Why does exchange rate keeps changing?

I know one man who bought disposable face masks in lots of 1000s when Swine Flu news broke on News channel. He bought and stored boxes of masks in his house. Month later everyone on street was wearing masks, thanks to Indian news channel, they reported 24 hours about flu and
made it sound more scary. He sold all his masks to local shops when they were out of stock and made good 30% margin.

Udaya Kumar, designer of the Indian rupee sign.

Udaya Kumar, designer of the Indian rupee sign.

Indian Diamond market is full of enterprising people. Once a trader, always a trader. In our markets its common to find people who are Diamond trader by profession, but in addition make profits out of trading land, stocks, electronics, currency and anything that is in demand.

I recently asked a question to one friend who occasionally does Foreign exchange trading. “Why does dollar price go up and down?“. He explained me the reason. I am going to simplify same explaination here.

Lets assume there are only two international traders between India and US.
– Mr Patel in Mumbai who supplies Diamond Jewelry to a store in New York.
– Mr. Brown in Chicago who supplies Industrial Robots in Noida.

Assume dollar price today is 45 rupees.

Today Patel sold 10 piece Jewelry set to NY store, cost of each piece was 1000 dollars. Total selling amount = 10,000 dollars. Now Patel wants to convert 10,000 dollars to Rupees. If rate is 45 rupees to 1 US dollar. After conversion Patel should get 4.5 Lakh rupees.

Same evening Mr. Brown from Chicago, sells one industrial robot in Noida for Rs. 2.25 lakhs. As per 45 rupees to dollar rate, Brown is expecting to convert Rs. 2.25 lakhs to 5000 US dollars.

So we have
— 10,000 US dollars to be converted to rupees. [After conversion worth Rs. 4.5 Lakhs]
— Rs. 2.25 Lakhs to be converted to dollars [After conversion worth 5000 US dollars]

We have a problem. Demand for Rupees is more than that for dollars. In other words for this particular trading day, there seems to be more supply of dollars than that of rupees.

Patel and Brown log to Foreign Exchange website to convert their currency.
First 5000 dollars gets exchanged easily. And the rate is Rs. 45 to 1 US dollars. Brown is happy he got his 2.25 lakhs converted to 5000 US dollars, he logs out of website and goes home. Patel still has more 5000 US dollars to convert in to Rupees. He got some money on credit from a friend and promised to return him on time with small interest fee. Patel also wants to pay salary to karigar (people on manufacturing floor) who manufactured jewelry for him.

Patel is now desperate to convert remaining 5000 dollars to rupees.

Lets add one more character in to story now.

Mr Desai who runs a Travel Agency and organises tours to countries like UK, USA, Asia etc. He logs to website and sees someone waiting to exchange 5000 US dollars to rupees. Desai knows that he will need US dollars sometime next month and was looking to buy some at good price. He offers a bargain. Last price for dollar was 45 rupees, but if someone sells dollars for 43 rupees, I will buy it.

Patel being in rush, agrees to sell dollars for lower price. Patel converts  remaining 5000 US dollars at rate of 43 rupees. 5000 x 43 =  2.15 lakhs. Patel doesn’t mind loosing small amount because he will able to make payments on time.

Now latest Exchange rate is:  Rs. 43 to 1 US dollar.

After few weeks , Desai (Travel agent) gets a big contract to organise tour for a group of 100 people. He needs lot of dollars, he logs in to website and sees Patel ready to sell 10,000 dollars for 47 rupees. Desai desperately needs dollars, he buys it.

Now excahnge rate is: Rs. 47 to 1 US dollar.

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