4.1.8: Exchange Rates Flashcards
What is exchange rate?
The weight of one currency relative to another.
What are the 3 exchange rates?
-Nominal.
-Real.
-Effective.
What is nominal exchange rate?
The rate at which one country’s currency exchanges for a basket of multiple foreign currencies.
What is real exchange rate?
The nominal exchange rate adjusted for the inflation rates in both countries.
What is effective exchange rate?
A weighted index of a currency’s value against a basket of currencies.
What are the 3 exchange rate systems?
-Free-Floating.
-Managed-Floating.
-Fixed.
What is free-floating currency?
Where the external value of a currency depends wholly on market forces of demand & supply.
What is an example of a free-floating currency?
UK Pound Sterling.
What is managed-floating currency?
Where the external value of a currency depends on demand & supply, but the Central Bank will intervene to control the currency’s volatility.
What is an example of a managed-floating currency?
Indian Rupee: fluctuates on the market, but the central bank intervenes when it falls outside a set range.
What is fixed exchange rate?
The fixing of the value of a currency to another currency or gold (set by the central bank).
What is an example of a fixed exchange rate?
Gold Standard.
What is appreciation?
Increase in the value of a currency (under floating exchange rates).
What is depreciation?
Decrease in the value of a currency (under floating exchange rates).
What is revaluation?
Increase in the value of a currency (under fixed exchange rates).
What is devaluation?
Decrease in the value of a currency (under fixed exchange rates).
What factors affect a currency’s value?
-Relative Inflation Rates.
-Relative Interest Rates.
-State Of The Economy.
-Political Stability.
-Speculation.
How does relative inflation rates affect a currency’s value?
If the country’s inflation rate is higher than its competitors, the value of the currency will fall.
How does relative interest rates affect a currency’s value?
High interest rates makes investing funds in the country attractive, as the rate of return on investment is higher.
This increases demand for the currency, causing an appreciation.
How does the state of the economy affect a currency’s value?
A strongly performing economy will increase the confidence of investors & speculators.
How does political stability affect a currency’s value?
Instability may cause a loss of confidence and put downward pressure on the currency value.
How does speculation affect a currency’s value?
If speculators think a currency will appreciate, demand will increase, as the rate of return on investment is higher.
This can cause an increase in the value of the currency.
How can the government intervene in currency markets?
-Buy foreign currency in exchange for the pound.
-Decrease interest rates.
How can the government use foreign currency transactions in currency markets?
To weaken a currency, the supply can be increased by buying foreign currency (or gold) with the currency.