Lesson 42-Exchange rates

Question 1

Define exchange rates

Answer 1

This refers to the price of a currency measured in terms of another currency.

Question 2

How is the exchange rate determines/

Answer 2

The market forces of demand and supply

Question 3

Explain the 4 factors affecting the demand of a currency

Answer 3

1. Demand for exports- An increase in demand for exports implies that there is an increase in the currency of that country (APPRECIATION)
2. Inward foreign direct investments- A increase in investments coming into a country from another country would mean that the demand for its currency would also go up as investments cannot be made in another country without converting the foreign currency to domestic currency (APPRECIATION)
3. Interest rates- If the interest rates given by banks in a country are higher than that of other countries, then hot money flow into this country. This will mean that the demand for this country’s currency rises.
4. Speculation- If speculators in the FOREX markets expect the value of a currency to rise in the future they will increase their current demand for that currency leading to an APPRECIATION

Question 4

Define hot money

Answer 4

This refers to a situation when investors go in search of countries where the banks provide high interest rates.

Question 5

What are the 4 factors affecting the supply of a currency

Answer 5

1. Demand for imports- In order to import foreign goods, it becomes necessary to convery the local currency to the forgein currency leadint o a rise in supply of curency if imports increase
2. Outwards foreign direct investments- If firms and businesses decide to invest money in another country there will be an increase in the supply of the currency leading to DEPRECIATION
   3.Interest rates of other countries- If the interest rates provided by banks in other countries are higher than that of the domestic country then the local citizens may deposit their money in foreign banks which will lead to an increase in the supply of foreign currency thus DEPRECITION
3. Speculation- If the speculators expect the value of a currency to fall in the future they will sell of their existing stocks leading to a rise in the supply of the currency this DEPRECIATION.

Question 6

Define appreciation

Answer 6

This refers to a situation when the external value of a currency increases

Question 7

What are the reasons for appreciation of a currency

Answer 7

1. An increase in demand of the currency
2. A decrease in the supply of the currency

Question 8

What will be the outcome of appreciation

Answer 8

A rise in imports and a fall in exports

Question 9

Define depreciation

Answer 9

This refers to a situation when there is a fall in the external value of a currency.

Question 10

What are the reasons behind the depreciation of a currency

Answer 10

1. A decrease in demand of a currency
2. An increase in the supply of a currency

Question 11

What will be the outcome of depreciation

Answer 11

An increase in exports and a fall in imports

Question 12

What is the external value of a currency

Answer 12

This refers to the exchange rate of a currency

Question 13

What is the internal value of a currency

Answer 13

This refers to the purchasing power of a currency. The purchasing power of a currency refers
to the basket of goods that can be bought in terms of cost of living.

Question 14

What is the exchange rate policy?

Answer 14

This refers to the manipulation of exchange rates by the govt to achieve it desired objectives.

Question 15

What are the objectives aimed to achieve by influencing the exchange rates?

Answer 15

Stabilizing the current account of the BOP

Question 16

Define devaluation

Answer 16

This refers to the deliberate reduction in the external value of a currency of a country by the govt

Question 17

What will be the effect of devaluation

Answer 17

An increase in exports an a fall in imports

Question 18

What is the Marshall lerner condition and how should it be satisficed in order to stabilize the current account through a rise in exports and a fall in exports

Answer 18

1.Demand for exports should be elastic as exports will not rise if the demand for exports is not elastic
2. Demand for imports should be elastic- Even though imports become expensive if the importers continue to buy at a high price the devaluation will not be successful.

Question 19

Define revaluation

Answer 19

This is the opposite of devaluation when the gvt deliberately increases the external value of a currency.