International Trade and Policy
Foreign Exchange Rate
Under the Supervision of:Megha Maam
Presented By:Kushaldeep Gill
Mansi Geol
Abhishek Jain
Sakshi Gulati
Sandhya Keisham
Suvam Dhar
BBA, 2nd Year, Section A
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 nations 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 countrys 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 countrys 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 doesnt 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
Key currency
US dollar
German mark
Japanese yen
British pound
French franc
ECU
Swiss franc
Netherlands guilder
Other
All
countries
Industrial
countries
Developing
countries
60.3%
12.1
5.1
3.9
1.3
0.8
0.7
0.4
15.4
64.3%
14.7
7.0
3.1
1.4
1.8
0.2
0.3
7.2
57.1%
10.1
3.7
4.6
1.2
1.0
0.4
21.9
10
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 currencys
value relative to other currencies, correcting a
surplus
14
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
15
Devaluation/Revaluation: Legal and Economic Impact
Devaluation/Revaluation: Legal and Economic Impact
Effects of Devaluation
The
gap between official exchange rate and
equilibrium exchange rate will be reduced.
Exports
become more competitive in the
international market.
Imports become more expensive.
Effects of Revaluation
The
gap between official exchange rate and
equilibrium exchange rate will be reduced.
Exports
become less competitive in the
international 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 Disadvantages
Advantages
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 A floating exchange rate is one
value is fixed against the value of
which is determined by market
another currency
forces
Its Fixed
Its Flexibility
Higher Foreign Exchange
Reserves
Lower Foreign Exchange
Reserves
Certain
Uncertainty
Necessary for Small Nations For Developed Nations
Thank you
