Foreign Exchange Market
The buying and
selling of currency.
Ex. In order to purchase souvenirs in France, it is first
necessary for Americans to sell (supply) their dollars and buy Euros.
Any transaction that
occurs in the balance of payments necessitates foreign exchange.
The exchange rate (e)
is determined in the foreign currency markets.
Changes in exchange
rates
Exchange rates (e)
are a function of the supply and demand for currency.
An increase in the
supply of a currency will decrease the exchange rate of a currency.
A decrease in supply
of a currency will increase the exchange rate of a currency.
An increase in
demand for a currency will increase the exchange rate of a currency.
A decrease in demand
for a currency will decrease the exchange rate of a currency
Appreciation and depreciation
Appreciation of
a currency occurs when the exchange rate of that currency increases.
Depreciation of
a currency occurs when the exchange rate of that currency decreases (e
decreases)
Note: the more you supply, the value depreciates. The more
you demand value appreciates.
Exchange rates determinants
- Consumer tastes (buyers taste)
- Relative income
- Relative price level
- Speculation
Exports and imports
The 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.
As two currencies trade:
1. One supply
line will change; the other demand line will change.
2. They will move
in the same direction.
3. One currency will appreciate, the other will
depreciate.
Flexible rate
Based on the supply and demand of that currency versus the
other currency. It is very sensitive to the business cycle and it provides
options for investment.
Fixed rates
It is based on a countries willingness to distribute
currency and to control the amount.
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