The Global Context

Question 1

What is an exchange rate ?

Answer 1

The price of one currency in terms of another

Question 2

Name the causes of exchange rates? (4)

Answer 2

• trade balance
• inward FDI
• interest rate
• speculation

Question 3

How does a trade balance cause the exchange rate to change?

Answer 3

Increased demand for UK exports means that the demand for UK pounds also increases. As to buy imports you have to supply currency in exchange for the other currency.

Question 4

How does a inward FDI cause the exchange rate to change?

Answer 4

• Attracting FDI means that they must exchange to the currency of that country to build or invest in that country.
  This increases the demand for that country’s currency

Question 5

How does the interest rate cause the exchange rate to change?

Answer 5

• interest rates are the cost of borrowing and the reward for saving.
  So if interest rates increases foreigners may choose to save their money in pounds to get a higher return. If the interest rates are higher than in other countries. So the demand for currency increases.
  This is called hot money flows

Question 6

How does speculation cause the exchange rate to change?

Answer 6

• if the pound is of a low value but an external event occurs to appreciate the pound then people will buy up the pound on foreign exchange markets.
• when the pound appreciates then they will sell.

E.g. pound may depreciate because of Brexit. So people are not buying the pound reducing its value.