foreign currencies and foreign exchange€¦ · web viewinterpret exchange rate tables. explain...

FOREIGN CURRENCIES AND FOREIGN EXCHANGE

INTRODUCTION

Economics Money has several functions. It serves as a medium of exchange, a store of value, and a measure of value. In world trade, money also functions as a medium of exchange used to carry out payments on international transactions. The value of a currency, when used in international exchanges, is frequently set in foreign exchange markets where the forces of supply and demand establish the price at which different currencies are exchanged. Foreign exchange (FX or ForEx) rates set in such a market are called floating or flexible exchange rates. When currency values are not set by foreign exchange markets, they are set at fixed rates (also called pegged) or between fixed limits by governments.

Decisions to buy or sell foreign currency are influenced by the same economic principles that affect all economic choices. In this lesson, students will apply their reasoning skills to explain changes in the exchange rate between two currencies.

CONCEPTS

1. Supply and demand2. Exchange rates3. Fixed exchange rates4. Flexible exchanged rates

OBJECTIVES

The student will:

1. Explain why citizens or businesses in one country might require the currency of another country.

2. Explain how foreign exchange values are influenced by supply and demand.

3. Explain how an increase/decrease in the availability of a currency may cause a decline/rise in that currency’s foreign exchange value.

4. Read and interpret exchange rate tables.5. Explain why some groups benefit and

others lose when exchange rates change.

CONTENT STANDARD

SSEIN3 The student will explain how changes in exchange rates have an impact on the purchasing power of individuals in the United States and in other countries.

a. Define exchange rates as the price of one nation’s currency in terms of another nation’s currency.

b. Locate information on exchange rates.c. Interpret exchange rate tables.d. Explain why, when exchange rates change,

some groups benefit and others lose.

LESSON DESCRIPTION

Students take part in a foreign exchange simulation. The exercise provides an opportunity for students to use supply and demand analysis to explain how flexible exchange rates are established in currency markets. The students will then practice reading exchange rate tables and making judgments about what parties gain and what parties lose when exchange rates change.

Time required: Approximately 50 minutes

MATERIALS:

1. 10 candy bars or other desirable commodity.

2. Enough copies of Handout 1 that each student has 12 yuan bills

3. One copy of Handout 2.4. Student Activity 1-FOREIGN EXCHANGE

WINNERS AND LOSERS5. One transparency of Visual 1, “What affects

the supply and demand of currencies?”

PROCEDURE

PART 1

1. Prepare for this lesson by making enough duplicates of Handout 1 (Chinese Yuan) to provide about 12 bills with varying denominations of yuan for each student. Cut the currency out of the page so you can distribute the bills separately. Make a few extra yuan to ensure that you do not run out. You should make at least 5 US dollars out of Handout 2. The teacher keeps the dollars.

2. Announce that today the class will look at money and the process by which it is exchanged and valued by the people in two or more countries.

3. Distribute the yuan to the students and inform them that they will act as citizens of China. Each student should receive four or five notes, of varying denominations. Distribution should be random, so do not worry that some students get more yuan than others.

4. Appoint a student in the front of the room to serve as a United States merchant selling the candy bars (or other desirable item) for $1 each. Instruct your merchant that the price is set at $1, and they can only take US dollars, not Chinese Yuan.

5. Announce that the merchant is selling candy bars for $1 a piece. At this point, the students will probably try to buy the candy with yuan. Be sure that your merchant rejects their offers by reminding these other students that he/she needs US dollars to purchase the candy (or other desirable item).

6. Announce to the students that you are now an international currency dealer and that you have 5 US dollars for sale and they will be auctioned to the person who bids the most yuan.

7. Round 1. Do not announce that there will be multiple rounds. Announce that the auction will begin and that the only acceptable payment is Chinese Yuan. Let

the students bid; decide at what prices you will sell the US dollars. You will get low bids to begin with and it is ok to initially take a couple of low bids. The bids should start to increase. Record the auction price of each dollar and give a $1 bill to each successful bidder. Continue until you have auctioned the five US dollar bills. Allow the owners of the dollars to exchange the dollars for the candy bars (or other desirable item).

