Determination of the exchange rate

Question 1

What are the factors that determine demand and supply of a currency?

Answer 1

International trade in goods and services
Inward and Outward investment
Relative interest rates
Speculation
Relative inflation

Question 2

What effect does rise in exports have on the domestic currency and why?

Answer 2

Rise in exports cause RISE in DEMAND for domestic currency

Because foreign currency must be exchanged for domestic currency to pay for exports

Question 3

What effect does rise in imports have on domestic currency and why?

Answer 3

Rise in imports causes RISE in SUPPLY of domestic currency

Because domestic currency must be exchanged for foreign currency in order to pay for the imports

Question 4

What effect does fall in demand for exports have on the currency value?

Answer 4

Fall in demand for exports = fall in value of currency

Question 5

What effect does fall in demand for imports have on the currency value?

Answer 5

Fall in demand for imports = rise in value of currency

Question 6

What effect does a rise in inward investment have on domestic currency? Why?

Answer 6

Rise in inward investment to an economy will cause a RISE in DEMAND for domestic economy
Because people have to buy sterling

Question 7

What effect does a rise in outward investment have on domestic currency?

Answer 7

Rise in outward investment from an economy will cause a RISE in SUPPLY of domestic economy

Question 8

What effect would a rise in interest rates have on the value of the domestic currency?

Answer 8

Rise in interest rates will cause a RISE in the value of domestic currency

Question 9

Why will a rise in interest rates cause a rise in value of domestic currency?

Answer 9

Businesses and financial institutions will gain a higher rates of return on savings placed in domestic bank accounts
Therefore foreign currency will be exchanged for domestic currency to save in domestic bank accounts

Question 10

What does the effect of a rise in interest rates on the domestic currency depend on?

Answer 10

Depends on how high interest rates in UK compared to other economies

Question 11

What will happen to the domestic and foreign currency if speculators expect the value of domestic currency will rise in future?

Answer 11

If speculators believe the value of domestic currency will rise in future they are likely to BUY the domestic currency and SELL the foreign currency

Question 12

What will happen to the domestic and foreign currency if speculators expect the value of domestic currency will fall in future?

Answer 12

If speculators believe the value of domestic currency will fall in future they are likely to SELL the domestic currency and BUY the foreign currency

Question 13

What happens to the domestic currency if the UK has higher inflation?

Answer 13

If the UK has higher inflation than the rest of the world, there is less demand for UK currency