4.1.8 - Exchange rates Flashcards
What’s an exchange rate?
he exchange rate is the rate at which one currency trades against another.
What’s a floating exchange rate?
Demand and supply determine the exchange rate between currencies (GBP to USD).
What’s a Fixed Exchange Rate?
The value between two currencies remains at a static level over time (USD to Saudi Riyal). The monetary authority ties its official exchange rate to another nation’s currency but it doesn’t mean that it will be fixed all the time.
What’s a managed exchanged rate?
Allows central bank to intervene (buying and selling currency) in FX markets in order to change the direction of the currency (to minimise fluctuations and keep the currency close to its target)
What’s a managed exchanged rate?
Allows central bank to intervene (buying and selling currency) in FX markets in order to change the direction of the currency (to minimise fluctuations and keep the currency close to its target)
Name 2 methods on how the exchange rates can be measured
- Real exchange rate
- Bi-lateral exchange rate
- Spot exchange rate
- Forward exchange rate
- Trade weight index
What’s the spot exchange rate?
Exchange rate for transactions that took place immediately.
What is the bilateral exchange rate?
Rate at which one currency can be traded against another.
Example:
include £/$ (1GBP = 1.23 Dollar as of Jan 2023)
Name 2 factors that influence exchange rates
- Relative interest rates
- Relative inflation rates
- Current account deficit/surplus
- Speculation
What’s a current account deficit?
When
Imports > Exports
What’s a current account surplus?
When
Imports < Exports
Why do relative inflation rates affect the exchange rate?
If inflation is lower in the UK than anywhere else, UK exports become more competitive (cheaper) which means an increase in demand for the £ to buy UK goods.
How does speculation affect the exchange rate?
If people speculate that the value of £ will fall, they will sell their £ for another currency with a higher value. As demand for £ decreases, it depreciates leading to a self-fulfilling prophecy.
What’s the exchange rate mechanism (ERM) ?
A system introduced by the European Economic Community to reduce exchange rate variability and achieve monetary stability in Europe.
When was the UK part of the ERM?
1990
