Exchange Rate Flashcards
Meaning / Measurement of the Exchange Rate
The exchange rates show the value of one currency when swapped with another.
AUD/USD = $0.68 —> $1 AUD = $0.68 USD
Factors Affecting the Exchange Rate
Laws of supply and demand apply.
The value of the AUD is influenced by how much people want to buy AUD (demand) and how much AUD is available (supply).
If more people want to buy AUD, its value goes up. If there is more AUD available than people want to buy, its value goes down.
Impacts on the Demand for AUD
Anytime an overseas customer wants to buy Australian G+S. Money comes into Australia from another country (currency)
Since we wouldn’t want their foreign currency, it is exchanged for AUD to complete the transaction. Thus there is an increase in demand for AUD in the Foreign Exchange market (FOREX).
Greater demand for our currency leads to an appreciation of the AUD.
Impacts of the Supply for AUD
If Australia wants to purchase imports from another country, then we need to exchange our AUD on the FOREX market for the currency that the seller wants from us.
This increases the supply of the AUD, as we release more AUD into the FOREX market. Due to there being more AUD available, the value of the AUD will depreciate.
Demand for Exports and Imports and its effects on the value of AUD
Demand for Exports creates demand for AUD - thus an appreciation of the AUD.
Demand for Imports creates supply of AUD - thus a depreciation of the AUD.
- Increase in export demand = Appreciation
- Decrease in import demand = Appreciation
- Increase in import demand = Depreciation
- Decrease in export demand = Depreciation
Commodity Prices
A higher price means more AUD is required to purchase a given amount (volume) of exports. (We are a large exporter of commodities)
So if the volume of exports doesn’t change, AUD would appreciate.
How does the Exchange Rate affect Terms of Trade?
An increase in the terms of trade would be caused by either:
- A decrease in the price of imported goods (less AUD supply)
- An increase in the price of exports (higher AUD demand)
Foreign Investment
Investments by Australians overseas creates a supply of AUD. (Same as Imports)
Investment by foreigners into Australia creates a demand for AUD. (Same as exports)
Relative Interest Rates
Relative Interest Rates (or Interest Rate Differentials) measure the difference between two different interest rates around the world.
When interest rates in Australia are higher compared to other countries, more foreign investors want to invest in Australia to earn better returns. To do this, they need to exchange their currency for Australian dollars (AUD), increasing the demand for AUD. Therefore, higher interest rates in Australia usually lead to higher demand for AUD.
Credit Ratings
When making decisions about where to invest, relative interest rates is only one side of the equation. Investors must also consider the risk of investing in certain countries.
Credit rating is basically a measure of the credit-worthiness of a country.
Poor credit rating: people are less likely to invest, and demand for their currency will fall. People currently owning that currency will want to move it out, so they’ll increase supply on the FOREX market, further depreciating the currency.
Trade Weighted Index (TWI)
The exchange rate can also be measured in terms of its value against a weighted average of the currencies which are traded the most with Australia. The TWI has a base of 100 (set in 1970) but the weights are adjusted annually to account for changes in trading relationships.
Movements in the TWI indicate whether the AUD has appreciated or depreciated against a basket of currencies, rather than against just one currency.
