Foreign Exchange Rate

Presented By:-

Kushaldeep Gill Sakshi Gulati

Mansi Geol Sandhya Keisham

Abhishek Jain Suvam Dhar

International Trade and Policy

BBA, 2nd Year, Section A

Under the Supervision of:-Megha Ma’am

Index

•Exchange Meaning of Exchange Rate

•Exchange Rate System

•Factors Influencing Exchange Rate System

• Fixed Exchange Rates

•Floating Rates

•Advantages and Disadvantages

•Differences Between Fixed and Floating Exchange Rates.

Exchange Rate

•Price for which the currency of a country can be exchanged for another country's currency

•The price of a nation’s currency in terms of another currency

•Two components, the domestic currency and a foreign currency.

•Can be quoted either directly or indirectly.

Exchange Rate System

•Each country, through varying mechanisms, manages the value of its currency. As part of this function, it determines the exchange rate system that will apply to its currency.

• Floating

• Fixed

• Hybrid.

Factors That Influence Exchange Rates

• Interest Rates

• Inflation Rate

• Trade Balance

• Political Stability

• Internal Harmony

• General State of Economy

• Quality of Governance.

Quotation of Exchange Rates

•An exchange rate can be quoted in two ways:•Direct

•The price of the foreign currency in terms of domestic currency

•Indirect

•The price of domestic currency in terms of the foreign currency

Exchange Rate Market

•Exchange rates are determined in the foreign exchange market.•The market in which international currency trades take place

•The Actors•The major participants in the foreign exchange market are:•Commercial banks•International corporations•Nonbank financial institutions•Central banks

Types of Changes In Exchange Rates

•Two types of changes in exchange rates:•Depreciation of home country’s currency

•A rise in the home currency prices of a foreign currency

•It makes home goods cheaper for foreigners and foreign goods more expensive for domestic residents.

•Appreciation of home country’s currency•A fall in the home price of a foreign currency •It makes home goods more expensive for foreigners and foreign goods cheaper for domestic residents.

Fixed Exchange Rate System

An exchange rate between currencies that is set by the governments involved rather than being allowed to fluctuate freely with market forces. (…) authorities actively enter the currency markets to buy and sell according to variations in supply and demand.

The government of a country doesn’t let the exchange rate change in accordance with the demand and supply for the currency

Key Currencies: Share of national currencies in total identified official holdings of foreign exchange, 1998

10

US dollar 60.3% 64.3% 57.1%German mark 12.1 14.7 10.1Japanese yen 5.1 7.0 3.7British pound 3.9 3.1 4.6French franc 1.3 1.4 1.2ECU 0.8 1.8 -Swiss franc 0.7 0.2 1.0Netherlands guilder 0.4 0.3 0.4Other 15.4 7.2 21.9

All Industrial DevelopingKey currency countries countries countries

Fixed Exchange Rate System

•Establish a par value against one or more key currencies

•Create a stabilization fund to defend this fixed rate•Government must be ready to make good on all demands to convert to/from foreign currency

•At some point, because of basic economic changes, the fixed rate can become impossible to defend and must be changed.

Exchange Rate Stabilization Under Fixed Rates

Exchange Rate Stabilization Under Fixed Rates

Devaluation and Revaluation

•Devaluation is intended to lower the value of a currency relative to other currencies, correcting a balance of payments deficit

•Revaluation is intended to raise the currency’s value relative to other currencies, correcting a surplus

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Devaluation and Revaluation

•Legally, the changes are made in the par value of the home currency in terms of the reference currency

•Economically, the effect is to change the value of the currency relative to the main trading partners - who may retaliate by changing their own fixed rates

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Devaluation/Revaluation: Legal and Economic Impact

Devaluation/Revaluation: Legal and Economic Impact

Effects of Devaluation

•The gap between official exchange rate andequilibrium exchange rate will be reduced.

•Exports become more competitive in theinternational market.

•Imports become more expensive.

Effects of Revaluation

•The gap between official exchange rate andequilibrium exchange rate will be reduced.

•Exports become less competitive in theinternational market.

•Imports become cheaper.

To Be Successful

•fixed exchange rates require consistency or coordination in these areas.•Multiple objectives within a country may require conflicting policies, so priorities may be critically important.

•Independent monetary policies are not possible.

•Tax, interest rate, or inflation rate differences will lead to capital flows that will undermine the currency fix.

•Productivity and productivity growth differences affect relative inflation rates.

The main arguments for adopting a fixed exchange rate system are as follows:

•Trade and Investment

•Some flexibility permitted:

•Reinforcing gains in comparative advantage

•Disciplines on domestic producers

•Reductions in the costs of currency hedging

Advantages

•Promotes International Trade

•Necessary for Small Nations

•Removes Speculation

•Necessary for Small Nations:

•Economic Stabilization

Disadvantages

•Outmoded System

•Discourage Foreign Investment

•Monetary Dependence

•Cost-Price Relationship not Reflected.

Floating Exchange Rate System

• A country's exchange rate regime where its currency is set by the foreign-exchange market through supply and demand for that particular currency relative to other currencies. Thus, floating exchange rates change freely and are determined by trading in the foreign exchange market. This is in contrast to a "fixed exchange rate" regime

Features • Currency prices established daily by an unrestricted

market

• Large foreign exchange reserves are not needed to defend a fixed rate

• Rates respond to economic shifts; payments imbalances are corrected by rate changes

• Gives greater freedom to domestic economic policy

• Works only if there is enough trade in a currency to make a viable market

• Greater freedom for domestic policy may mean poor economic policy has fewer immediate consequences

• Market rates may move erratically.

The main arguments for adopting a floating exchange rate system are as follows

• Outmoded System

• Discourage Foreign Investment

• Monetary Dependence

• Cost-Price Relationship not Reflected:

• Reduced need for currency reserves

• Useful instrument of economic adjustment

• Partial automatic correction for a trade deficit:

• Less opportunity for currency speculation

• Freedom (autonomy) for domestic monetary policy

Advantages and DisadvantagesAdvantages

•Automatic balance of payments adjustment•Freeing internal policy•Absence of crises•Flexibility•Lower foreign exchange reserves

Disadvantages

•Uncertainty•Lack of investment•Speculation•Lack of discipline in economic management

Fixed vs Floating Exchange Rates

A fixed exchange rate is one, whose value is fixed against the value of another currency

A floating exchange rate is one which is determined by market forces

Its Fixed Its Flexibility

Higher Foreign Exchange Reserves

Lower Foreign Exchange Reserves

Certain Uncertainty

Necessary for Small Nations For Developed Nations

•Thank you