chapter 38- foreign exchange systems

Question 1

Define appreciation of currency

Answer 1

appreciation of a currency occurs when there is an increase in its value relative, to another currency operating in a floating exchange rate system

Question 2

Define depreciation of currency

Answer 2

depreciation of a currency occurs when there is a fall in its value relative to another currency operating in a floating exchange rate system

Question 3

Define floating exchange rate systems

Answer 3

means that the currency is allowed to fluctuate against other currencies according to market forces, without any government intervention

Question 4

Define fixed exchange rate systems

Answer 4

exist when the central bank or any monetary authority buys and sells foreign currencies to ensure that the value of its currency stays at the pegged value.

Question 5

Benefit of fixed exchange rate

Answer 5

it reduces uncertainties for international trade, allowing firms(both foreign and domestic), to be certain about future costs and prices, thereby encouraging international trade and exchange

Question 6

Limitations of fixed exchange rate

Answer 6

1 reduces the country’s ability to use monetary policies to affect the economy which is necessary in times of recession
2 huge opportunity cost in using large amounts of foreign exchange reserves to maintain the fixed rate

Question 7

Define revaluation

Answer 7

a revaluation occurs when the price of a currency operating in a fixed exchange rate system is officially and deliberately increased

Question 8

Dealing with high exchange rates

Answer 8

1 cutting export prices and accepting low profit margins
2 focus on non-price factors
3 focus on supplying price inelastic goods
4 if trading partners have high exchange rates, firms can look for alternative suppliers
5 relocate to other locations where operations are less exposed to exchange rate fluctuations