The Exchange Rate pair represents 1 unit of the domestic currency (the “base currency”) purchasing an amount of the foreign currency or (the “quote currency”). Because the USD is considered the world’s reserve currency, and it is currently the most traded currency, our analysis uses the USD as the as the quote currency in any currency pair. Take note that in trading FOREX, traders have standardized pairs that may be opposite. For example, a common trading pair is USDCAD (Canadian dollar). Finesse inverts the pair to be CADUSD so that we know how much USD a single CAD would be worth at a given time. Hence, this standardizes all our foreign currency analysis in USD. Exchange Rates are affected by (1) the country’s inflation rate (higher inflation devalues the currency); (2) central bank interest rates (higher rates cause investors to purchase the currency and the country’s bonds thereby increasing the currency’s value, and vice versa); (3) stock market (investors buy the currency to invest in the rising stock market, and vice versa); and (4) the current account (investors purchase the foreign currency to buy its exports, or the country’s consumers sell the currency to pay for imported goods). Exchange Rates can be fixed (ex. gold standard) by the country or more commonly float (fiat) so that they are based on currency demand. A country can have only 2 of 3 of the following: A fixed Exchange Rate, free capital movement, and independent monetary policy according to the Mundell Fleming Model.
