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Wednesday, July 24, 2013



EXCHANGE RATES Presentation Transcript:

The exchange rate is the amount of foreign currency paid to obtain a unit of the home currency (this is the definition used by the IB)

If the exchange rate rises, the home currency appreciates, more of the foreign currency is needed in order to purchase the home currency.

If the exchange rate falls, the home currency depreciates; less of the foreign currency is needed to purchase the home currency

The real exchange rate takes into account the effects of inflation

3.Exchange rate systems
Fixed Exchange Rates
Floating Exchange Rates
Managed Exchange Rates

4.Fixed Exchange Rates
Under the fixed exchange rate system rates are fixed at some value and the central bank intervenes to ensure it stays at that agreed upon rate
A fixed exchange-rate system (also known as pegged exchange rate system) is a currency system in which governments try to keep the value of their currencies constant against one another
If there is a permanent switch away from the agreed on rate, the central bank will be faced with constantly buying or selling to maintain the old rate.

1. Promotes International Trade
2. Necessary for Small Nations:
3. Promotes International Investment
4. Removes Speculation
5. Necessary for Developing Countries
6. Suitable for Currency Area
7. Economic Stabilization
8. Not Permanently Fixed
9. Other Arguments

1. Outmoded System
2. Discourage Foreign Investment
3. Monetary Dependence
4. Cost-Price Relationship not Reflected
5. Not a Genuinely Fixed System
6. Difficulties of IMF System

7.Floating Exchange Rates
Under the flexible exchange rate system, rates are allowed to float.
Currencies are allowed to float and govt. intervenes periodically to influence the price but does not set the price.
A floating currency is a currency that uses a floating exchange rate as its exchange rate regime.

8.Managed Exchange Rates
The managed float is basically a flexible exchange rate system in which rates are permitted to float, but the central bank intervenes on a regular basis to keep the rate within some agreed upon limits.
Govt. can influence exchange rates, usually through the Central Bank by:
Buying and selling both domestic and foreign currency
Altering interest rates in order to influence short term capital flows
Altering return on investment

1. Independent Monetary Policy
2. Shock Absorber
3. Promotes Economic Development
4. Solutions to Balance of Payment Problems
5. Promotes International Trade
6. Increase in International Liquidity:
7. Market Forces at Work
8. International Trade not Promoted by Fixed Rates
9. International Investment not Promoted by Fixed Rates
10. Fixed Rates not Necessary for currency Area
11. Speculation not Prevented by Fixed Rates

1. Low Elasticity
2. Unstable conditions
3. Adverse Effect on Economic Structure
4. Unnecessary Capital Movements
5. Depression Effects of Capital Movements
6. Inflationary Effect
7. Factor Immobility
8. Failure of Flexible Rate System

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