What is the exchange rate of a currency and what determines it?

The exchange rate of a currency is the price of one currency measured in terms of another. For example, the exchange rate of the euro against the króna is simply the price of one euro in Icelandic króna. Currency exchange rates are determined by supply and demand in foreign exchange market trading. When the exchange rate of a currency increases, the currency is said to "appreciate", while when the exchange rate decreases, it is said to "depreciate".

Various factors affect the supply and demand for a particular currency, both in the long and short term. Important factors influencing the exchange rate in the long term include foreign trade, terms of trade, commodity prices, interest rate spreads with abroad, and inflation, but in the short term, the exchange rate can change due to speculation and changes in investors’ risk appetite. However, many other factors affect currency exchange rates. It is very difficult to predict exchange rate movements. However, many other factors affect currency exchange rates. It is very difficult to predict exchange rate movements.

Changes in exchange rates are limited by the exchange rate regime of the relevant currency area. Under a floating exchange rate regime, the exchange rate of a currency is determined in the foreign exchange market. A fixed exchange rate, on the other hand, involves the central bank of the currency area in question actively buying or selling foreign currency in order to maintain a certain exchange rate.