4.1 - Floating Exchange Rates

Question 1

What are the key features of a floating rate?

Answer 1

External value determined by market forces
No central bank intervention
No assigned target

Question 2

Which factors cause changes to a floating system?

Answer 2

Trade Balances
FDI
Portfolio Investment
Interest Rate Differentials
Speculation

Question 3

How does trade balance affect a floating rate?

Answer 3

Strong trade + CA surplus tends to cause appreciation
High exports, high currency demand

Question 4

How does FDI affect a floating rate?

Answer 4

Attracting high net inflows of capital investment increases currency demand

Question 5

How does portfolio investment affect a floating rate?

Answer 5

Strong inflows into equities + bonds cause appreciation

Question 6

How do interest rate differentials affect a floating rate?

Answer 6

High interest rates cause ‘hot money’ inflows (Short term capital)
Causes appreciation