Foreign Exchange Rate

Question 1

What is foreign exchange?

Answer 1

All other currencies other than domestic currency of a given country

Question 2

What is foreign exchange rate?

Answer 2

rate at which one currency is exchanged for another

Question 3

What is currency depreciation?

Answer 3

fall in value of domestic currency in terms of foreign currency

Question 4

What happens with currency depreciation?

Answer 4

domestic currency is less valuable
exports increase
imports decrease

Question 5

What is currency appreciation?

Answer 5

increase in value of domestic currency in terms of foreign currency

Question 6

What happens with currency appreciation?

Answer 6

domestic currency is more valuable
exports decrease
imports increase

Question 7

What are the types of FER?

Answer 7

fixed exchange rate system
flexible exchange rate system
managed floating rate system

Question 8

What is fixed exchange rate system?

Answer 8

system in which exchange rate for a currency is fixed by the govt

Question 9

What is the basic purpose of adopting fixed exchange rate system?

Answer 9

to ensure stability in foreign trade and capital movts

Question 10

How is stability achieved in fixed exchange rate system?

Answer 10

govt buys foreign exchange when exchange rate becomes weaker and sells foreign exhchange when exchange rate becomes stronger
govt maintains large reserves

Question 11

What is “external standard”?

Answer 11

gold (1870-1914)

dollar (1944-1971)

Question 12

What is pegging?

Answer 12

when value of domestic currency is tied to value of another currency

Question 13

What is parity value of currency?

Answer 13

when value of domestic currency is fixed in terms of other currency or gold

Question 14

Explain gold standard

Answer 14

• external values of all currencies maintained by fixing their prices in terms of gold
• central bank was ready to buy and sell unlimited quantities of gold at a fixed price
• 1870-1914

Question 15

Explain bretton woods standard

Answer 15

• us dollar - core of the system
• all currencies pegged to $ at a fixed exchange rate
• IMF - central institution of international monetary system
• 1944-1971

Question 16

What is devaluation?

Answer 16

fall in value of domestic currency by the govt

increase in exchange rate by the govt under fixed exchange rate system

Question 17

What is revaluation?

Answer 17

rise in value of domestic currency by the govt

decrease in exchange rate by govt under fixed exchange rate system

Question 18

What is flexible exchange rate system?

floating exchange rate

Answer 18

system where exchange rate is determined by forces of dd and ss of different currencies in foreign exchange rate market

Question 19

What is managed floating rate system?

dirty floating

Answer 19

system in which exchange rate is determined by market forces and central bank influences the exchange rate through intervention in the foreign exchange market

Question 20

How does dirty floating work?

Answer 20

central bank intervenes in foreign exchange market to restrict fluctuations in the exchange rate within certain limits
aim - keep exchange rate close to desired target values

Question 21

How is fluctuations dealt with in the managed floating system if the value of domestic currency falls below the limit?

Answer 21

if there is excess demand for domestic currency, the value of the currency falls below the limit, so the central bank increases supply of rupees by selling rupees for dollars and acquiring holdings of dollars.

Question 22

How is fluctuations dealt with in the managed floating system if the value of domestic currency rises above the limit?

Answer 22

if there’s excess supply for domestic currency, the value of the currency rises above the limit, so the central bank buys more holdings of rupees, increases demand and sells dollars in the market.

Question 23

Demand or outflow is demanded for ____

eg: exchanging rupees for euros

Answer 23

1) import of goods and services
2) tourism abroad
3) unilateral transfers sent abroad
4) purchase of assets in foreign countries
5) speculation

Question 24

What is speculation?

Answer 24

speculating and making gains from appreciation/depreciation of currency

Question 25

Why is there a rise in demand for foreign currency?

Answer 25

* if price of foreign currency falls, imports from that country will be cheaper so dd for foreign currency will increase * if price of foreign currency falls, tourism to that country will be promoted, so dd rises * if price of a foreign currency falls, dd rises as more people want to make gains from speculative activities

Question 26

What are the characteristics of dd curve of foreign exchange?

Answer 26

y-axis is rate of foreign exchange x-axis is demand for foreign exchange it is a negative sloping line because of the inverse relationship btwn demand for foreign exchange and rate of foreign exchange low rate of foreign exchange = higher demand

Question 27

What are the characteristics of supply curve of foreign exchange?

Answer 27

y-axis is rate of foreign exchange x-axis is demand for foreign exchange it is a positive sloping line because of the direct relationship btwn demand for foreign exchange and rate of foreign exchange high rate of exchange = higher supply

Question 28

Supply or inflow of foreign exchange is demanded by ______

Answer 28

1) export of goods and services 2) foreign investment 3) remittances (universal transfers) from abroad 4) speculation

Question 29

Why is there a rise in supply for foreign currency?

Answer 29

* if price of foreign currency rises, exports from domestic country to foreign country will be cheaper so ss for foreign currency will increase * if price of foreign currency rises, supply will increase as people want to make gains from speculative activities

Question 30

Where is the equilibrium exchange rate is determined?

Answer 30

it is determined at a level where demand of foreign exchange and supply of foreign exchange is equal

Question 31

Flexible exchange rate is also known as __________

Answer 31

free exchange rate

Question 32

What is the shift of demand curve in the dd and ss diagram when there is an increase in demand?

Answer 32

shift to the right excess demand domestic currency depreciation (price of $ increases)

Question 33

What is the shift of demand curve in the dd and ss diagram when there is an decrease in demand?

Answer 33

shift to the left deficit demand domestic currency appreciation (price of $ decreases)

Question 34

What is the shift of supply curve in the dd and ss diagram when there is an increase in supply?

Answer 34

shift to the right excess supply domestic currency appreciation (price of $ decreases)

Question 35

What is the shift of supply curve in the dd and ss diagram when there is an decrease in supply?

Answer 35

shift to the left deficit supply domestic currency depreciation (price of $ increases)

Question 36

What is foreign exchange market?

Answer 36

market in which foreign currencies are bought and sold

Question 37

A large no. of foreign currencies are ____, _____ and _____ in the foreign exchange market

Answer 37

traded, converted and exchanged

Question 38

What are the functions of foreign exchange market?

Answer 38

credit function hedging function transfer function

Question 39

What is transfer function?

Answer 39

it is the function of transferring of purchasing power btwn the countries involved in the transaction

Question 40

What is credit function?

Answer 40

it is the function of providing credit for foreign trade like bills of exchange

Question 41

What is hedging function?

Answer 41

hedging is when exporters and importers agree to sell and buy goods or services on a later date at the current prices and rates of exchange

Question 42

What is the purpose of hedging?

Answer 42

to avoid losses that might be caused due to exchange rate variations

Question 43

What are the kinds of foreign exchange market?

Answer 43

spot market | forward market

Question 44

What is spot market?

Answer 44

it refers to the market in which the receipts and payments are made immediately (2 business days) daily nature deals only in spot transactions

Question 45

What is the rate of exchange called in a spot market?

Answer 45

spot exchange rate/current exchange rate

Question 46

What is forward market?

Answer 46

it refers to the market in which sale and purchase of foreign currency is settled on a specific future date at a rate agreed upon today

Question 47

What is the purpose of forward market?

Answer 47

* to minimise the risk of loss due to adverse changes in the exchange rate (through hedging) * to make profit (through speculation)

Question 48

What is the rate of exchange called in a forward market?

Answer 48

forward exchange rate