SUBMITTED TO SUBMITTED BY

Prof. ASHOK BHANSALI RAHUL GUPTA

PGPBM (2009-11)
ISB&M; NOIDA

Question 1-What are the advantages and disadvantages of a fixed versus floating exchange rate
systems?
Answer: Floating exchange rate regimes are market determined exchange rates in which value of
currency fluctuates with market conditions. In the fixed rate regime, the central bank of country is
responsible for maintenance of exchange rate at predetermined price with the help of different monetary
policies.
The main economic advantage of floating exchange rates is that they leave the monetary and fiscal
authorities free to concentrate on internal goals such as employment, stable growth and commodities
prices because in this case free floating exchange rate works as an automatic stabilizer to control the value
of currency.
The main economic advantage of fixed exchange rates is that they promote global trade and investment
by gaining trust of corporate and investors as they know government is there to control all the risk
associated with exchange rates. This can be very important in long run growth.
A s given in the case, Singapore after getting independence from UK have three developmental
imperatives to counter-
1. Reduce unemployment
2. Promote industrialization
3. Become a globally competitive off-shore financial sector.
So they adopted policy of managing their exchange rates i.e. semi-fixed exchange rate regime, which
allows exchange rates to vary within a certain band which assured foreign investors that there is
government to take care of exchange rates, prices.
I would try to bring out disadvantages of fixed and floating exchange rates with the help of economic
conditions given in the case:


Floating Exchange rate:-
1. As discussed earlier, Singapore government has three development imperatives. By having
floating exchange rate government would not be able to control inflation. So this can hamper their
first two objectives to reduce unemployment and to promote industrialization.
2. Free floating Singapore Dollar (SGD) would become highly volatile in short run; leading to
misallocation of resources in long run.



Fixed Exchange Rate:-
Singapore economy is a more off shore financial market. So fixing its currency at a exchange
rate would mean aligning there currency to some other currency .But its not possible due to
divergence in business cycles of different countries. As we can see in the case of Hong Kong they
have fixed their currency against USD and their business cycle is aligned to Chinese business cycle. It
helped them a lot when everything was going well throughout the globe then Hong Kong was doing well
throughout all the sectors .But when Asian financial crisis hit the globe, then HK$ came under pressure,
because they want a tighter monetary policy at that point but their interest rates were lower as they were
aligned with USD. Hong Kong experienced severe deflation due to contraction in money supply. Also
investors feared that Hong Kong government might devalue HK$. Finally stock market fell by 25% and
when government tried to overcome this by increasing interest rates then they slipped into recession.


Question 2:- What is real exchange rate?
Answer:- Real exchange rate is the measure in terms of ratio at which the any countries own
currency is equivalent to other currencies in terms of purchasing power. It is preferred over
nominal exchange rates as nominal rates only measures the ratio at which countries currency is
traded in spot market. It gives much clearer picture of any countries exchange rates.
Real Exchange Rate=Nominal exchange Rate-Inflation
Question 3:- What do you think determines exchange rates in short term, medium term and long
term?
Answer- Factors determining exchange rates
Short Run
1. Trend followed in the market.
2. How investor have positioned himself/herself.
3. Sentiments of investors.
4. Foreign investments.
5. Risk appetite of investor.
6. How option foreign markets have positioned themselves.
Medium Run
1. Real interest rate differentials.
2. Current account trends.
3. Capital Flows.
4. Monetary policy.
5. Fiscal Policy.
6. Relative economic growth.
Long Run
1. Purchasing Power Parity.
2. Net Foreign Assets.
3. Productivity i.e. GDP.
4. Trends in terms of trades.
5. Savings/investment balance.
Question 4:-How do exchange rates interacts with trade balances, inflation rates and fiscal policies?
Answer-
I nflation
Country having lower inflation rate, the purchasing power related to that currency decrease less relative to
countries with higher inflation rate. So the value of money decreases less as compared to other currencies.
So all these relative works results into higher exchange rates.
Interest rates, inflation and exchange rates are all highly correlated. By manipulating interest rates, central
banks exert influence over both inflation and exchange rates, as we can see in case of Singapore as they
have managed inflation below 2% throughout last two decades just by managing their exchange rates in
pre-decided band.
Trade balance
Trade Balance=Exports-Imports
Everything that impact imports and exports are determining factor of trade balance. Exchange rate
determines the prices of commodities traded. So its very important factor in determining trade balance. If
the price of a country's exports rises by a greater rate than that of its imports, then trade have favorably
improved for that country. Trade surplus shows greater demand for the country's exports. This, in turn,
results in rising revenues from exports, which provides increased demand for the country's currency (and
an increase in the currency's value). And vice-versa happens in case of trade deficit.
Fiscal Policies
Fiscal Policy is managing countries expenditures and revenue collection to influence countrys economy.
The main sources of revenues for government are taxation, seigniorage, borrowing money, fiscal reserves
and selling of assets.
We know value of currency is determined by exchange rates. Taxes are important earning from trade and
trade is directly related to exchange rates. So while making fiscal policies countries must care about
exchange rates. As Singapore was having advantage of large savings by their citizens.
Question 5 :- How exchange rates do impacts firms?
Answer:- When domestic currency is valued more against foreign currency, it makes import cheaper and
exports expensive. So businesses having more import will be flourishing and exports led businesses will
not, and in vice versa situation just opposite will happen to businesses.
Moreover, in simple words exchange rates are important factor in formulating monetary and fiscal
policies. These policies determine business environment of any country. For example, if interest rates
increase in India, then it affects the valuation of all investments in our country i.e. if interest rate increases
then returns increases on investment. As investment increases in corporate, corporate will go for fresh and
better projects.