4.5 - Exchange rates Flashcards
(14 cards)
Define exchange rate
The price of one currency in terms of another currency set on forex markets
Free floating exchange rate
The value of a country’s currency is determined by the interaction of demand and supply in the foreign exchange markets.
Demand for a currency
Comes from firms households, government and the central bank
From overseas, it is from:
- foreign buyers of US-exported goods
- Foreign direct investment
- portfolio investment
- spectulation
Supply for a currency
- US buyers of imported goods and services
- Foreign direct investment by US into overseas
- Portfolio investment from the US to other
- Speculation
Diagram what would happen if the demand for us goods in overseas markets goes up
Define appreciation
Appreciation of an exchange rate is an increase in the value of a country’s currency against another currency.
define Depreciation
An exchange rate depreciation is a decrease in the value of a country’s currency against another currency.
Diagram what happens if us businesses invest more into overseas
How do interest rates affect exchange rate
They affect portfolio investment and speculation
Define fixed rate
A fixed exchange rate is where the value of two or more currencies has exchange rates that cannot change against each other.
Advantages of fixed rate
- encourages free trade
- help reduce inflation
- stops countries from competativly valuing to give their exporters and advantage
Disadvantage of fixed rate
- loss of monetary policy as a tool
- large gold and foreign currency reserves are needed
- countries with less efficient producers find it difficult to compete when their currency cannot depreciate
Monetary union
A monetary union system occurs when a single currency replaces individual currencies amongst a group of countries.
There is price transpareancy and no transaction costs
define managed exchange rate
A managed exchange rate means that governments will intervene intermittently through the central bank to affect the value of the currency.
