15 : Exchange Rates Flashcards
What are exchange rates
The price which one currency can be traded for another :
Exchange rate will be determined by the demand and supply for exports and imports.
What are the effects of a high pound
AFFECTS : :(
- the price et our exports are very expensive = low sales
- imports from foreign countries are cheaper
- less British sale at home : since people can buy for much cheaper in foreign countries
(Remember SPICED ! : stronger pound = imports cheaper & exports dearer
What are the effects of a low pound
AFFECTS : : )
-The price of our exports abroad are very cheap = high sales
- imports from foreign countries are expensive
- more British sales at home in uk : because foreign imports are to
expensive to buy
What are equilibrium exchange rates
When foreign exchange is bought and sold on the foreign exchange markets :
- governments may buy & sell currencies in order to influence the price of a currency
How can you calculate exchange rates
Explanation :
• 70% of the UK trade is with the USA and 30% is with France
• The value of the pound falls by 10% against the US Dollar and by 20%
• The trade weight index will now have changed.
• The fall in the US Dollar contributes a 7% fall in the exchange rate (10% ×
0.7) whilst the fall in the Euro contributes a 6% fall (20% × 0.3).
• The average fall is the sum of these two components (i.e. 13%).
• If the trade weighted index started off at 100, its new value will be 87
What are the factors that influence pounds (£)
• Inflation
• Interest Rates
• Speculation
• Change in competitiveness
• Relative strength of other currencies
• Balance of Payments
How does inflation influence (effect) the pound
• if inflation in the UK is lower thar elsewhere, then UK exports will become more competitive and there will be an increase in demand for £.
• Also foreign goods will be less competitive and so UK citizens will supply less fs to buy foreign goods. Therefore the rate of £ will tend to increase.
How do interest rates influence (effect) the pound
• If UK interest rates rise relative to elsewhere, it will become more attractive to deposit money in the UK, Therefore demand for Sterling will rise.
• This is known as “hot money flows” and is an important short run determinant of the value of a currency.
How does speculation influence (effect) the pound
• If speculators believe the sterling will rise in the future, they will demand more now to be able to make a profit. This increase in demand will cause the value to rise.
Therefore movements in the exchange rate do not always reflect economic
fundamentals, but are often driven by the sentiments of the financial markets.
For example, if markets see news which makes an interest rate increase more likely, the value of the Pound will probably rise in anticipation.
How will a Change in competitiveness influence (effect) the pound
If British goods become more attractive and competitive this will also cause the value of the Exchange Rate to rise.
This is important for determining the long run value of the Pound.
How does the relative strength of other currencies in influence (effect) the pound
Between 1999 and 2001 the £ appreciated because the Euro was seen as a weak currency.
How does the balance of payments influence (effect) the pound
A large deficit on the current account means that the value of imports is greater than the value of exports.
