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Foreign Exchange Rates | O Level Economics 2281 & IGCSE Economics 0455 | Detailed Free Notes To Score An A Star (A*)

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  • Price of one currency in terms of another currency
    • For example 1 USD is equal to 250 PKR etc.
    • Trading between countries requires exchange rate to gauge the currencies
  • Market supply and market demand of the currency can determine the foreign exchange rate
    • The higher the demand, the higher the exchange rate
      • Based on exports or net transfer usually
    • The lower the supply, the higher the exchange rate usually.
  • Causes of foreign rate fluctuations
    • Imports exports change and their demand changes
        • Imports greater than exports
        • Currency devalues
    • Exports greater than imports
      • Currency appreciates
  • Inflation
    • Higher inflation will result in fall in exports
    • Therefore, currency will fall
  • Interest Rate changes
    • High interest rate means people abroad would like to invest in the country, so they will require the currency as they want to gain more interest
      • So currency value increases
  • Foreign Direct Investments
    • It would increase the currency requirements if foreign investment is coming in the country
  • Thinking about the future
    • If companies believe better profits will occur in the future, they will want more the currency today
    • Confidence in the economy increases will increase interest rate.
  • Government intervention
    • Government can set exchange rates as well
    • Can affect demand as well.
  • Exchange Rate Fluctuation Issues
    • Imports price rise and exports price falls if currency devalues
    • Imports price reduces and export price increases is the currency appreciates
    • Currency devaluation will improve balance of trade
    • Currency appreciation will worsen balance of trade
  • Floating Exchange Rate
    • Exchange rate determined freely by market forces
    • Appreciation if exchange rate increases
    • Depreciation if exchange rate falls
    • Benefits
      • Stabilization occurs automatically
      • Internal policy objectives can be pursued without focusing on balance of payments
      • External changes won’t effect the country from inflation in other countries
        • Fixed exchange rate results in import of inflation from inflated import products
      • Foreign reserves at high level not required because exchange rate does not have to be changed by choice.
    • Cons
      • It leads to uncertainty in the market
      • Investment would reduce as people are not sure about the prediction regarding the economy
      • Speculation about fluctuations can create uncertainty
      • Discipline will reduce and short-run problems can exasperate
  • Fixed Exchange Rate
    • Central bank sets an exchange rate
      • Increase in value called revaluation
      • Decrease in value called devaluation
    • Advantages
      • Certainty
      • Investment
      • Low inflation
      • Balance of payments are stable as BOP uncertainty is removed
    • Problems
      • Other macroeconomic objectives can be affected
      • Flexibility issues as temporary shocks nay nit be responded immediately
      • Under or over valuation of currency may occur
Hunain Zia

Hunain Zia has previously achieved considerable success in the high-school educational stream, gaining a massive 154 Total A Grades and 7 Major Distinctions, a process in which he broke/ set 11 different world records, including the most A grades ever achieved, most subjects ever appeared in, most distinctions, gaining distinctions across two separate boards (Pearson Edexcel and CAIE) within the same year/ ever, and even 19 hours of constant examination. All records stand intact today. Hunain pursued his Honors Accounting Degree from the prestigious Bentley University, and then completed an LLB (in Honors) from University of London. Currently, he manages multiple social and commercial projects, has founded digital streams and works tirelessly in the education sector.

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