This dissertation consists of two independent but related chapters on exchange rate theory and practice. The first chapter analyzes target zone exchange rate systems and provides an extension to the standard model of Krugman (1991). The standard model does not allow for imperfect credibility nor for interventions within the band, thence, it cannot explain the empirical evidence from the target zones of the European Monetary System and the Nordic countries. The model in this chapter allows for a realignment in the central parity of the exchange rate while the fundamentals follow a mean-reverting Brownian motion which models the intramarginal interventions of the central banks. We argue that, with these extensions, the model accounts well for the empirical facts. The second chapter develops a model of asymmetrical currency substitution. The friction for exchange rate determinacy is provided by costly spot market transactions. A stationary equilibrium exists if and only if the cost of spot market transactions is greater than either country's money growth rates, and country 1 money growth rate is lower than that of country 2, given that country 2 has a stronger currency. When the countries cooperate, there are two optimal money growth rates that maximize the steady state utility of the consumers. The optimal money growth rate strictly decreases in currency substitutability and the cost of income taxation. When they do not cooperate, there is a unique positive Nash money growth for country 1 which increases in response to increases in country 2 money growth if the transaction costs are not too high. / Ph. D.