Exchange rates

Question 1

Definition of exchange rates

Answer 1

An exchange rate is the price of one currency in relation to another

Question 2

What are the different exchange rates?

Answer 2

floating , fixed and managed

Question 3

What are floating exchange rates?

Answer 3

value of currency is determined by market forces of demand and supply for currency

Question 4

What are fixed exchange rates?

Answer 4

fixed by central banks against another currency (large foreign reserves have to be held)

Question 5

What are managed exchange rates?

Answer 5

Same as floating but subject to government intervention

Question 6

What is appreciation?

Answer 6

Increase value in currency due to higher demand for currency

Question 7

What is revaluation?

Answer 7

adjustment of the value of a currency in relation to other currencies.

Question 8

What is depreciation?

Answer 8

a decrease in value for currency due to a decrease in demand

Question 9

What is devaluation?

Answer 9

value of currency decreasing under fixed exchange rate

Question 10

How can government intervene to change value of currency?

Answer 10

change interest rates/ encourage investment

Buy its own currency to increase its own value

Question 11

What is the role of financial markets

Answer 11

Financial markets facilitate the buying and selling of financial assets

Question 12

What are factors affecting fiscal deficits?

Answer 12

GDP, size and population, unexpected events, discretionary fiscal policy, tax avoidance/evasion

Question 13

What is the definition of automatic stabilisers?

Answer 13

Forms of government expenditure and some tax revenue that change automatically in line with GDP

Question 14

What is the difference between a cyclical and structural budget deficit?

Answer 14

-Cyclical occurs during a recession
-Structural remains when the economy is operating at normal

Question 15

What is the role of the central bank?

Answer 15

Controls monetary policy, bank to the government , bank to other banks, regulate financial system

Question 16

What is the purpose of financial markets?

Answer 16

To bring lenders and borrows together

Question 17

What are the types of lenders?

Answer 17

Savers, investors

Question 18

What are borrowers?

Answer 18

Individuals , firms and governments

Question 19

What are example of intermediaries in financial markets?

Answer 19

Investment banks , commercial banks , Pension funds, hedge funds

Question 20

How do lenders make money in financial markets?

Answer 20

Offer low return, high interest rate

Question 21

What are the different types of financial markets?

Answer 21

Capital , money, currency

Question 22

What is capital markets?

Answer 22

Governments and firms use capital markets to borrow and lend long term (Longer than 12 months)

Question 23

What are money markets?

Answer 23

Used by firms and markets to borrow and lend short term

Question 24

What are currency markets?

Answer 24

Currency markets, also known as foreign exchange or forex markets, are global decentralized markets where currencies are bought and sold.

Question 25

What is the role of the central bank?

Answer 25

Implementation of monetary policy, banker to the government , acts as a banker to the banks , regulation in the banking industry

Question 26

Why may a currency appreciate in value?

Answer 26

Due to increased demand ( or a decrease in supply)

Question 27

Why may a currency depreciate in value?

Answer 27

Due to decreased demand (or increase in supply)

Question 28

Why may demand for a currency increase?

Answer 28

-Increased relative (to the world) interest rates -Speculators -Increased FDI -Rise in incomes abroad -Increase in competitiveness (for exports)

Question 29

Why may demand for a currency decrease?

Answer 29

-Lower interest rates -Speculators moving away -Firms moving away -Increase in income domestically

Question 30

What is the difference between devaluation , revaluation , depreciation , appreciation?

Answer 30

Market-driven = depreciation/appreciation Government-driven = devaluation/revaluation

Question 31

What are the positives of a floating exchange rate?

Answer 31

reduced need for currency reserves freedom for domestic monetary policy (adjustment of interest rates/exchange rates) useful instrument for macroeconomic adjustment (depreciation => growth) can correct current account deficit

Question 32

Negatives of floating exchange rates?

Answer 32

-volatile (reduced FDI=> reduced trade benefits) -self correction of trade deficits unlikely (speculative factors affect value more) -inflation (depreciation leads to higher import costs)

Question 33

Benefits of fixed exchange rate?

Answer 33

-lower exchange rate uncertainty (FDI/trade) -some flexibility permitted (devaluation/revaluation) -reductions in the cost of trade -discipline on domestic producers (increase efficiency to remain competitive)

Question 34

What are the negatives of fixed exchange rates?

Answer 34

-Loss of monetary policy independence (no freedom to adjust interest rates) -vulnerability to speculation -requires large foreign currency reserves

Question 35

What are the effects of currency appreciation?

Answer 35

SPICED

Question 36

What are the negative effects of of a currency appreciation?

Answer 36

Lower growth - potential current account deficit Higher unemployment in export industries/domestic (cheaper imports)

Question 37

What are the positive effects of currency appreciation?

Answer 37

Lower inflation Cheaper imports Potential efficiency gains for domestic industries (to compete with foreign firms)

Question 38

What are the effects of a currency depreciation?

Answer 38

WPIDEC

Question 39

What are the positive effects of a currency depreciation?

Answer 39

Increase employment in export/domestic industries Higher inflation

Question 40

What is the Marshall learner effect?

Answer 40

The Marshall–Lerner effect states that a currency depreciation will only improve a country's trade balance if the sum of the price elasticities of exports and imports is greater than one. PEDx+PEDm>1

Question 41

What does the J curve show?

Answer 41

The J curve describes what happens to a country's trade balance after a currency depreciation: Short term: The trade balance gets worse (imports cost more, export volumes don’t rise yet). Long term: The trade balance improves as export volumes increase and import demand drops.