exchange rate theories

Exchange rate theories explain how the value of one currency relative to another is determined. The **Purchasing Power Parity (PPP)** suggests currencies adjust so that identical goods cost the same everywhere. The **Interest Rate Parity** theory states that differences in interest rates between countries influence exchange rates to prevent arbitrage. The **Supply and Demand** model sees exchange rates as the result of currency buying and selling—more demand for a currency than supply increases its value. These theories help understand why currencies fluctuate based on economic factors like inflation, interest rates, and trade balances.