6.3 forex rate

Question 1

Define forex rate

Answer 1

The foreign exchange rate is the value or price of a currency expressed in terms of another currency.

Question 2

How is forex rate determined

Answer 2

determined by the market demand and supply of the currency.

Question 3

What is the equilibrium forex rate

Answer 3

price at which demand and supply of the currency equals

Question 4

Describe graph of forex
y axis
x axis

Answer 4

y axis - exchange rate val
x axis - quantity

Question 5

List the causes of forex fluctuation

Answer 5

Changes in the demand for exports and imports

Inflation

Changes in interest rate

FDI/MNCs

Speculation

Government intervention

Question 6

What happens when countries import > export

Answer 6

more of their currency is being supplied (going out) than being demanded

Exchange rate depreciates

vice versa

Question 7

How does inflation affect forex rate

Answer 7

High inflation - high prices of commodities in foreign markets - low demand - low exports

Question 8

How do changes in interest rates influence forex rate

Answer 8

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

Question 9

What is FDI

2 types and affects

Answer 9

Foreign Direct investment

inward - forex rises since demand increases

outward - forex falls since supply increases

Question 10

How do FDIs/MNCs influence forex rate

Answer 10

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

Question 11

Define hot money

Answer 11

capital which is frequently transferred between financial institutions in an attempt to maximize interest or capital gain.

Question 12

How does speculation influence forex

Answer 12

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

Question 13

How does govt intervention influence forex

Answer 13

Govts can purposely buy up or sell reserves of their currency to influence ex rate

Question 14

Impact on export and import prices if forex falls

vice versa

Answer 14

Export prices fall
import prices rise

vice versa

Question 15

What is a floating forex rate

Answer 15

exchange rate that is determined freely by market demand and supply

Question 16

What is appreciation (currency)

Answer 16

The rise in the value of one currency against others, on a floating exchange rate

Question 17

What is depreciation (currency)

Answer 17

The fall in the value of one currency against others, on a floating exchange rate is known

Question 18

What are the adv of a floating exchange rate

Answer 18

Automatic Stabilisation
Frees up internal policy
Insulated from external changes
Don’t need too much foreign reserves

Question 19

Explain how there is automatic stabilisation which frees up internal policy in a floating exchange rate

Answer 19

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

Question 20

Explain how floating exrate helps insulate external charges

Answer 20

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

Question 21

Why do govts not have to worry much ab forex reserves when they on a floating sys

Answer 21

no need to maintain reserves to deliberately change the exchange rate

Question 22

List disadv of floating sys

Answer 22

Uncertainty

Lack of Investment:

Speculation

Question 23

how do flaoting sys cause uncertainity

what else can this result in

Answer 23

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.

Question 24

What is a fixed forex rate

who is it controlled by
what do they do

Answer 24

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.

Question 25

What is devaluation (fixed ex rate)

Answer 25

A deliberate fall in the value of a fixed exchange rate is called a

Question 26

What is revaluation (fixed ex rate)

Answer 26

A deliberate rise in the value of a fixed exchange rate is called a

Question 27

Adv of a fixed ex rate

Answer 27

Certainty
Encourages foreign investment
Keeps inflation low
Balance of payments stability

Question 28

How does forex lead to inflation

which type

Answer 28

cost push inflation

Deprecaition of currency leads to increases costs for firms (increased cost of raw materials, etc) which leads to increased prices .

Question 29

Disadvantages of a fixed exchange rate

Answer 29

Conflicts with other macroeconomic objectives

Risk of overvaluation or undervaluation

Question 30

How does a fixed ex rate conflict with other macroeconomic obj

Answer 30

If they raise interest rates to help revalue currency, it may conflict with economic growth (contractionary monetary policy)

Question 31

Why is it difficult to value a currency correct in a fixed ex rate

Answer 31

If the rate is too high, it will make exports uncompetitive. If it is too low, it could cause inflation.