The exchange rate of a currency under a floating exchange is determined by market forces such as supply and demand. These factors are:
1. Currency appreciation &
depreciation: Currencies in a floating exchange system can either appreciate
or
depreciate. Appreciation is when a floating
exchange system increases in value in terms of another currency. Depreciation is
when a currency decreases in value in terms of another currency.
2. Flow of funds: When there is an imbalance
in balance of payments, there will
either be an inflow of funds as foreign investment
and
an outflow of funds as invest to foreign countries.
3. Interest rate over inflation: Due to the higher or lower interest rate over inflation, the investors will tend to chose or not chose to invest in the country with the higher or lower differential of interest rate over inflation respectively.
4. Trade balance: There will be higher demand for the currency that
export much
more than the import and lower demand for currency that import much more
than the export, because of
the
imbalance.
5. Investor’s
confidence: Investors are dependent to the country's economic strengths that they will be more likely to buy that country's
assets, pushing up the value of country's currency.
6. Speculation: When people expect appreciation or depreciation, the demand of the currency will increase or decrease respectively.