Speculation fails to smoothen exchange rate movements

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  Second, there is little or no speculation on a fixed exchange rate. However, a fixed exchange rate contradicts the objective of having free markets and it is not able to adjust to shocks swiftly like the floating exchange rate.

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  A trade deficit therefore causes a currency to depreciate. Flow-ons Created when a large trade is split up into several smaller trades. Capital flows Cross-border investment. Speculation Short-term investment based on expected currency movements.

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  This also causes speculation and damage to the weak economies. ) On the other hand in case of fixed exchange rate the rate is fixed by the government. There are various types of currency which one should understand to manage the risk.

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  While currency swaps eliminate risk, they also eliminate the possibility for gains with positive exchange rate movements.

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  Exchange rate movements in the short term are news-driven. Announcements about interest rate changes, changes in perception of the growth path of economies and the like are all factors that drive exchange rates in the short run.

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  Fixed rates should eliminate destabilising speculation - Speculation flows can be very destabilising for an economy and the incentive to speculate is very small when the exchange rate is fixed. Disadvantages of the Fixed Exchange Rate: 1.