Exchange Rates Flashcards
What are exchange rates
The price of one currency in terms of another
What is a currency
System of payment adopted by a country
2 categories of exchange rate system
fixed exchange rate
floating exchange rate
what is a fixed exchange rate
is fixed against either the value of another currency or to a measure of value (gold)
what is a floating exchange rate
where the value of a currency is determined by the forces of demand and supply
(currencies bought and sold on FOREX)
what is the demand for currencies based upon
exports demand
inflows of investment
speculative buying (hot money)
central bank buying up their own currency
what is the supply of currencies based upon
demand for imports
outflows of investment
speculative selling
central bank selling their own currency
what is hot money
capital flows moving to countries with higher interest rates or expected changes in exchange rates
what could a country do to fix the exchange rate in relation to another currency
lower interest rates (hot money leaves)
Buy the other country’s currency
limit the other country’s investment into their country to lower demand for their currency
4 measures of exchange rates
bilateral exchange rates
effective exchange rates
nominal exchange rates
the real exchange rate
what is the bilateral exchange rate
measuring 1 currency against 1 other
what is the effective exchange rate
describes the strength of a currency relative to a basket of other currencies
what is the nominal exchange rate
the number of units of the domestic currency that are needed to purchase a unit of a given foreign currency
what is the real exchange rate
tells you how much the goods and services in the domestic currency can be exchanged for the goods and services in a foreign country
what is the purchasing power parity
in the long run, exchange rates between countries should even out so that goods essentially cost the same in both countries
what are the 3 exchange rate systems
freely floating
fixed exchange rate
a hybrid system
what is a freely floating exchange rate system
the exchange rates move freely and are solely determined by changing supply and demand for the currency
what is a fixed exchange rate system
the government or the central bank sets the exchange rate- involves maintaining the rate at a set target
what are the hybrid exchange rate systems
managed floating
semi-fixed
pegged
what is a managed floating exchange rate system
floating system, but the government occasionally intervenes to influence the rate
what is a semi-fixed exchange rate system
more like fixed, but a small degree of float is allowed between an upper and lower band of the currency
what is a pegged exchange rate system
the value of a currency is pegged to another currency, (euro or US$)
what happens if equilibrium is above the fixed rate- a shortage of the national currency
Gov would intervene: sell their own currency and buy overseas currencies instead- shifting supply curve right, and foreign currency holdings will rise
what happens if the equilibrium is below the fixed rate- a surplus of the national currency
Gov buys their own currency by selling foreign currency reserves- this boosts demand for their own currency shifting D right
