Exchange rates and the balance of payments Flashcards
Why do countries trade?
One of the primary reasons that countries trade is because factors of production are not evenly distributed amongst countries. ie, South Africa has large reserves of platinum and but no wool, conversely, Malaysia has large quantities of wool but no platinum, thus it makes sense for the two countries to engage in trade with one another.
What is the foreign exchange market?
The foreign exchange market is the market in which the currency of one country is exchanged for the currency of another.
How would one go about purchasing goods or services from another country?
On would sell rands on the foreign exchange market for the currency of whatever country said goods/services will be originating from and then purchase the goods in that specific currency.
What is exchange rate?
The change rate is the rate at which one currency is exchanged for another.
What is appreciation?
Appreciation is the increase in value or price of one currency in comparison to another, this implies the depreciation of the other currency.
What is depreciation?
Depreciation is the decrease in value or price of one currency in comparison to another and this implies the appreciation of the other currency.
what is the direct method?
The direct methods provides how much local currency (rands) has to be exchanged for one unit of foreign currency (dollars). ie R10=1$.
What is the indirect method?
The indirect method provides how much foreign currency (dollars) has to be exchanged for one unit of local currency (rands). ie $0.10 = R1
Name and explain four types of exchange rate regimes.
Fixed Regime - This is a where the government fixes the exchange rate and maintains it with different policies.
Flexible or floating regime - This is where the exchange rate is determined by the market forces of supply and demand.
Adjustable peg - Monetary authorities attempt to maintain par values for their exchange rate but accept the fact that circumstances will arise in which they may need to adjust it.
Managed float - Monetary authorities seek to have a stabilising affect on the exchange rate but without trying to fix it at some publicly announced value.
What causes a flexible exchange rate to move?
Changes in the supply and demand for that specific currency on the exchange market. let us use the rand for example;
Appreciation of the rand (depreciation of the dollar) caused by an increase in the demand for rands (increase in the supply of dollars) or a decrease in the supply of rands (decrease in the demand for dollars).
Conversely the exchange rate can change if the rand depreciates (the dollar appreciates). This can be caused by a decrease in the demand for rand (decrease in the supply of dollars) as well as the increase in supply of rands (increase in the demand for dollars.)
List some factors that can change demand and supply of a given currency.
Income increases in South Africa lead too a higher demand for US goods. People exchange their rands for dollars on the exchange market which increase the supply of rands, dollar appreciates and the rand depreciates.
Higher interest rates in South Africa entice American investors to invest in SA, this increases the supply of dollars on the foreign exchange market and thus the dollar depreciates and the rand appreciates.
Speculation. if the dollar value is forecasted to fall, then the demand for dollars decreases and thus the dollar depreciates and the rand appreciates.
Inflation. High inflation in SA means that US goods are relatively cheaper, because of this, the demand for US good will in crease and in accordance with the demand increase the supply of rand on the exchange market will increase, thus the rand depreciates and the dollar appreciates.
What is arbitrage
Arbitrage is the process of buying in on market and selling for a higher price in another.
What is interest rate parity?
Interest rate parity is a situation is which there are equal rates of return on investments, taking exchange rates into account.
What is purchasing power parity?
Purchasing power parity is where a basket of goods is priced the same in two countries, taking into account the exchange rates. eg, if the exchange rate is $1=R10, the a dvd worth $20 must cost R200 otherwise money in one area is worth more than money in another.
What is nominal exchange rate?
The amount of one money (currency) that another money (currency) buys.
