Exchange Rates

Question 1

Floating Exchange Rates

Answer 1

The exchange rate of a currency is determined purely by market forces.

Question 2

Fixed Exchange Rates

Answer 2

The exchange rate of a currency is fixed by the central bank or government against other currencies or gold.

Question 3

Managed Exchange Rates

Answer 3

The exchange rate of a currency is determined by market forces but intervention by the central bank also influences the exchange rate.

Question 4

Revaluation and Appreciation

Answer 4

Revaluation:
Revaluation occurs under a fixed exchange rate when the central bank decides to raise the value of the currency compared to others.

Appreciation:
Appreciation occurs under a floating exchange rate when market forces cause the value of a currency relative to others to rise.

Question 5

Devaluation vs Depreciation

Answer 5

Devaluation:
Devaluation of a currency occurs in a fixed exchange rate when the government decides to lower the value of the currency.

Depreciation:
Depreciation of a currency occurs under a floating exchange rate when the value of the currency increases relative to others due to market forces.

Question 6

Factors Influencing Floating Exchange Rates

Answer 6

Relative Inflation Rates:
If inflation is comparatively high then the value of the currency will fall.

Relative Interest Rates:
High interest rates encourage hot money flows, raising demand for the currency and therefore appreciating its value.

The State of the Economy:
If the economy is growing, speculator’s confidence will grow, encouraging foreign investors to buy the currency, raising its value

Balance of Payments:
A long-term deficit would cause supply of a currency to be relatively high compared to demand, causing a fall in its value. However, the money associated with this is small compared to ‘hot money’.