exchange rates Flashcards
(26 cards)
what is an exchange rate
the exchange rate is the rate at which on currency trades against another on the foreign exchange market
factors affecting demand and supply for exchange rates (2)
exchange rates will fall if there is a fall in demand or a rise in supply
exchange rates will rise if there is a rise in demand or fall in supply
interest rates effect on exchange rates (2)
is UK interest rates rise relative to elsewhere it will become more attractive to deposit money in the UK and demand for sterling will rise leading to hot money inflows
a lower interest rate causes a fall and results in hot money outflows
effects of inflation on exchange rates (3)
if inflation is lower than elsewhere then UK exports will become more competitive and there will be an increase in demand for the pound to buy UK goods
foreign goods will be less competitive and so UK citizens will buy less imports
countries with low inflation rates tend to see and appreciation in the value of their currency
effects of speculation on exchange rates
if speculators believe the pound willi rise in future they willi demand more now to be able to make profit this increase demand and will cause it to rise
effect of imports and exports on exchange rates (2)
an increase in demand for UK goods and services abroad will increase demand for £
an increase in demand for foreign goods and services will increase the supply of pound sterling
effect of tourism on exchange rates (2)
an increase in tourism will increase demand for the £
a increase in UK citizens travelling abroad willi increase supply of £
effects of rising exchange rate on balance of payment (3)
if exporters raise prices then demand will fall however this demand on price elasticity, if inelastic then earnings will rise
if imports fall in price and UK demand is inelastic then total payments for imports will fall
a combination of elastic demand for exports and elastic demand for imports would worsen the balance of trade
how are exchange rates determined
on the foreign exchange market by demand and supply forces
how is the demand for sterling determined (3)
- demand from foreign earners who wish to buy British goods and services
- demand from foreign companies wishing to invest in the UK
- demand from speculators, foreign companies and governments wishing to hold surplus funds in sterling
how is the supply of sterling determined (3)
- supply of £ from UK firms converting into foreign currencies in order to buy foreign goods and services
- supply of £ from UK firms converting into foreign currencies to invest overseas
- supply o f£ from speculators and companies wishing to hold a surplus funds in foreign currencies
main factors that influence exchange rates (8)
- inflation: if its lower than elsewhere UK exports will be more competitive
- interest rates: if they are high people will wish to deposit money in the UK so £ rises
- speculation: if speculators believe the £ will rise then it increases demand and it will rise
- change in competitiveness: British goods are more competitive then £ will rise
- relative strength of other currencies: if other countries are at risk then UK is more stable
- balance of payments: deficit means import is greater than exports leading to depreciation
- government debt: investors sell bonds so £ falls
- economic growth/recession
what are floating exchange rates (2)
when there is a free market with no government intervention and the exchange reate is allowed to find its equilibrium level
the exchange rate willi alter if there is a change in either demand or supply of sterling
how does a currency depreciate in value (5)
price of exports fall so more exports
price of imports rises so less imports
higher inflation due to higher import prices
higher growth due to improved balance of trade
more hot money outflow
how does a currency appreciate in value (5)
price of export rises so less exports
price of imports falls so more imports
low inflation due to low imports prices
low growth due to poor balance of trade
more hot money inflows
what are fixed exchange rates
when the exchange rate with another country stays the same with the government ensuring this happens
advantages of fixed exchange rates (3)
- promotes international trade as there is more certainty over the exchange rate
- could help to keep inflation stable: no fluctuations in imported raw material prices
- currency less vulnerable to speculation
disadvantages of fixed exchange rates (3)
- unable to set interest rates freely as must adjust them to keep exchange rate fixed
- government need to hold large reserves of gold and foreign currency which is expensive
- the rate which is fixed may be inappropriate and cause trade deficit, less growth and more unemployment
advantages of floating exchange rates (3)
- balance of trade can be helped since currency can freely fall which helps increase employment
- no need to hold lots of foreign currency reserves
- control over interest rates and monetary policy for other economic objectives like controlling inflation
disadvantages of floating exchange rates (2)
- currency fluctuations cause uncertainty for international trade and business and encourages speculation
- possibility of protectionist measures and trade barriers being used to correct exchange rate movements
what is managed exchange rate (dirty float)
these allow a currency to float but within specified limits. when currency nears the upper or lower limit the government intervenes
impact of a weak exchange rate on the UK firms (5)
UK exports will appear relatively cheap which will increase to quantity sold therefore UK firms will find the value of their profits have increased
Uk firms should see a rise in domestic/sales demands as foreign goods become more expensive for UK citizens/UK goods become more compensative in the domestic market
UK firms who earn profits aboard will find the value of their profits have increased
Foreign investors will find it cheaper to invest in UK firms which may help them expand.
Foreign tourists will gain more £s for their currency so UK firms in particular sectors e.g. tourism and transport may see a boost to business.
impact of a strong exchange rate on firms (6)
- reduced competitiveness so less exports. market share may be lost to foreign firms
- imports are cheaper which can be passed down as lower prices
- energy and fuel costs are reduced
- foreign FDI is cheaper meaning more firms will relocate
- easier to pay off debts
- reduced tourism can impact firms who are based on tourism attractions
effect of rising exchange rates on the current account (3)
- goods and services become more expensive for foreign buyers which reduces competitiveness of products leading to less exports
- strong currency makes foreign goods and services cheaper for domestic consumers and business leading to an increase in import volumes
- reduced exports and increased imports worsens the trade balance
