Changes in forex (Flexible exchange rate system)

Question 1

Define foreign exchange rate (forex)

Answer 1

price of domestic currency in terms of foreign currency

Question 2

Define flexible exchange rate system

Answer 2

• mkt forces of dd and ss of a currency
• in foreign exchange mkt
• determine the eqm exchange rate

Question 3

Factors affecting dd for domestic currency

Answer 3

dd in foreign mkt arises when foreigners:
- buy exports
- invest in country (ie. FDI)

Question 4

Factors affecting ss of domestic currency

Answer 4

ss arises when citizens:
- buy imports
- invest abroad

Question 5

Define appreciation

Answer 5

• increase in domestic currency
• relative to foreign currency
• in flexible/floating ex rate system
• rise in dd
• fall in ss

Question 6

Define depreciation

Answer 6

• fall in px of domestic currency
• relative to foreign currency
• in flexible/floating ex rate system
• fall in dd
• rise in ss

Question 7

Causes of changes in exchange rate

Answer 7

1. Relative inflation rates
2. Relative growth rates
3. Political factors
4. Relative interest rates
5. Long-term investment prospects
6. central bank intervention

Question 8

Relative interest rates

Answer 8

• country’s IR higher relative to trading partners, currency will depreciate
  1. Exports > ex relative to foreign
• qdd for exports fall, dd for currency fall
  2. Imports cheaper than domestically produced gds
• dd for M rise, sell more of domestic currency to buy foreign currency
• ss for domestic c rise

Question 9

Relative growth rates (Economic growth)

Answer 9

• Assume econ growth in sg
• NY rises, consumers enjoy rise in purchasing power
• Rise in DDm
• Rise in SS for $S to buy foreign currency to pay for M, c.p.
• surplus of $S in forex mkt
• depreciation of $S

Question 10

Relative growth rates (Recession)

Answer 10

• Assume recession in Sg’s trading partner e.g UK
• fall in incomes of UK consumers
• fall in DD for sg exports and DD for $S in forex mkt
• surplus –> depreciation

Question 11

Relative interest rates

Answer 11

• e.g fall in Sg’s i/r relative to US
  1. fall in expected rate of return
• rise in short-term capital outflow frm sg to us (ie. hot money outflow)
• Rise in SS of $S
  2. Fall in short-term capital inflow
• fall in DD for $S
  3. Surplus of $S –> depreciation

Question 12

Long term investment prospects

Answer 12

e.g fall in corporate tax rate in US 2018 (35% to 21%)
- Higher expected rates of returns –> rise in FDI
- rise in capital inflow
- rise in dd for USD in forex mkt – > appreciation

Question 13

Political factors (political instability)

Answer 13

• rise in outward FDI
• loss of confidence
• massive capital outflow to other countries
• increase in SS for domestic currency in forex mkt –> depreciation