Exchange rates and their determination


what it is and factors affecting demand

-Price of one currency in terms of another

Interest Rates

  • Can affect the flows of money around the world.
  • An increase in IR will increase the demand for pounds and cause the ER to rise

Currency Speculators

  • Speculators are firms, individuals or financial institutions tha tbuy and sell currencies in the hope of making a capital gain
  • Attracts speculators because prices of currencies sometimes vary dramatically
  • They bus a currency and hope to sell it for a higher price later
  • If they think the value will increase, they will buy it. Increasing the demand

The Demand for Exports

  • Exports will have to be paid in their own currency. Demand rise=ER rise
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Factors affecting supply

Interest Rates in other countries

  • If IR is higher in other countries, savers in the UK may decide to place their money in foreign banks
  • They must buy foreign currency and increase the flow of pounds into the foreign exchange markets.
  • Increasing the supply and reduce the ER

Currency Speculators

  • If they think the price will fall, they will sell to. Increasing the supply and lower ER

Demand for Imports

  • Imported goods have to be bought with foreign currency
  • Outward FDI will affect the supply. It will increase the supply
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How they're determined

Foreign exchange market: market where foreign currencies can be bought and sold

  • Forces of supply and demand determine the equilibrium ER

Affect of change in supply

  • Increase in supply reduces the ER
  • Fall in demand for imports has the opposite effect

Affect of change in demand

  • Demand for pound increases exchange rate
  • Fall in demand has the opposite effect
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