Chapter 7- Exchange rates Flashcards
(28 cards)
Why is there a need for foreign exchange?
Foreign currency cannot be used for domestic transactions.Hence if we are buying (importing) goods from other countries, we need to pay in their currency; the opposite is true when other countries are buying from us
Define the foreign exchange market.
the system through which a nation’s currency is exchanged for the currency of another.
Why is the foreign exchange market defined as a system?
It’s defined as a system because it does not have a specific location but rather consists of communications of networks that operate 24 hours a day.
Why is the foreign exchange market defined as a system?
It’s defined as a system because it does not have a specific location but rather consists of communications of networks that operate 24 hours a day.
What is an exchange rate?
It is a relative price that indicates the price of one currency in terms of another currency.
What is an increase in the value of a currency in terms of another?
Appreciation, also known as revaluation of currency.
What is an decrease in the value of a currency in terms of another?
Depreciation, also known as devaluation of currency.
What does the bilateral nature of exchange rates imply?
It implies that exchange rates can be quoted in two ways; as direct or indirect quotations.
How are direct quotations used to quote exchange rates?
It expresses the value of the foreign currency in terms of the domestic currency. For example US$1= R9.81
How are indirect quotations used to quote exchange rates?
The indirect quotation would show the value rand in terms of the US dollar. For example, R1= US$0.1013
What is the difference between the fixed and floating exchange rate system?
In a fixed exchange rate system, the exchange rate can be kept unchanged. In a floating exchange rate system, it can be allowed to change in accordance with the demand for and supply of a currency.
How does the fixed rate exchange system work?
The central bank of a country is required to undertake transactions in the foreign exchange market to keep the exchange rate a specific level, or within prescribed limits. In this system, a country can devalue its currency if it raises it’s rate if the rates are quoted directly.
What are the 2 foreign exchange sub-markets?
- Spot Market
- Forward Market
How does the spot market work?
-Transactions are concluded for immediate delivery, usually in 2 days.
-Spot exchange rates differs with the size of transaction
*Individuals & business =less favorable rates
*Big businesses & banks=more favorable rates =larger transactions
How does the forward market work?
– transactions are concluded for delivery on a stipulated future date which is further away than two days
- Purpose is to fix the price of a foreign currency at current levels to avoid exchange risk
What are nominal exchange rates?
They are the actual rates charged in foreign exchange dealings. They do not indicate whether it is cheaper or more expensive to purchase goods abroad or domestically.
What are real exchange rates used for?
To show the price difference between two commodities, however it indicates nothing about the quality of the products
What are effective exchange rates?
-An index that describes the strength of a currency relative to a basket of other currencies.
- Tells us whether the relative value of a currency is stronger or weaker
Analyze the demand for foreign exchange.
The demand for a particular currency is largely a derived demand. In other words, the currency is needed for purchase of goods, services or assets, and to make current or capital transfers.
Distinguish between direct and Indirect demand.
If for example, the demand for imports from the USA increases, there will be an indirect increase in demand for dollars because the dollars are demanded for the purchase of goods. Direct demand is for those involved in currency trading.
Explain the relationship between the exchange rate of two currencies and the quantity demanded for a particular currency.
This relationship is illustrated in figure 7.2. In this figure, the demand for US dollars declines when the rand appreciates. In other words, fewer rands are needed to purchase the same quantity of US dollars. Conversely, a depreciation of the rand against the US dollar results in a greater demand for the US dollar. The demand curve slopes downwards, only if the direct method of quoting the currency is used.
Explain the relationship between the exchange rate of two currencies and the quantity supplied for a particular currency.
Again using figure 7.2, The supply of US dollars will rise as the rand appreciates against the US dollar. The supply of foreign exchange depends on the value of goods and services and assets sold to the rest of the world.
Define the market clearing rate.
Where the total quantity of the demand for the currency is equal to the total quantity of currency supplied= equilibrium exchange rate.
List the Factors that could cause an increase in the SA demand for foreign currency.
-Increase in GDP
-Increase in demand
-Improved quality of foreign goods
-Perceived domestic political threat
-Increased interest rate differential between foreign & domestic assets
-Expected depreciation of the rand
-Expected economic downturn in economic activity
THESE ARE THE SAME FACTORS THAT COULD INFLUENCE THE SUPPLY OF FOREIGN CURRENCY!!!!
