6.3 forex rate Flashcards
Define forex rate
The foreign exchange rate is the value or price of a currency expressed in terms of another currency.
How is forex rate determined
determined by the market demand and supply of the currency.
What is the equilibrium forex rate
price at which demand and supply of the currency equals
Describe graph of forex
y axis
x axis
y axis - exchange rate val
x axis - quantity
List the causes of forex fluctuation
Changes in the demand for exports and imports
Inflation
Changes in interest rate
FDI/MNCs
Speculation
Government intervention
What happens when countries import > export
more of their currency is being supplied (going out) than being demanded
Exchange rate depreciates
vice versa
How does inflation affect forex rate
High inflation - high prices of commodities in foreign markets - low demand - low exports
How do changes in interest rates influence forex rate
Country’s interest rate rises, overseas residents may be keen to save or invest money in that country
Demand for currency of that country rises
Demand for the overseas currency falls
What is FDI
2 types and affects
Foreign Direct investment
inward - forex rises since demand increases
outward - forex falls since supply increases
How do FDIs/MNCs influence forex rate
When they expand, they invest in capital and labour abroad. Need to pay in that countries forex. That countries forex increase. Home countries forex decreases
Define hot money
capital which is frequently transferred between financial institutions in an attempt to maximize interest or capital gain.
How does speculation influence forex
foreign exchange traders and investment companies move money around the world to take advantage of higher interest rates and variations in exchange rates to earn a profit.
If an investor loses confidnece, they will withdraw money and invest it elsewhere
vice versa
How does govt intervention influence forex
Govts can purposely buy up or sell reserves of their currency to influence ex rate
Impact on export and import prices if forex falls
vice versa
Export prices fall
import prices rise
vice versa
What is a floating forex rate
exchange rate that is determined freely by market demand and supply
What is appreciation (currency)
The rise in the value of one currency against others, on a floating exchange rate
What is depreciation (currency)
The fall in the value of one currency against others, on a floating exchange rate is known
What are the adv of a floating exchange rate
Automatic Stabilisation
Frees up internal policy
Insulated from external changes
Don’t need too much foreign reserves
Explain how there is automatic stabilisation which frees up internal policy in a floating exchange rate
Any disequilibrium in the balance of payments would be automatically corrected by a change in the exchange rate.
If imports > exports (BOP in defecit) then exchange rate depreciates, making imports more exp. Corrects BOP
This results in govts not having to worry ab bop. They can focus on other economic objectives
Explain how floating exrate helps insulate external charges
helps to insulate a country from inflation elsewhere
If a country were on a fixed exchange rate then it would ‘import’ inflation through higher import prices
Why do govts not have to worry much ab forex reserves when they on a floating sys
no need to maintain reserves to deliberately change the exchange rate
List disadv of floating sys
Uncertainty
Lack of Investment:
Speculation
how do flaoting sys cause uncertainity
what else can this result in
Since currency values fluctuate constantly, businesses, investors and consumers will be uncertain about the economy and its future.
Lose confidence if it fluctuates tm
This may discourage foreign investments
may encourage speculative movements of ‘hot money’ from country to another, thereby causing more exchange rate fluctuations.
What is a fixed forex rate
who is it controlled by
what do they do
fixed and controlled by the central bank
central bank will intervene in the market by buying and selling its currency in the foreign exchange market to maintain a fixed exchange rate.
What is devaluation (fixed ex rate)
A deliberate fall in the value of a fixed exchange rate is called a
What is revaluation (fixed ex rate)
A deliberate rise in the value of a fixed exchange rate is called a
Adv of a fixed ex rate
Certainty
Encourages foreign investment
Keeps inflation low
Balance of payments stability
How does forex lead to inflation
which type
cost push inflation
Deprecaition of currency leads to increases costs for firms (increased cost of raw materials, etc) which leads to increased prices .
Disadvantages of a fixed exchange rate
Conflicts with other macroeconomic objectives
Risk of overvaluation or undervaluation
How does a fixed ex rate conflict with other macroeconomic obj
If they raise interest rates to help revalue currency, it may conflict with economic growth (contractionary monetary policy)
Why is it difficult to value a currency correct in a fixed ex rate
If the rate is too high, it will make exports uncompetitive. If it is too low, it could cause inflation.
