currencies, FOREX has little (if any) supervisory entity regulating its actions.
The foreign exchange market assists international trade and investments by
enabling currency conversion. For example, it permits a business in the United
States to import goods from the European Union member states, especially Euro
zone members, and pay EUROS, even though its income is in United States dollars.
It also supports direct speculation and evaluation relative to the value of
currencies, and the carry trade, speculation based on the interest rate differential
between two currencies.