PRESENTATION ON ECON-2302

HOW FOREIGN
EXCHANGE
RATE IS FIXED?
OC IBRAHIM ROLL: 8612901
TA ASIF ROLL: 8612869
Foreign Exchange Markets
 Peopleexchange currencies because they want to buy foreign goods and
services. The foreign exchange markets make currency exchange
possible.
 ForeignExchange Market- A market in which the money (currency) of
one nation can be used to purchase (can be exchanged for) the money of
another nation.
FX Market development in Bangladesh
• During 1971, Bangladesh did not have any forex reserve.
• Since 1971 to Jan 09, 1972 our official currency was Rupee.
• On Jan 10, 1972 our official currency becomes Taka and was pegged with
Pound Sterling. Per value of Taka was declared at 18.9667 per pound sterling.
• In 1983, pegging was shifted to USD.
• Taka was declared convertible for current international transactions on March
24, 1994.
• Floating rate system was declared on May 31, 2003.
• Forex reserve of the country reached at USD22.50 billion on Aug 07, 2014.
Foreign Exchange
Foreign Currencies are known as foreign exchange.

When the price of one country’s currency is

described in terms of another country’s currency
it is known as the exchange rate.
One euro = 1.5 dollars
One yen = 1/100 dollar
One peso = 1/10 dollar
Flexible Exchange Rates
• Flexible or floating exchange rates are determined by supply & demand
of one country’s currency in terms of the value of another country’s
currency.

• In other words supply and demand determine the prices of currencies in

the foreign exchange market
Appreciation & Depreciation of Currencies
The values of currencies are described in terms
of appreciation and depreciation.
• If one currency becomes more valuable in terms of
another currency it appreciates.
• If one currency becomes less valuable in terms of
another currency it depreciates.
Markets and Currency Exchange
• Demand for a currency is primarily determined by demand for a
country’s products.
• If there is an increase in demand for Samsung tablets, then there will
be an increase in demand for South Korean currency (won).
• This increase in demand for the won would lead to an increase in
supply of the dollar (we must supply our dollars in order to buy the
won)
DETERMINANTS OF EXCHANGE RATES

 Changes in Tastes- a foreign good is popular (Toyota Prius) :.

Demand for Yen up
 Relative Real Interest Rates – If interest rates rise in US
foreigners want to save here : Demand for USD up
 Relative (Y) Income Changes- Europe goes into a recession :.
Demand for USD down
 Relative Price Changes- Inflation hits Bangladesh :. Demand for
BDT down
 Speculation – Currency traders expect the price of the USD to rise
against the BDT :. Demand for the USD up
THE MARKET FOR CURRENCY
The supply of BDT is upward
sloping because US goods
become cheaper as the dollar
P price of BDT rises so more BDT S

Dollar price of one BDT

will be supplied to buy US
goods

3 The demand for BDT is

downward sloping because
as BDT become cheaper
Bangladeshi goods become
cheaper and Americans are
2 willing to buy more
Bangladeshi goods and
more BDT.

1
D

Quantity of BDT Q
 U.S. TRANSACTIONS

Points to remember:
U.S. exports create a foreign
demand for dollars and a supply of
foreign currencies in the Foreign
Exchange Market
U.S. imports create a domestic
demand for foreign currencies and
a supply of US dollars in the
Foreign Exchange Market
Graphing Currency Exchange
EXCHANGE
P RATE: $2 = £1
S
$3 = £1

Dollar price of one pound

3

Pound
appreciates
2

D1
1

Quantity of pounds Q
Graphing Currency Exchange
S
EXCHANGE
P RATE: $2 = £1
S2

Dollar price of one pound 3

D
D1
Quantity of pounds Q
Trading in the Foreign Exchange Market
• When an importer enters the foreign exchange market (FEX) he/she will
be both a buyer and a seller of currency.
• As an importer you will be a buyer of the currency you need and a seller
of the currency you have.
• Buyers = Demand
• Sellers = Supply
 Exchange Rates & Trade Balances
• Flexible exchange rates automatically adjust to eliminate balance of
payments deficits or surpluses.
• If there is increased demand for a country’s goods (it has a trade
surplus), then a country’s currency increases in value, and its goods
become more expensive.
• This decreases the amount that foreign citizens want, restoring trade
balances.
BALANCE OF PAYMENTS
This is a statement compiled by the U.S.
Commerce Department that shows all the
payments a nation receives from foreign
countries and all the payments it makes to
them. It is a statement of foreign exchange.
U.S. BALANCE OF PAYMENTS * (2007)
Current Account
1)U.S. goods exports............................................................................... $+1149
2)U.S. goods imports............................................................................... -1968
3)Balance on goods......(lines 1 + 2)............................................................. - 819
 4)U.S. services exports............................................................................ + 497
5)U.S. services imports............................................................................ - 378
6)Balance on services........(lines 4 +5)....................................................................... + 119
7)Balance on goods and services.......(lines 3 + 6)......................................................... - 700
 8)Net investment income..(net interest & dividend payments on foreign financial assets)..... + 82
9)Net transfers (foreign aid, pensions for US retirees living abroad, money sent home by immigrants) - 113
 10)Balance on current account ...(lines 7 + 8+ 9)........................................................ - 731
 Capital Account
11)Foreign purchases of assets in the U.S..(foreigners buying US assets) ...........+ 2058
12)U.S. purchases of assets abroad...(US citizens buying foreign assets).............- 1289
 13)Balance on capital account..........(lines 11 + 12)..................................................... + 768
 14)Balance on current and capital account (10 + 13) ....................................................... + 37
 Official Reserves account
14)Official reserves (the amount the Federal Reserve must inject or subtract to bring the balance to 0) - 37
 
BALANCE OF PAYMENTS $0
*in billion of US dollars
Balance of Payment Accounts
• Current Account is a record of a country’s currency exchange
for the:
• exports and imports of goods and services
• net investment income – interest income earned from foreigners on our foreign
investments and paid out to foreigners for their investments here
• net transfers – direct payments for foreign aid, pensions to U.S. citizens living
abroad, a remittances by immigrants to relatives abroad and those same payments
into the U.S.
• Capital Account is a record of a country’s currency exchange
for the purchase or sale of real or financial assets and the
corresponding monetary (capital) flows to pay for them.
• Real assets include office buildings, factories, homes, land.
• Financial assets include stocks and bonds (government and private).
• Decisions about investing are based on expected
returns. This would be determined by interest rates
on financial assets and expected profit on real assets.
Balance on the Current and Capital Accounts
• For both accounts exports (the sale of goods, services or assets)
generate an accumulation of foreign currency and are considered a
credit (+) and imports (the purchase of goods, services or assets)
require the use of foreign currency and are considered a debit (-).
Official Reserves Account –
• a measure of foreign currencies held in reserve by a
country’s central bank used to make up any deficit in the
combined current and capital accounts.
• The bottom line must be zero. You must pay for your
purchases with foreign currencies. Your inflows and
outflows must balance.

• In our country our large current account deficits tend to be

balanced with large capital account surpluses.
Appreciation & Depreciation of Currencies

If an nation’s currency appreciates,

some foreign currency depreciates
relative to it.
THANK YOU