What are exchange rates?

An exchange rate is the price of one countries currency in relation to that of another.

e.g. £1 = $1.6

http://www.xe.com/

How are exchange rates determined?

Exchange rates are determined on

the foreign exchange markets

throughout the world.

What factors affect the value of a currency?

If an exchange rate is free floating, then changes in the demand and supply of a currency will result in a change in

the countries exchange rate.

E.g. an increase in demand will cause the value to rise and a decrease in demand will cause the value to fall.

What do the terms ‘appreciated’ and ‘depreciated’ mean in relation

to exchange rates? • If the value of a currency falls in

relation to another then the exchange rate is said to have depreciated.

• If the value of a currency rises in relation to another then the exchange rate is said to have appreciated.

Factors affecting exchange rates…

The Volume of exports An increase in exports by UK

firms will mean more pounds are required to buy these exports. This increases the demand for

sterling, which will cause a rise in the value of the £.

The Volume of exports An increase in exports by UK

firms will mean more pounds are required to buy these exports. This increases the demand for

sterling, which will cause a rise in the value of the £.

The Volume of imports An increase in imports coming into the UK will mean more sterling has

to be sold in order to purchase foreign currency needed to buy

imports. This will lead to an increase in supply of £’s and so the

value will fall.

The Volume of imports An increase in imports coming into the UK will mean more sterling has

to be sold in order to purchase foreign currency needed to buy

imports. This will lead to an increase in supply of £’s and so the

value will fall.

Government Intervention Governments might purchase their

own currency to influence its value. When they purchase the

currency it increases demand and so causes a rise in the value

Government Intervention Governments might purchase their

own currency to influence its value. When they purchase the

currency it increases demand and so causes a rise in the value

Speculation The short term price of a currency

is influenced by speculation. If dealers on the exchange market think the value of a currency will

fall in the future, they might to sell any reserves of this currency that they have. This increases supply

and therefore reduces the value of the currency.

Speculation The short term price of a currency

is influenced by speculation. If dealers on the exchange market think the value of a currency will

fall in the future, they might to sell any reserves of this currency that they have. This increases supply

and therefore reduces the value of the currency.

The level of interest rates A rise in interest rates will attract

savings from abroad; this will raise the demand for sterling and hence increase its value. A fall in interest rates will have to opposite effect.

The level of interest rates A rise in interest rates will attract

savings from abroad; this will raise the demand for sterling and hence increase its value. A fall in interest rates will have to opposite effect.

Investment and capital inflows An inflow of funds or long term investment, will increase the

demand for sterling and hence its value. An outflow will have the

opposite effect.

Investment and capital inflows An inflow of funds or long term investment, will increase the

demand for sterling and hence its value. An outflow will have the

opposite effect.

Summary of the factors affecting exchange rates…

Anything that causes an increase in demand for a currency or reduces

the supply of a currency will cause its value to

rise.

Anything that increase supply or reduces

demand of a currency will cause it value to fall.

Why are exchange rates important to businesses?

Because exchange rates influence the

price of imports and exports.

What are the effects of a depreciating exchange rate on businesses?

•Exports become cheaper.

•Imports will become more expensive

What problems are caused by a depreciating exchange rate?

•Materials purchased from abroad will be more expensive.

• Rising import prices can lead to inflation. •Businesses will be uncertain about prices.

What are the effects of an appreciating exchange rate?

•Exports become more expensive.

•Imports become cheaper.

What problems are caused by appreciating exchange rates?

•Exporting businesses will be less competitive

abroad.• Businesses that rely on imported materials will

benefit.

What factors influence how significantly businesses are affected by changes in the

exchange rate?

• The response of customers.

• The degree of control over prices.

• The businesses reliance on components and raw

materials.