03. Exam - Exchange Rates

Question 1

What are the worlds four biggest currencies and why?

Answer 1

• Pound - UK - world leader in 1800s (industrial revolution)
• US Dollar - US - rose in 1900s as major economic, agricultural and financial leader
• Yen - Japan - 1950s & 60s post war growth and development
• Euro - very well traded and includes France and Germany who were historical economic super powers.

Question 2

When did the Australian dollar float and in what year was it most traded (and why)?

Answer 2

Floated in Dec 1983 and in 2014 was the world’s 5th most traded currency ($8b per day). Reasons include the strong demand for commodities.

Question 3

What is the FOREX?

Answer 3

Foreign exchange market which is a market in which the currency of one country is exchanged for the currency of another. The price at which currency exchanges is called the foreign exchange rate.

Question 4

What is the definition of currency depreciation / currency appreciation?

Answer 4

Depreciation - the currency’s value falls relative to another currency
Appreciation - the currency’s value rises relative to another currency.

Question 5

Briefly explain Australia’s currency movement from 2000 to 2008

Answer 5

In 2000 it was very low 0.53 against other currencies, but started to rise steeply in 2007 to 0.93 USD. The Financial crisis hit in 2007 /2008 and the Lehmann Brothers Bank collapsed and the currency dropped to 0.66 USD. Given the crisis money moved to safe haven currency.

Question 6

What do foreign countries demand from Australia in terms of exports?

Answer 6

• Our innovation - eg. skin healing, special materials, or black box recorders
• our organic foods
• Wine
• Education
• Property

Question 7

Who is demanding AUD?

Answer 7

1) foreign firms and consumers who BUY goods & services in AUD
2) foreign firms and consumers who INVEST in Australia
3) currency traders who believe the value of the dollar will appreciate.

Question 8

What does demand of the AUD do?

Answer 8

It shifts the curve to the right which pushes the dollar higher.

Question 9

Explain what happened to demand for AUD during the GFC (include what happens on a diagram)?

Answer 9

Foreign firms and consumers and speculators reverted to safehaven currencies such as USD, which decreased the demand for AUD and pushed the demand curve to the left and resulted in the AUD reducing. Traders then saw the dollar was too low and purchased in, which pushed the demand back to the right.

Question 10

Explain Australia’s currency movement in 2007 to 2009

Answer 10

2007 - Jan 0.78 - 0.79
2007 - increased steadily reaching 0.93 in November
2008 July - reached near parity (high 90s)
2008 - Fell steadily during Aug & Sep, and in Oct- hit 0.61
2008 - Dec to Jan increased back up to 0.72, but corrected, and was not till March 2009 started to steadily climb getting back to 0.93 in Nov 2009

Question 11

Explain how Australia supplies the AUD?

Answer 11

1) Aust firms & consumers buy good and services produced o/s
2) Aust firms and consumers invest o/s
3) Currency traders who believe the value of the dollar in the future will be lower than it is today.

Question 12

What were the four reasons why the Australian dollar appreciated in 2010-2012?

Answer 12

1) Resources boom
2) Australian interest rate differential was high
3) Traders had high expectations of the AUD
4) Monetary stimulus in the US by Fed Reserve so the USD fell against the AUD

Question 13

Why did the resources boom occur?

Answer 13

• Increased demand for minerals and energy resources such as coal and iron ore by China
• massive foreign direct investment into mining projects
• rising terms of trade (prices of exports compared to imports)
  These all helped appreciate the currency

Question 14

What is an interest rate differential?

Answer 14

Where the interest rates are high in one country compared to another so firms and consumers want to invest in a foreign country to access that rate (it is attractive to foreign investors). So it is Aust rate - foreign interest rate.

Question 15

Why did the value of AUD in September 2014 to December 2015 fall? (3)

Answer 15

1) major reduction in demand for iron ore by China and the rest of the world created a glut of steel and iron ore
2) Traders assessed economic variables and bet against the AUD suspecting it would fall
3) Aust interest rates were lower - to the lowest in history (esp. compared to the US who were increasing rates).

Question 16

What are the terms of trade?

Answer 16

The price of exports divided by the price of imports. Export prices lower and imports higher = lower terms of trade.

Question 17

Explain how Australia’s AUD would appreciate?

Answer 17

1) World demand for Aust exports increase - demand shifts right
2) Expected future exchange rates have room to grow - speculators - demand shifts right
3) interest rates in Australia are higher than elsewhere - demand shifts right.

Question 18

Explain how Australia’s dollar would depreciate?

Answer 18

1) Aust demand fro imports increases
2) Aust interest rate decreases against other countries
3) Expected future exchange rate falls

Question 19

What affect does appreciation of the AUD have on the Australian economy?

Answer 19

• great for buying imports
• less competitiveness as our exports get more expensive
• cheaper imports mean that domestic CPI will rise more slowly and inflation will fall.
  Overall it is a contractionary effect - which will decrease aggregate demand

Question 20

What affect does depreciation of the AUD have on the Australian economy?

Answer 20

• exports are cheap so attract buyers
• more tourism and more students coming for education
• imports are higher cost
• CPI rises faster and inflation increases
  Overall it is an expansionary effect - Increases aggregate demand so increases GDP

Question 21

Who wins with depreciation in Australia?

Answer 21

• domestic producers of wheat - contracts are in USD
• Australian tourism as it is cheaper
• domestic producers who export as their goods will now be cheaper

Question 22

Who loses with depreciation in Australia?

Answer 22

• Australians travelling overseas

- Australian consumers buying imports

Question 23

Name three things that will push the supply of AUD to the left?

Answer 23

• a reduction in imports into Aust (less AUD in market)
• a reduction in income payments to foreigners
• a reduction of Aussies travelling Overseas.

Question 24

Name four things that will push the supply of AUD tot the right?

Answer 24

• an increase in imports into Australia
• an increase in interest rates in the US
• an increase in Australians investing overseas.
• expansionary monetary policy will decrease our interest rates and push supply to the right

Question 25

Why do interest rates change the supply of AUD?

Answer 25

Because if our interest rates go down, there is a higher differential, which means lower foreign investment and lower AUD in the market, but our exports will go up.

Question 26

Name two things that will decrease the value of Australian exports?

Answer 26

• an economic down turn among Australia’s trading partners
• an increase in foreign investment (= increase in demand for assets = increase in AUD = lower exports as less competitive)

Question 27

What is the result of a boom in economic activity?

Answer 27

• imports and exports will increase, however imports will go up more than exports.