Unit 7 Notes - May 3rd, 2016

Foreign Exchange (FOREX)

·         The buying and selling of currency.

·         Any transaction that occurs in the Balance of Payments necessitates foreign exchange.

·         Exchange rate is determined in the foreign currency markets.

Changes in Exchange Rates

·         Exchange rates are a function of the supply and demand for currency.

o   An increase in the supply of a currency will decrease the exchange rate of a currency.

o   A decrease in the supply of a currency will increase the exchange rate of a currency.

o   An increase in demand for a currency will increase the exchange rate of a currency.

o   A decrease in demand for a currency will decrease the exchange rate of a currency.

Appreciation & Depreciation

Appreciation: of a currency occurs when the exchange rate of that currency increases.

Depreciation: of a currency occurs when the exchange rate of that currency decreases.

Exchange Rate Determinants

·         Consumer’s Taste

·         Relative Income

·         Relative Price Level

·         Speculation

Exports and Imports

·         The exchange rate is a determinant of both imports and exports.

·         Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper thus reducing exports and increasing exports and reducing imports.

·         Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports.

Floating/Flexible Rates

Based upon supply and demand of that currency versus other currencies. Very sensitive to the business cycle and it provides options for investments.

Fixed Rates

Based upon a countries willingness to distribute currency and to control the amounts.