Currency Peg

A currency peg is when the value of one country’s currency is directly tied to the value of another country’s currency (or a basket of other currencies). For example, 3.75 Saudi riyal is always worth 1 US dollar, no matter what – that’s a “hard” peg. A “soft” peg is when a currency is allowed to trade within a set level of the peg. For example, China’s yuan: each day the Chinese government sets a price point relative to the US dollar and the yuan is allowed to fluctuate within 2% of that point.

Both hard and soft pegs often require the country setting the peg to trade foreign currency in order to protect the peg – if lots of investors are selling the riyal, then the Saudi government will buy the riyal and sell its holdings of US dollar so that the peg remains and 1 US dollar continues to be worth 3.75 riyal.