Exchange Rates

Question 1

What’s the definition of an exchange rate

Answer 1

The values of one countries currency in terms of another. It’s a measure of relative purchasing power.

Question 2

what is the foreign exchange market?

Answer 2

• The foreign exchange market (forex, FX or currency market) is a global, worldwide decentralized over the counter financial market for trading currencies
• The purpose of the foreign exchange market is to assist international trade and investment.
• It also supports speculation
• The foreign exchange market is unique because of liquidity
• Its geographical dispersion
• Its continuous operation: 24 hours a day except weekends
• The variety of factors that affect exchange rates

Question 3

what can cause an appreciation of the AUD?

Answer 3

an increase in demand or a decrease in supply

Question 4

A depreciation of the AUD can be cause by:

Answer 4

a decrease in demand or an increase in supply

Question 5

Factors currently having the biggest effect in terms of downwards pressure on the dollar

Answer 5

1. ) USA strong recovery
2. ) Interest rate differentials narrow
3. ) Slow down in China

Question 6

Factors currently having the biggest effect in terms of upwards pressure supporting the Australian dollar.

Answer 6

1. ) Rebound in commodity prices
2. ) Rise in ToT
3. ) Sales of government bonds o/s
4. ) Chinese Investment in real estate

Question 7

Factors affecting the exchange rate

Answer 7

World growth

domestic growth

relative interest rates

Terms of Trade

commodity prices

Relative infltion

RBA/by/sell currency
speculators.

sale of government bonds

Question 8

The effect of a depreciation of the AUD

Answer 8

Short run:
• Lower export income (primarily inelastic exports)
• Higher import expense (primarily inelastic imports)
• Deterioration in the balance of goods and services
• CAD deteriorates commencement of J curve effect

Long Run:
• Improved international competitiveness in both export markets and against foreign imports in domestic markets
• This can in the long run improve the CAD as new export customers are sourced and import replacement industries develop – improves local profits and employment rate.

Other effects
• Higher inflation – imported inflation
• Revaluation of foreign debt denominated in foreign currencies upward (60% of Australia’s foreign debt is denominated in foreign currencies)
• Revaluation of interest repayments on foreign currency denominated debt upwards – impacts on size of the CAD
• Raises debt servicing ratio
• Impacts positively on industries that earn the majority of their income overseas – Billabong, Aristocrat leisure. Revenue is revised up on currency effects.
• Makes Australian assets cheaper for foreigners to buy companies, shares, and mining assets are cheaper. FDI and portfolio investment may increase. This can be positive or negative.
• On the other hand, foreign assets are more expensive to buy. This is

Question 9

The effect of the exchange rate on the Balance of Payments

Answer 9

• A floating exchange rate in a free market has the advantage of providing automatic adjustment in the balance of payments
• The exchange rate varies to change the prices of goods, services and assets.
• A free exchange rate helps to reduce swings in the current account balance.

Question 10

Definition of the trade weighted index (TWI)

Answer 10

The Trade Weighted Index (TWI) measures movements on the value of the $A against a weighted basket of the currencies our major trading partners.

Question 11

Reasons for the TWI to rise include:

Answer 11

• Australian being seen as a good place to invest at a time of world uncertainty
• Higher Australian interest rates compared with our trading partners, which encourages foreign investment into Australia
• An improvement in Australia’s trade performance through growth in commodity demand, especially mineral resources.