Exchange rates and their determination

-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

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

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