Final answer:
Exchange rates are used to determine the value of one currency in relation to another currency, influencing the costs of imports and exports in international trade. Fluctuations in exchange rates can impact the profitability of trade transactions and create uncertainties for businesses. Hedging activities help manage these risks.
Step-by-step explanation:
Exchange rates play a crucial role in international trade. They are used to determine the value of one currency in relation to another currency. This value affects the costs of imports and exports, influencing the competitiveness of a country's products in global markets. For example, when a country's currency depreciates, its exports become cheaper for foreign buyers, leading to increased demand. On the other hand, an appreciation in currency can make imports more affordable for domestic consumers.
Exchange rates can fluctuate due to various factors, such as interest rates, economic growth, inflation, and political stability. These fluctuations can impact the profitability of international trade transactions. For instance, a sudden increase in the value of a country's currency may reduce its export revenues and harm domestic industries.
Furthermore, exchange rates can create uncertainties and risks for international businesses. To manage these risks, companies may engage in hedging activities, such as forward contracts or options, to protect themselves from adverse currency movements. Overall, exchange rates serve as a vital tool for evaluating the economic performance of countries and facilitating international trade.