Exchange Rate: What ,Why and

How

Abhishek NayakUnder-graduate , Dept of Electrical Engineering

11115003

History

•  Money is any object of value that is generally accepted as payment for goods and services and repayment of debts within a market

• From livestock and sacks of cereal grain to cowries(sea shells) to beads to currently used paper and metal currencies.

BARTER• Barter is a system of exchange by

which goods or services are directly exchanged for other goods or services without using a medium of exchange .

• May be Bilateral or multilateral.

Limitations of barter• Need for presence of double coincidence of

wants:

• Absence of common measure of value:

• Indivisibility of certain goods:

• Difficulty in storing wealth:

• Money, in and of itself, is nothing.

• The value that people place on it has nothing to do with the physical value of the money. Money derives its value by being a medium of exchange, a unit of measurement and a storehouse for wealth.

COINS and CURRENCY

• In 600 B.C., Lydia's King Alyattes minted the first official currency. The coins were made from electrum, a mixture of silver and gold that occurs naturally, and stamped with pictures that acted as denominations

• In 600 B.C., the Chinese moved from coins to paper money

•  Eventually, the banks (primarily in Europe) started using bank notes.

• These notes could be taken to the bank at any time and exchanged for their face values in silver or gold coins.

GOLD Standard

• From 1821 to 1914 most of the world’s currencies were redeemable into GOLD.

• Britain was the first to adopt this method in 1821.

• Then it had fixed 1£ at ¼ of 1 ounce of gold.

• However after 1932 (End of the first great economic depression) USA was the only country to still have pegged its currency to Gold Standard

• Most european countries started a floating system .

Gold was still pegged at 35$ per ounce.

Smithsonian Agreement

• 1972

• Gold Backing had decreased (war spending)

• US chose to suspend Dollar convertibility to Gold.

• A year later most pegged currencies reverted back to floating system.

Floating vs. Fixed• A fixed exchange rate denotes a nominal

exchange rate that is set firmly by the monetary authority with respect to a foreign currency or a basket of foreign currencies.

•  By contrast, a floating exchange rate is determined in foreign exchange markets depending on demand and supply, and it generally fluctuates constantly.

Around 180 official currencies of 196 nations.

HOW

What determines EXCHANGE RATE

• 1. Differentials in Inflation

• 2. Differentials in Interest Rates

• 3. Current-Account Deficits

• 4. Public Debt

• 5. Terms of Trade

• 6. Political Stability and Economic Performance

Sources

• www.bloomberg.com

• www.cia.gov/library/publications/the-world-factbook

• www.wikipedia.org

• www.howstuffworks.com