Exchange Rates - IB Economics

Topics: Foreign exchange market, Bretton Woods system, Monetary policy Pages: 7 (1530 words) Published: May 19, 2014
The exchange rate is the price of one country’s currency in terms of another country’s currency Quoted exchange rates can be either direct or indirect,

Direct: home currency per unit of foreign currency

39 Rupees per US Dollars
80 Rupees per Pound
Indirect: foreign currency per unit of home currency

 0.0255102 US Dollar   per Indian Rupee
0.491594 Pound per Indian Rupee

Appreciation of Currency

Currency Appreciation means that the given currency has become more valuable with respect to another currency. For example if the rupee appreciates it means that rupee has become more valuable in relation to dollar. In case of appreciation a "downward" movement takes place. For instance if the rupee moves downwards from 42 per dollar to 39 per dollar then rupee is said to appreciate. Appreciation make Indian goods expensive for foreigners and make foreign goods cheaper Appreciation leads to unfavorable Balance of Payments

Depreciation of a currency
Currency Depreciation means that the given currency has become less valuable with respect to another currency. A depreciation of the local currency means that it takes more local currency to buy a unit of foreign currency A depreciation of a country’s currency makes its goods cheaper for foreigners and makes foreign goods more expensive. Depreciation leads to favorable BOP

Factors affecting exchange rates (floating exchange rate )

Exchange rate of a country appreciates if the demand of that country’s currency increases or if there is a shortage in supply

Exchange rate of a country depreciates if the demand of that country’s currency decreases or if there is an increase in supply

1. A change in income
If a country’s national income increases then its demand for imports will increase and supply of its currency increase ER depreciates when supply increases
If foreign income rises(US GDP rises), demand for India’s export will increase, i.e. demand for Indian rupees will increase , rupee will appreciate

2. A Change in Relative Prices.
Inflation in a country will affect the ER
As the domestic price rises imports will become cheaper and exports will be expensive Supply of currency will increase and demand for currency will fall down If there is inflation in India , its cheaper for India to import and supply of rupee increases, rupee depreciates

3. Interest Rates.
If interest rates rise in one country, then saving becomes highly attractive and demand for currency increases and appreciates If interest rates in US decreases as compared to India then savings in US become less attractive Demand for Indian rupees will increase, as a result rupee appreciates and dollar depreciates

4. Investment Prospects
If investors find a country attractive for investment , demand for that country’s currency will increase and ER will appreciate If investment prospect become better in India compared to US, the demand for US Dollars will fall and dollar depreciates. 5. Speculation

Speculation or speculators in currency can affect the Er
If the speculators feels rupee is overvalued and is due to fall. People holding India Rupees will rush to sell, and supply of Rupee will increase

Which is Better, A Strong or Weak Indian Rupee?

When the Indian Rupee is strong or increases in value against all other currencies, the following situations will most likely occur.

2 1. It is cheaper for Indian businesses to import from foreign countries because the rupee is strong so foreign goods and services will cost less. The consumer will benefit from this since import prices on goods would go down. 3

4 2. It would be cheaper for Indian citizens to travel abroad since the consumer would be getting more for their Indian Rupee. This usually makes things like food, hotels, and souvenirs cost less.

1 1....
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