Exchange rates

Question 1

What is an exchange rate?

Answer 1

the price of one currency in terms of another

Question 2

What are fixed and floating exchange rates?

Answer 2

Fixed/pegged Exchange rate= where a currency’s value is fixed against the value of another currency/ currencies

Floating exchange rates= where the value of the currency is solely determined by supply and demand. No target exchange rate.

Question 3

What happens when demand for a currency increases, or when supply of a currency increases??

Answer 3

If demand increases, price increases

If supply increases (Ceteris Parabus) then price falls

Question 4

How do governments keep fixed exchange rates

Answer 4

The central bank buys or sells their currency depending on the pressure to raise or lower the value.

Question 5

What factors determine the demand for currency?

Answer 5

• The demand for exports of goods and services
• Inflows of investment into a country
• speculative buying of the currency (hot money)
• central bank buying up their own currency

Question 6

What factors determine the supply for currency??

Answer 6

• The demand for imports of goods and services
• outflows of investment into a country
• speculative selling of the currency
• central bank selling their own currency

Question 7

What is the link between exchange rates and interest rates?

Answer 7

Exchange rates follow interest rates (hot money), if interests rates rise, speculators will buy a countries currency if their interest rates are high because their money will be worth more.

Question 8

Positives and negatives of fixed exchange rates

Answer 8

Positives- provide greater certainty for exporters and importers and there is normally less speculative activity. Help keep costs under control and maintain low inflation.

Negatives- can be fragile and prone to attacks, they take away the natural stabilisers of economic activity, the exchanges rates.