Theme 4: Exchange rates

Question 1

What happens if the pound appreciates?

Answer 1

Stronger

Pound

Imports

Cheaper

Exports

Expensive

Question 2

Draw a diagram to show the impact of a decrease in the supply of pounds on the exchange rate.

Answer 2

Question 3

Draw a diagram to show the impact of a decrease in the supply of pounds on the exchange rate.

Answer 3

Question 4

How do imports and exports impact the exchange rate?

Answer 4

A decrease in imports leads to an appreciation of the pound

A decrease in exports leads to a depreciation of the pound.

Question 5

What will happen to the exchange rate as a result of an increase in the number of UK consumers travelling abroad in the summer?

Answer 5

The supply of pounds will increase which will lead to a depreciation

Question 6

What will happen to the exchange rate as a result of an increase in the number of Chinese consumers travelling to the UK?

Answer 6

The demand for pounds will increase causing an appreciation

Question 7

What is speculation?

Answer 7

When investors predict changes in a currency’s exchange rate to make a profit.

Question 8

If Argentina increased its base interest rate what would happen?

Answer 8

There would be an outward shift of the demand curve for Argentine Pesos

There would be an increase in hot money flows in to the country

There would be an increase in the price of Pesos relative to other currencies

Question 9

What are the factors influencing a countries exchange rate?

Answer 9

1. Imports and exports
2. Speculation
3. Relative interest rates
4. Relative inflation rates
5. FDI
6. Quantitative easing

Question 10

Why will quantitative easing depreciate the currency?

Answer 10

As the supply of money in an economy will increase.

Question 11

What is a floating exchange rate?

Answer 11

Where the values of a currency are determined by free market forces and where the value of a currency changes from day to day.

Question 12

What are fixed exchange rates? and what are the closest examples of when they are used currently?

Answer 12

Where a country’s currency has a fixed value against another currency or commodity.

• Using another currency often the dollar
• Set up a common currency eg the euro

Question 13

What is a managed exchange rate?

Answer 13

An exchange rate system where free markets determine the value of a currency but where central banks intervene from time to time to change the value of their currency.

Question 14

What is an example of a form of fixed exchange rate that is no longer used?

Answer 14

Gold standard

Question 15

How does a central bank influence the exchange rate?

Answer 15

Directly- By buying and selling currency using gold and foreign reserves held in its central bank.

Indirectly- raising or lowering interest rates.

Question 16

Draw an adjustable peg exchange rate diagram

Answer 16

Question 17

What is an adjustable peg system?

Answer 17

An exchange rate system where currencies are fixed in value in the short term but can be devalued or revalued in the long run

Question 18

What is a crawling peg system?

Answer 18

An adjustable peg system of exchange rates where there is an inbuilt mechanism for regular changes in the currencies central value of the currency.

Question 19

What is a managed or dirty float?

Answer 19

Where the exchange rate is determined by free market forced but governments intervene from time to time to alter the free market price of a currency.

Question 20

What is a strength and a weakness of fixed exchange rates?

Answer 20

+ no volatility which encourages international trade and long term investment

+financial discipline on governments not to overspend.

-Less robust as speculation can force a devaluation of the currency.

-

Question 21

What are the advantages and disadvantages of the floating or free exchange rate system?

Answer 21

-High volatility which is a barrier to international investment and trade

+No need for government intervention which means it is unlikely to collapse.