Unit VII (Foreign Exchange)

• Foreign Exchange:

-  Buying and selling of currency-Any transactions that occurs in the balance of payments necessitates foreign exchange-Exchange Rate (ex): is determined in the foreign currency markets

• Changes in Exchange Rates:

-Exchange rates (e) are a function of supply and demand for currency- an increase in the supply of a currency- a decrease in supply of a currency will increase the exchange rate of currency- increase in demand for currency will increase the exchange rate of currency- decrease in demand for a currency will decrease the exchange rate of currency
Appreciation and Depreciation:·         Appreciation of currency occurs when exchange rate of that currency increases (e^)
·         Depreciation of a currency occurs when the exchange rate of that currency decreases

• Exchange Rate Determinants:

-Consumer tastes-Relative income-Relative price level-Speculation
-Exports and Imports:·         Exchange rate is a determinant of both exports and imports
·         Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper, thus reducing exports and increasing imports
·         Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports

• Floating/ Flexible Rates:

Depends upon supply and demand of that currency vs. other currenciesVery sensitive to business cycle / provide options for investments
Fixed Rates:Based on a country's willingness to distribute currency and to control the amount
As two currencies trade:1.    One supply line will ∆, the other demand line will ∆.
2.    They will move in the same direction
3.    One currency will appreciate, the other will depreciate