Exchange Rates

Question 1

What is an exchange rate?

Answer 1

An exchange rate is the price of one currency expressed in terms of another, for example, £1 = $1.25.

Question 1

What is meant by a currency?

Answer 1

A currency is the system of money in general use in a particular country, for example, in the UK the currency is pounds sterling (£). The value of a currency can rise and fall against other currencies.

Question 2

Why do businesses buy foreign currencies?

Answer 2

• To pay for goods and services overseas
• To invest in enterprise overseas

Question 3

What is meant by appreciation?

Answer 3

A rise in the value of a currency.

Question 4

What is meant by depreciation?

Answer 4

A decline in the value of a currency.

Question 5

How do changes in the value of currencies affect the prices of exports and imports?

Answer 5

When the exchange rate of pounds appreciates, the price of UK exports increase, and the price of imported goods in the UK fall.

When the pound depreciates the opposite happens.

Question 6

How can exchange rates create uncertainty for businesses?

Answer 6

• Uncertainty over revenue:
  If firms agree deals priced in foreign currencies, they may receive more or less revenue than expected if the exchange rate alters in the intervening period.
• Uncertainty regarding quantities likely to be sold:
  Price changes on exported goods causing demand changes
• Uncertainty regarding competitors’ responses