FOREIGN

EXCHANGE
RATE

EXCHANGE RATE
Is the price of a unit of foreign currency in
the terms of domestic currency.
The ratio at which two currencies are traded.
The price of one countrys currency in terms
of other countrys currency.

Two types of exchange

rates

Floating Exchange Rate

- The value of a countrys
currency changes based on
market force.

Fixed Exchange Rate

- The government manipulates
the value of countrys currency.

Impotance of Exchange Rate

It serves as the basic link between the local and
the overseas market for various goods, services
and financial assets.
Exchange rate movements can affect actual
inflation as well as expectations about future price
movements. Changes in the exchange rate tend to
directly affect domestic prices of imported goods
and services.

Exchange rate movements can affect

the countrys external sector through
its impact on foreign trade. An
appreciation of the peso, for instance,
could lower the price competitiveness
of our exports versus the products of
those competitor countries whose
currencies have not changed in value.

Determinants of Exchange rates

1. Inflation Rates
Changes in market inflation cause changes in currency
exchange rates. A country with a lower inflation rate
than another's will see an appreciation in the value of
its currency. The prices of goods and services increase
at a slower rate where the inflation is low. A country
with a consistently lower inflation rate exhibits a rising
currency value while a country with higher inflation
typically sees depreciation in its currency and is usually
accompanied by higherinterest rates

2. Interest Rates

Changes in interest rate affect currency value

and dollar exchange rate. Forex rates, interest
rates, and inflation are all correlated.

2. Interest Rates
Government debt is public debt or national
debt owned by the central government. A
country with government debt is less likely to
acquire foreign capital, leading to inflation.

4. Terms of Trade
the terms of trade is the ratio of export prices to
import prices. A country's terms of trade improves
if its exports prices rise at a greater rate than its
imports prices.

4. Terms of Trade
A country's political state and economic performance
can affect its currency strength. A country with less risk
for political turmoil is more attractive to foreign
investors, as a result, drawing investment away from
other countries with more political and economic
stability.

6. Recession
When a country experiences a recession, its
interest rates are likely to fall, decreasing its
chances to acquire foreign capital. As a result, its
currency weakens in comparison to that of other
countries, therefore lowering the exchange rate.
6. Recession
If a country's currency value is expected to rise,
investors will demand more of that currency in order to
make a profit in the near future. As a result, the value of
the currency will rise due to the increase in demand.
With this increase in currency value comes a rise in the
exchange rate as well.

Balance of Payment

The record of a countrys transactions in goods,

services and assets with the rest of the world ;
also the record of a countrys sources (supply)
and uses (demand) of foreign exchange.