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