Foreign Exchange Rates Flashcards
What is an exchange rate?
An exchange rate is the price of one currency in terms of another.
Define the term foreign exchange market (forex).
The foreign exchange market (forex) is where international currencies are bought and sold.
True or False? The central bank controls the exchange rate system of a country.
True.
What is a floating exchange rate system?
A floating exchange rate system occurs when the forces of demand and supply determine the rate at which one currency exchanges for another.
How does appreciation occur in a floating exchange rate system?
In a floating exchange rate system, if there is excess demand for the currency on the forex market, the currency appreciates.
Define the term currency depreciation.
Currency depreciation occurs when there is an excess supply of the currency on the forex market, causing its price to fall.
What is a fixed exchange rate system?
A fixed exchange rate system is where the country’s central bank intervenes in the currency market to fix (peg) the exchange rate in relation to another currency.
How can a central bank influence exchange rates in a fixed system ?
In a fixed exchange rate system, the central bank buys its currency to increase its demand (an appreciation) or sells its currency to increase its supply (a depreciation).
State the meaning of parity.
Parity refers to when the peg is set at an equal value between two currencies, e.g., 1 Brunei Dollar = 1 Singapore Dollar.
What is a revaluation?
A revaluation occurs if the central bank decides to change the peg in a fixed exchange rate system and increase the strength of its currency.
Define the term devaluation.
A devaluation occurs if the central bank decides to change the peg in a fixed exchange rate system and decrease the strength of its currency.
How do relative interest rates influence exchange rates ?
If a country increases its interest rate, demand for its currency by foreign investors increases, causing the currency to appreciate. If the interest rate decreases, the supply of the currency increases, causing it to depreciate.
What is the impact of relative inflation rates on exchange rates?
As inflation in a country rises relative to others, its exports become more expensive, decreasing demand for its currency and causing it to depreciate.
How does foreign direct investment (FDI) impact exchange rates?
Foreign direct investment (FDI) into a country creates a demand for its currency, leading to appreciation.
FDI by the country’s firms abroad creates a supply of its currency, leading to depreciation.
How does the current account influence exchange rates?
An increase in net exports in a country results in an appreciation of its currency, while falling net exports result in a depreciation.
State the meaning of speculation.
Speculation occurs when traders buy a currency in the expectation that it will be worth more in the short to medium term, at which point they will sell it to realise a profit.
How do MNCs influence exchange rates?
An increase in the number of MNCs globally results in more money flows between countries, each of which influences exchange rates.
What is the impact of exchange rate changes on the current account?
A depreciation of the currency causes exports to be cheaper for foreigners and imports to be more expensive. This potentially improves the current account balance (depending on the price elasticity of demand for exports and imports).
How do exchange rate changes affect economic growth?
A depreciation that results in an increase in net exports will lead to economic growth, while an appreciation will have the opposite effect.
What is the impact of exchange rate changes on unemployment?
If depreciation leads to an increase in exports, unemployment is likely to fall as more workers are required to produce the additional products demanded.
An appreciation of the currency will have the opposite effect.