8. Round 2. Increase the supply of yuan by distributing the remaining amount to the students. Again, every student does not need to have the same amount of yuan. There should now be substantially more yuan in circulation throughout the classroom. Announce that the American merchant has five more candy bars for sale and that the price ($1) has not changed. Conduct another auction of the 5 $1 bills that you have retrieved from the merchant. The purchase price of the dollars should be higher than in round 1. Record the prices and allow the students to purchase the candy bars.

9. Ask the students to focus on Visual 1. A. How many total yuan were

paid for the five US dollars in Round 1? Round 2? In other words, what was the price of a US dollar in terms of Chinese yuan in each round?

B. How wide were the price variations of yuan per dollar in each round? What do you think happens to this variation over time?

C. What do you think was the primary reason for the dramatic change in the exchange rate from round 1 to round 2?(The increase in the amount yuan in circulation caused the value of the yuan to decrease.)

D. What determined the exchange rate of yuan and dollars?(The discussion should be steered towards supply and demand if it does not move that way naturally)

10. OPTIONAL EXTENTION DISCUSSION. If you feel that your students have a firm grasp of exchange rates and supply/demand, you may choose to deepen the discussion with the following question. This may not be appropriate for all ability levels.

What affects the supply and demand of currencies?

Explain why flexible exchange rates change frequently over time; over years, months, weeks, and even during a given day. The reasons are based on supply and demand. A. Changes in preferences for foreign

goods. For example, if Americans want to buy more Japanese goods from Japan, they will demand more Japanese yen (and supply more US dollars in exchange for yen). The dollar/yen exchange rate would change and the yen would be worth more dollars (and the dollar would be worth fewer yen).

B. Changes in prices in different countries. For example, China experiences high inflation (as in the earlier simulation) compared to the US. The Chinese would supply more yuan to the foreign exchange market. The dollar/yuan exchange rate would change (and the dollar would be worth more yuan).

C. Changes in the interest rates in different countries. For example, if you could earn 10 percent on a savings account in Europe and only three percent in the US, Americans would want to supply their dollars and

demand more Euros in order to deposit their money in a European bank. The dollar/euro exchange rate would change and the euro would be worth more dollars (and the dollar would be worth fewer euros).

D. Changes in incomes in different countries. For example, if incomes in the US were increasing compared to those in Mexico, people in the US could afford to buy more Mexican goods and more US goods as well. Demand for pesos would go up, and the supply of dollars would increase in exchange for pesos. The dollar/peso exchange rate would change and the dollar would be worth fewer pesos (and the peso would be worth more dollars).

E. Speculation. For example, if many people think that the dollar will increase in value compared with the euro, they will buy (demand) dollars today (and supply euros) in hopes of selling the dollars back at higher prices later. The dollar/euro exchange rate would change, and the dollar would be worth more euros (and the euro would be worth fewer dollars).

PART 2

11. Distribute Student Activity 1 to all students. Review with your students the top section to ensure that they can read the exchange rate tables and understand the terms appreciation and depreciation. Then have students complete the handout, stopping to discuss after each section to ensure understanding.

CLOSURE

Review with the students the following points:

1. An exchange rate is the price of one currency in terms of another.

2. Flexible exchange rates are set by supply and demand like all other free markets.

3. Changes in the exchange rate create winners and losers.

FOLLOW UP ACTIVITIES/ ASSESSMENT

1. Have students look up current exchange rates in newspapers or on the internet and practice converting a set amount of one currency into a variety of others.

2. Essay QuestionsA. Defend or refute the following

statement. A strong dollar is good for all Americans.(A strong dollar is not necessarily good for all Americans. While good for Americans wishing to travel abroad, to invest in another country, or consume imported products, an appreciating dollar hurts exporters trying to sell

American products overseas and the workers in those industries, as well as businesses who cater to foreign tourists visiting the US)

3. Imagine a situation in which there is a huge increase of US citizens choosing to visit Europe. All of these visitors will need to purchase euros for their stay in Europe. Assuming no other changes with the dollar or the euro, what effect will their actions have on the supply and demand of these currencies in the foreign exchange market? What will happen to the price of each currency? Draw a model of the foreign exchange market with supply and demand curves to illustrate your point.(The supply of US dollars increased when US citizens paid dollars to buy euros and the demand for dollars did not change. The demand for euros increased and the supply of euros did not change. The dollar would therefore depreciate against the euro.)

