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Flashcards in Intl Finance Exchange rates Deck (35)
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1

An exchange rate.

measures the value of one currency in
units of another currency

2

depreciation.

A decline in a currency’s value. When the British
pound depreciates against the U.S. dollar, this means that the U.S. dollar is strengthening
relative to the pound.
This means that it takes BR more pounds to buy same amt of US dollars

3

appreciation.

An increase in currency value
Ex
Br pound appreciates
So Br can buy more Us goods for same amt of pounds

4

exchange rates are determined by

supply and demand

5

Demand schedule

The U.S. demand for British pounds results partly from international trade, as U.S. firms
obtain British pounds to purchase British products. This demand schedule is downward
sloping because corporations and individuals in the United States would purchase more
British goods when the pound is worth less (since then it takes fewer dollars to obtain
the desired amount of pounds).

6

Supply schedule

British demand for U.S. dollars. British supply of pounds for sale, since pounds are supplied in the foreign exchange market in exchange for U.S. dollars When the pound’s valuation
is high, British consumers and firms are more willing to exchange their pounds
for dollars to purchase U.S. products or securities; hence they supply a greater number
of pounds to the market to be exchanged for dollars. Conversely, when the pound’s valuation
is low, the supply of pounds for sale (to be exchanged for dollars) is smaller,
reflecting less British desire to obtain U.S. goods.

7

Increase in Demand for country's currency

P ^ , Q ^
The currency appreciates

8

Decrease in Demand for country's currency

P down , Q down
Country's currency depreciated

9

Increase in Supply for country's currency

P down, Q up

The country's currency depreciates

10

Decrease in Supply for country's currency

P up, Q down

Country's currency appreciates

11

U.S inflation goes up, what happens to D, S, Price

US demand goes up, British dont buy US goods so supply goes down, This pressures exchange rate Prices to go up

12

U.S interest rates goes up what happens to D, S, Price

Demand for pound drops b/c US investors favor US rates. it also attracts BR investors so supply increases. Thus, price increases

13

real interest rates

adjusted for inflation

14

U.S income increases, what happens to D, S, Price

Demand increases, supply stays the same. P increases.

15

fixed exchange rate system

exchange rates are either held constant or allowed to
fluctuate only within very narrow boundaries

16

devaluation

A central bank’s actions to devalue a currency in
a fixed exchange rate system

17

Revaluation

upward adjustment of
the exchange rate by the central ban

18

freely floating exchange rate system

exchange rate values are determined by market
forces without intervention by governments

19

freely floating exchange rate system- Advantages

country is more insulated from the inflation of other
countries. country is more insulated
from unemployment problems in other countries.
Exchange rate adjustments
serve as a form of protection against “exporting” economic problems to other countries

20

freely floating exchange rate system- Disadvantages

country that has problem of high inflation and unemployment will continue to have same issues

21

managed float or “dirty” float exchange rate system

allowed to fluctuate on a daily basis and there are no official boundaries but governments can and sometimes do intervene to prevent their
currencies from moving too far in a certain direction

22

pegged exchange rate

home currency’s value is pegged to one foreign currency or to an index of currencies.

23

Dollarization

replacement of a foreign currency with U.S. dollars

24

Fixed exchange rate advantages

1. Exports and import international trade without worries of changes in currency.
Can make payments with protection against depreciation and obtain currency without rush of appreciation
2. Safe direct foreign investment
3. Safe investment

25

Fixed exchange rates disadvantage - inflation

Us inflation ⬆️

US demand for UK good⬆️

UK has inflation cuz everyone buys from them

26

Fixed exchange system disadvantage unemployment shock

US unemployment ⬆️

US demand for UK good⬇️

UK production ⬇️
And unemployment ⬆️

27

Freely floating ER SYSTEM advantage
Inflation shock example

Us inflation ⬆️

US demand for UK good⬆️
UK does not buy from US SOO supply of pound ⬇️
Pound appreciates and now U.K. prices are higher in terms of dollar so
US Demand for U.K. GOODS ⬇️
UK has no inflation

28

Freely floating ER system disadvantage inflation

Us inflation ⬆️

US demand for UK good⬆️
UK does not buy from US SOO supply of pound ⬇️
Pound appreciates and now U.K. prices are higher in terms of dollar so
You need a greater number of dollars to buy the same number of pounds
US Demand for U.K. GOODS ⬇️
US Firms increase prices because raw materials are expensive now.
US inflation ⬆️⬆️⬆️⬆️

29

If ones country's currency appreciates/depreciates the other country's currency must do the

Opposite

30

Trade flows vs capital flows

Trade flows: inflation, tariffs

Capital flow: income and interest rates

Capital flows outbeats trades flows