Foreign Exchange/ Flexible & Fixed Rates

Foreign Exchange

Foreign Exchange- Any transactions that occurs in the balance of payments necessitates foreign exchange.

.Exchange Rate is determined in the foreign currency markets.

.In order to purchase souvenirs in France, it is first necessary for Americans to sell (Supply) their dollars and buy Euros (Demand.

Changes in the Exchange Rates

.Exchange Rates are a function of the supply and demand for currency

.An increase in the supply of a currency will decrease the exchange rate of a currency.

.A decrease in supply of a currency will increase the exchange rate of a currency

.An increase in demand for a currency will increase the exchange rate of a currency

.A decrease in demand for a currency will decrease the exchange rate of a currency

Appreciation and Depreciation

.Appreciation of a currency occurs when the exchange rate of the currency increases

.Depreciation of a currency occurs when the exchange rate of that currency decreases

.The more you supply, the more the value depreciates. The more you demand, the more the value of the money appreciates

Exchange Rates Determinants

.Consumer Rates

.Relative Income

.Relative Price Level

.Speculation

Exports and Imports

Exchange Rate is a determinant of both exports and imports

.Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper, thus reducing exports and increasing imports

.Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive, thus increasing exports and reducing imports

As two currencies trade:

.One supply line will change while the other demand line will also change

They will move in the same direction

.One currency will appreciate while the other will depreciate

Flexible Rates

.Based on supply and demand of that currency versus the other currency

.Very sensitive to the business cycle and it provides options for investment

Fixed Rates

Based on countries willingness to distribute currency and to control the amount