Why and how currency values change

A question from Yahoo! Answers:

Can someone explain to me why the dollar changes value and how it is decided?

A currency (including the dollar) changes its value for the same reason other financial assets (such as stocks and bonds) do: supply and demand imbalance.  If there are more people that want to buy a certain currency than there are people that want to sell it, the buyers have to offer sellers an inducement to sell in the form of higher price.  Conversely, if there are more people that want to sell a certain currency than there are people that want to buy it, the sellers have to offer buyers an inducement to buy in the form of lower price.

How it the exchange rate decided?  It’s not.  There are about 300 major banks worldwide that stand ready to buy and sell the major currencies at slightly (sometimes not so slightly) different rates.  If a particular bank sees a lot of demand for a certain currency, it raises its price; if it sees a lot of supply of a certain currency, it lowers its price.  At the end of the say, the bank (if it’s large enough) gets a phone call from The Wall Street Journal and/or Financial Times and tells them what the going rates are.  The newspaper averages the rates from all banks it polled and publishes the average.

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