Unit 7 Foreign Exchange

Foreign Exchange

Foreign Exchange:

·         
Buying and selling of currency

·         Any transactions that occurs in the balance of payments necessitates foreign exchange

·         Exchange Rate (e) is determined in the foreign currency markets

Changes in Exchange Rates:

Exchange rates (e) are a function of supply and demand for currency

- an increase in the supply of a currency

- a decrease in supply of a currency will increase the exchange rate of currency

- increase in demand for currency will increase the exchange rate of currency

- decrease in demand for a currency will decrease the exchange rate of currency

Appreciation and Depreciation:

·         Appreciation of currency occurs when exchange rate of that currency increases (e^)

·         Depreciation of a currency occurs when the exchange rate of that currency decreases

Exchange Rate Determinants:

Consumer tastes

Relative income

Relative price level

Speculation

Exports and Imports:

·         Exchange rate is a determinant of both exports and imports

·         Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper, thus reducing exports and increasing imports

·         Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports

Floating/ Flexible Rates:

Depends upon supply and demand of that currency vs. other currencies

Very sensitive to business cycle / provide options for investments

Fixed Rates:

Based on a country's willingness to distribute currency and to control the amount

As two currencies trade:

1.    

One supply line will ∆, the other demand line will ∆.

2.    They will move in the same direction

3.    One currency will appreciate, the other will depreciate