Unit 7: Foreign Exchange, Flexible & Fixed Rates

Foreign Exchange 

--Buying and selling of currency

• Transaction that occurs in the balance of payments necessitates foreign exchange.

• The exchange rate is only determined in the foreign currency markets. 

Changes in the exchange rates

- Exchange rates; the function of supply and demand for currency.

- An increase in the supply of a currency can decrease the exchange rate of a currency.

- A decrease in supply of a currency can increase the exchange rate of a currency.

- An increase in demand for a currency can increase the exchange rate of a currency. 

- A decrease in demand for currency can decrease the exchange rate of a currency.

Appreciation & depreciation 

1. Appreciation of a currency occurs when the exchange rate of that currency increases.

2. Depreciation of a currency occurs when the exchange rate of that currency decreases

A note to remember: when you supply more, the value depreciate. But the more you demand this allows the value to appreciate. 

The exchange rate determinants

-- Consumers taste (buyers taste)

-- Relative income 

-- Relative price level 

-- Speculation 

Exports & imports 

The exchange rate is always the determinant of exports and imports. 

••Appreciation of a dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper, reducing exports and increasing imports would be the cause. 

•• Depreciation of a dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive, increasing exports and reducing imports would be the cause. 

Two currencies of trade: 

1. One supply line will change, other demand will change as well.

2. They will move in the same direction (position)

3. One currency appreciating, the dollar depreciate. 

Note to remember: supply decreases, dollar appreciates. Supply increases then the value of dollar depreciates. 

Flexible rate 

- Based on the supply and demand of that currency versus the other currency. The business cycle provided options for investment.

Fixed rates 

- It is based on a countries willingness to distribute currency and to control the amount as well.