Handout 1

Handout 2

STUDENT ACTIVITY 1

Sample

Sample

Sample

Sample

Sample

FOREIGN EXCHANGE WINNERS AND LOSERS

Because different countries use different currencies, international trade requires a system for exchanging money among nations. If an American wants to buy goods made in Japan, somewhere along the line dollars must be exchanged for Japanese yen. The price of one currency in terms of another is called the exchange rate. If this exchange rate is prevented from changing it is called fixed (or pegged) and if it changes with supply and demand it is called flexible (or floating). Exchange rate tables, which can be found in newspapers, at banks, and on the internet, show the price of one currency in terms of another. For example, in Month 1 of the following exchange rate tables, one US dollar is worth 90.62 Japanese yen and conversely, a single Japanese yen is worth $.011 (1.1 US cents).

Exchange Rate Table for Month 1US Dollar British Pound Chinese Yuan Japanese Yen Euro

US Dollar --- 1.480 .1465 .0110 1.237British Pound .6754 --- .0989 .0075 .8082Chinese Yuan 6.826 10.1058 --- .0753 8.445Japanese Yen 90.624 134.163 13.276 --- 112.12

Euro .8082 1.1966 .1184 .0089 ---



Euro .9357 1.379 .1432 .0092 ---Part A. Use the two exchange rate tables to answer questions 1-3.

1. Is the exchange rate of dollars to euros fixed or flexible? Explain your answer.

2. A currency appreciates (or gets stronger) if it buys more of a foreign currency than it did before. Did the dollar appreciate against the Japanese yen from month 1 to month 2? Explain.

3. A currency depreciates (or gets weaker) if it buys less of a foreign currency than it did before. The US dollar depreciated against what currency(s) from month 1 to month 2?

Part B. Now use the exchange rate tables to answer questions 4-8.

4. An American family goes on vacation to see the beautiful city of London in Great Britain. They have budgeted $5000 to spend while they are there. How many British pounds will $5000 buy in month 1? Month 2? When should the family go on vacation?

5. An American family is buying Japanese electronics in the local retail store. Which month will those products be cheaper for the family? Explain.

6. A Chinese company contracts a French architect to design a new building in Shanghai for 100,000 Euro. How much (in yuan) would it cost the Chinese firm in month 1? Month 2? So in which month would the Chinese company prefer to pay off the contract?

7. The Chinese government wishes to invest in US Treasuries with their yuan. In which month should the Chinese government buy US Treasuries? Explain your answer.

8. An American aircraft manufacturer is trying to sell as many commercial aircraft in Japan as they can for $150 million per plane. What is the difference in the yen price between month 1 and month 2? During which month is the American firm more likely to sell more planes? Why?

Part C. Answer the remaining two questions.

9. Name two groups of people who would benefit from the US dollar becoming stronger (appreciating).

10. Name two groups of people who would benefit from the US dollar becoming weaker (depreciating).

STUDENT HANDOUT 1--KEY

FOREIGN EXCHANGE WINNERS AND LOSERS

Because different countries use different currencies, international trade requires a system for exchanging money among nations. If an American wants to buy goods made in Japan, somewhere along the line dollars must be exchanged for Japanese yen. The price of one currency in terms of another is called the exchange rate. If this exchange rate is prevented from changing it is called fixed (or pegged) and if it changes with supply and demand it is called flexible (or floating). Exchange rate tables, which can be found in newspapers, at banks, and on the internet, show the price of one currency in terms of another. For example, in Month 1 of the following exchange rate tables, one US dollar is worth 90.62 Japanese yen and conversely, a single Japanese yen is worth $.011 (1.1 US cents).



Euro .8082 1.1966 .1184 .0089 ---



Euro .9357 1.379 .1432 .0092 ---Part A. Use the two exchange rate tables to answer questions 1-3.

1. Is the exchange rate of dollars to euros fixed or flexible? Explain your answer.Flexible. In month 1, $1 US is worth .8082 euros. In month 2, $1 US is worth .9357 euros.

2. A currency appreciates (or gets stronger) if it buys more of a foreign currency than it did before. Did the dollar appreciate against the Japanese yen from month 1 to month 2? Explain.Yes. In month 1, $1 US was worth 90.624 yen. In month 2, $1 US was worth 95.724 yen. Therefore the dollar appreciated against the yen; it could buy more yen in month 2. Conversely, the yen depreciated against the dollar.

