beginners question...

Discussion in 'Forex' started by nooty, Aug 28, 2008.

  1. nooty


    I'm sort of confused when I see a list of currency prices..

    For example, take todays rate of the Bahraini Dinar.

    1 USD = 0.37717 BD

    1 BD = 2.6513

    These rates are the London midmarket rates, right?

    The Bahraini Dinar is pegged to the USD at 1 USD = 0.37600.

    So can somebody explain why it fluctuates?

    Also, when banks change dinars to US Dollars, and vice versa, for us, the rates are also different. What do they do exactly?
  2. Hey Nooty,

    The relationship between pairs is inverted.
    So for the USD vs BD:
    1 USD = 1/BD
    1 BD = 1/USD

    In otherwords:

    1/.37717 = 2.6513
    1/2.6513 = .37717
  3. nooty


    I know but I mean why doesnt it stay at .37600, why does it fluctuate
  4. Presumably because of interest rate differentials. If the interest rates in Bahrain were higher than the US, and you were to use US dollars to buy Bahraini dinars and put them in the bank in Bahrain, you would earn more interest than if you put your US dollars in a US bank.

    In the case of a forex transaction thorugh a broker you are basically borrowing one currency to buy another currency. If you were to borrow US dollars at a low interest rate to buy Bahraini dinars at a high interest rate, and the exchange rate was fixed, you would get a 'guaranteed' profit from the difference between the lending interest rate and the deposit interest rate (assuming that rate is actually positive).

    Accordingly the exchange rate you are offered takes this into account, because nobody wants you to get free money. So the fluctuations result from changes in actual interest rates, and the perceived potential for changes in interest rates.
  5. nooty


    I thought it was about supply/demand? Doesnt the Bahraini Central Bank buy/sell Bahraini Dinars to maintain the peg?
  6. Sure, possibly that's it depending on how the central bank maintains the fixed rate. If it does so by buying and selling on the open market rather than by restricting how and by whom the currency is traded.
  7. Buy sell spread?