What are the Major Types of Exchange Rates?

In the foreign exchange market, at a particular time, there exists, not one unique exchange rate, but a variety of rates, depending upon the credit instruments used in the transfer function. Major types of exchange rates are as follows:

1. Spot Rate:

Spot rate of exchange is the rate at which foreign exchange is made available on the spot. It is also known as cable rate or telegraphic transfer rate because at this rate cable or telegraphic sale and purchase of foreign exchange can be arranged immediately. Spot rate is the day-to-day rate of exchange.

The spot rate is quoted differently for buyers and sellers. For example, $ 1 = Rs 15.50 for buyers and $ 1 = Rs 15.30 for the seller. This difference is due to the transport charges, insurance charges, dealer’s commission, etc. These costs are to be born by the buyers.

2. Forward Rate:

Forward rate of exchange is the rate at which the future contract for foreign currency is made. The forward exchange rate is settled now but the actual sale and purchase of foreign exchange occurs in future. The forward rate is quoted at a premium or discount over the spot rate.

3. Long Rate:

Long rate of exchange is the rate at which a bank purchases or sells foreign currency bills which are payable at a fixed future date. The basis of the long rate of exchange is the interest on the delayed payment.

The long rate of exchange is calculated by adding premium to the spot rate of exchange in the case of credit purchase of foreign exchange and deducting premium from the spot rate in the case of credit sale.

If the spot rate is £1 = $ 2.80 and the rate of interest is 6%, then on 30 days bill, $ 0.014 will be added per pound in case of credit purchase and deducted in case of credit sale of dollars.

4. Fixed Rate:

Fixed or pegged exchange rate refers to the system in which the rate of exchange of a currency is fixed or pegged in terms of gold or another currency.

5. Flexible Rate:

Flexible or floating exchange rate refers to the system in which the rate of exchange is determined by the forces of demand and supply in the foreign exchange market. It is free to fluctuate according to the changes in the demand and supply of foreign currency.

6. Multiple Rates:

Multiple rates refer to a system in which a country adopts more than one rate of exchange for its currency. Different exchange rates are fixed for importers, exporters, and for different countries.

7. Two-Tier Rate System:

Two-tier exchange rate system is a form of multiple exchange rate system in which a country maintains two rates, a higher rate for commercial transactions and a lower rate for capital transactions.