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Macro Economics > Foreign Exchange Rate > Flashcards

Foreign Exchange Rate Flashcards

1
Q

What is foreign exchange?

A

All other currencies other than domestic currency of a given country

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2
Q

What is foreign exchange rate?

A

rate at which one currency is exchanged for another

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3
Q

What is currency depreciation?

A

fall in value of domestic currency in terms of foreign currency

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4
Q

What happens with currency depreciation?

A

domestic currency is less valuable
exports increase
imports decrease

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5
Q

What is currency appreciation?

A

increase in value of domestic currency in terms of foreign currency

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6
Q

What happens with currency appreciation?

A

domestic currency is more valuable
exports decrease
imports increase

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7
Q

What are the types of FER?

A

fixed exchange rate system
flexible exchange rate system
managed floating rate system

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8
Q

What is fixed exchange rate system?

A

system in which exchange rate for a currency is fixed by the govt

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9
Q

What is the basic purpose of adopting fixed exchange rate system?

A

to ensure stability in foreign trade and capital movts

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10
Q

How is stability achieved in fixed exchange rate system?

A

govt buys foreign exchange when exchange rate becomes weaker and sells foreign exhchange when exchange rate becomes stronger
govt maintains large reserves

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11
Q

What is “external standard”?

A

gold (1870-1914)

dollar (1944-1971)

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12
Q

What is pegging?

A

when value of domestic currency is tied to value of another currency

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13
Q

What is parity value of currency?

A

when value of domestic currency is fixed in terms of other currency or gold

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14
Q

Explain gold standard

A
  • external values of all currencies maintained by fixing their prices in terms of gold
  • central bank was ready to buy and sell unlimited quantities of gold at a fixed price
  • 1870-1914
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15
Q

Explain bretton woods standard

A
  • us dollar - core of the system
  • all currencies pegged to $ at a fixed exchange rate
  • IMF - central institution of international monetary system
  • 1944-1971
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16
Q

What is devaluation?

A

fall in value of domestic currency by the govt

increase in exchange rate by the govt under fixed exchange rate system

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17
Q

What is revaluation?

A

rise in value of domestic currency by the govt

decrease in exchange rate by govt under fixed exchange rate system

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18
Q

What is flexible exchange rate system?

floating exchange rate

A

system where exchange rate is determined by forces of dd and ss of different currencies in foreign exchange rate market

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19
Q

What is managed floating rate system?

dirty floating

A

system in which exchange rate is determined by market forces and central bank influences the exchange rate through intervention in the foreign exchange market

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20
Q

How does dirty floating work?

A

central bank intervenes in foreign exchange market to restrict fluctuations in the exchange rate within certain limits
aim - keep exchange rate close to desired target values

21
Q

How is fluctuations dealt with in the managed floating system if the value of domestic currency falls below the limit?

A

if there is excess demand for domestic currency, the value of the currency falls below the limit, so the central bank increases supply of rupees by selling rupees for dollars and acquiring holdings of dollars.

22
Q

How is fluctuations dealt with in the managed floating system if the value of domestic currency rises above the limit?

A

if there’s excess supply for domestic currency, the value of the currency rises above the limit, so the central bank buys more holdings of rupees, increases demand and sells dollars in the market.

23
Q

Demand or outflow is demanded for ____

eg: exchanging rupees for euros

A

1) import of goods and services
2) tourism abroad
3) unilateral transfers sent abroad
4) purchase of assets in foreign countries
5) speculation

24
Q

What is speculation?

A

speculating and making gains from appreciation/depreciation of currency

25
Q

Why is there a rise in demand for foreign currency?

A
  • if price of foreign currency falls, imports from that country will be cheaper so dd for foreign currency will increase
  • if price of foreign currency falls, tourism to that country will be promoted, so dd rises
  • if price of a foreign currency falls, dd rises as more people want to make gains from speculative activities
26
Q

What are the characteristics of dd curve of foreign exchange?

A

y-axis is rate of foreign exchange
x-axis is demand for foreign exchange
it is a negative sloping line because of the inverse relationship btwn demand for foreign exchange and rate of foreign exchange
low rate of foreign exchange = higher demand

27
Q

What are the characteristics of supply curve of foreign exchange?

A

y-axis is rate of foreign exchange
x-axis is demand for foreign exchange
it is a positive sloping line because of the direct relationship btwn demand for foreign exchange and rate of foreign exchange
high rate of exchange = higher supply

28
Q

Supply or inflow of foreign exchange is demanded by ______

A

1) export of goods and services
2) foreign investment
3) remittances (universal transfers) from abroad
4) speculation

29
Q

Why is there a rise in supply for foreign currency?

A
  • if price of foreign currency rises, exports from domestic country to foreign country will be cheaper so ss for foreign currency will increase
  • if price of foreign currency rises, supply will increase as people want to make gains from speculative activities
30
Q

Where is the equilibrium exchange rate is determined?

A

it is determined at a level where demand of foreign exchange and supply of foreign exchange is equal

31
Q

Flexible exchange rate is also known as __________

A

free exchange rate

32
Q

What is the shift of demand curve in the dd and ss diagram when there is an increase in demand?

A

shift to the right
excess demand
domestic currency depreciation (price of $ increases)

33
Q

What is the shift of demand curve in the dd and ss diagram when there is an decrease in demand?

A

shift to the left
deficit demand
domestic currency appreciation (price of $ decreases)

34
Q

What is the shift of supply curve in the dd and ss diagram when there is an increase in supply?

A

shift to the right
excess supply
domestic currency appreciation (price of $ decreases)

35
Q

What is the shift of supply curve in the dd and ss diagram when there is an decrease in supply?

A

shift to the left
deficit supply
domestic currency depreciation (price of $ increases)

36
Q

What is foreign exchange market?

A

market in which foreign currencies are bought and sold

37
Q

A large no. of foreign currencies are ____, _____ and _____ in the foreign exchange market

A

traded, converted and exchanged

38
Q

What are the functions of foreign exchange market?

A

credit function
hedging function
transfer function

39
Q

What is transfer function?

A

it is the function of transferring of purchasing power btwn the countries involved in the transaction

40
Q

What is credit function?

A

it is the function of providing credit for foreign trade like bills of exchange

41
Q

What is hedging function?

A

hedging is when exporters and importers agree to sell and buy goods or services on a later date at the current prices and rates of exchange

42
Q

What is the purpose of hedging?

A

to avoid losses that might be caused due to exchange rate variations

43
Q

What are the kinds of foreign exchange market?

A

spot market

forward market

44
Q

What is spot market?

A

it refers to the market in which the receipts and payments are made immediately
(2 business days)
daily nature
deals only in spot transactions

45
Q

What is the rate of exchange called in a spot market?

A

spot exchange rate/current exchange rate

46
Q

What is forward market?

A

it refers to the market in which sale and purchase of foreign currency is settled on a specific future date at a rate agreed upon today

47
Q

What is the purpose of forward market?

A
  • to minimise the risk of loss due to adverse changes in the exchange rate (through hedging)
  • to make profit (through speculation)
48
Q

What is the rate of exchange called in a forward market?

A

forward exchange rate

Macro Economics (3 decks)

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