3. A currency depreciates (or gets weaker) if it buys less of a foreign currency than it did before. The US dollar depreciated against what currency(s) from month 1 to month 2?The US dollar depreciated against the British pound and the Chinese yuan. It takes more dollars to purchase the same amount of the foreign currencies in month 2 than in month 1.

Part B. Use the exchange rate tables to answer questions 4-8.

4. An American family goes on vacation to see the beautiful city of London in Great Britain. They have budgeted $5000 to spend while they are there. How many British pounds will $5000 buy in month 1? Month 2? When should the family go on vacation?$5000 will buy 3377 British pounds in month 1 and 3117 pounds in month 2 for a difference of 260 pounds. It would be in the best interest of the family to go to London in month 1 before it depreciates.

5. An American family is buying Japanese electronics in the local retail store. Which month will those products be cheaper for the family? Explain.The Japanese yen depreciates against the dollar from month 1 to month 2. Therefore, the Japanese goods will be cheaper for Americans in month 2.

6. A Chinese company contracts a French architect to design a new building in Shanghai for 100,000 Euro. How much (in yuan) would it cost the Chinese firm in month 1? Month 2? So in which month would the Chinese company prefer to pay off the contract?100,000 euro is equal to 844,500 yuan in month 1 and worth 698,300 yuan in month 2. By exchanging yuan for euros in month 2, the Chinese firm could save 146,200 yuan.

7. The Chinese government wishes to invest in US Treasuries with their yuan. In which month should the Chinese government buy US Treasuries? Explain your answer.The yuan appreciates against the dollar from month 1 to month 2. Therefore, the Chinese could afford to purchase more US Treasuries in month 2.

8. An American aircraft manufacturer is trying to sell as many commercial aircraft in Japan as they can for $150 million per plane. What is the difference in the yen price between month 1 and month 2? During which month is the American firm more likely to sell more planes? Why?The planes will be 765 million yen cheaper in month 1 than month 2. Therefore, the American company is more likely to sell planes during month 1 than month 2.

Part C. Answer the remaining two questions.

9. Name two groups of people who would benefit from the US dollar becoming stronger (appreciating).American consumers of imports. Americans traveling overseas. Foreigners wishing to sell products to Americas.

10. Name two groups of people who would benefit from the US dollar becoming weaker (depreciating).American exporters. Foreigners wishing to buy American assets. Foreigners traveling to the US. Americans who provide goods and services to foreign visitors.

VISUAL 1

What affects the supply and demand of currencies?

Flexible exchange rates change frequently over time; over years, months, weeks, and even during a given day. The reasons are based on supply and demand.

A. Changes in preferences for foreign goods. For example, if Americans want to buy more American goods from Japan, they will demand more Japanese yen (and supply more US dollars in exchange for yen). The dollar/yen exchange rate would change and the yen would be worth more dollars (and the dollar would be worth fewer yen).

B. Changes in prices in different countries. For example, China experiences high inflation (as in the earlier simulation) compared to the US. The Chinese would supply more yuan to the foreign exchange market. The dollar/yuan exchange rate would change and the dollar would be worth more yuan.

C. Changes in the interest rates in different countries. For example, if you could earn 10 percent on a savings account in Europe and only three percent in the US, Americans would want to supply their dollars and demand more Euros in order to deposit their money in a European bank. The dollar/euro exchange rate would change and the euro would be worth more dollars (and the dollar would be worth fewer euros).

D. Changes in incomes in different countries. For examples, if incomes in the US were increasing compared to those in Mexico people in the US could afford to buy more Mexican goods and more US goods as well. Demand for pesos would go up, and the supply of dollars would increase in exchange for pesos. The dollar/peso exchange rate would change and the dollar would be worth fewer pesos (and the peso would be worth more dollars).

E. Speculation. For example, if many people think that the dollar will increase in value compared with the euro, they will buy (demand) dollars today (and supply euros) in hopes of selling the dollars back at higher prices later. The dollar/euro exchange rate would change, and the dollar would be worth more euros (and the euro would be worth fewer dollars).

foreign currencies and foreign exchange€¦ · web viewinterpret exchange rate tables. explain...

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