Week 7: Exchange Rate Changes

Question 1

What 5 factors influence exchange rates?

Answer 1

1. Inflation
2. Interest
3. Income
4. Government Controls
5. Expectations of future exchange rates

Question 2

How do interest rates affect exchange rates (£)?

Answer 2

Demand for UK bank deposits increase and so does the £.

Question 3

What is the formula for the real interest rate (Fisher Effect)?

Answer 3

Real Interest Rate = Nominal Interest Rate - Inflation Rate

Question 4

How does income affect the exchange rate?

Answer 4

If foreign income increases, demand for British goods increases- increasing demand for £

Question 5

How may governments influence the equilibrium exchange rate?

Answer 5

-Imposing foreign exchange barriers
-Imposing foreign trade barriers
-Affecting Macro variables (inflation/interest rates)

Question 6

What do many institutional investors take currency positions based on?

Answer 6

Expectations (anticipated interest movements)

Question 7

What causes a shift in demand for domestic assets?

Answer 7

-Domestic interest rate
-Foreign interest rate
-Expected future exchange rate

Question 8

What shifts with a rise in domestic interest rate?

Answer 8

Demand rightward

Question 9

Explain how interest rate changes function?

Answer 9

Domestic real interest rates rise => domestic currency appreciates.
When domestic interest rate rises due to expected increase in inflation => domestic currency depreciates

Question 10

What does a higher domestic money supply cause?

Answer 10

Depreciation of domestic currency

Question 11

What is Country Risk?

Answer 11

The potentially adverse impact of a country’s environment on forex returns

Question 12

How can country risk analysis be used?

Answer 12

To devise risk management strategies appropriate to the country.
A screening process to avoid conducting business with excessive risk