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Kunal Gupta Sunil Nerurkar Manish Pandey Snehal Prajapati Rahul Punalekar Vishal Radhesham Nishant Soni
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What is an Exchange Rate?
An exchange rate is the rate at which one currency can be exchanged for another In other words, it is the value of another country's currency compared to that of your own
The exchange rate is the price at which you can buy the currency of other country. If you are traveling to US and the exchange rate for U.S. dollars 1:43 INR, this means that for every U.S. dollar, you can buy 43 Indian Rupees
By manipulating interest rates. inflation and exchange rates are all linked.Factors Influencing Exchange Rates Differentials in Inflation ± Country lower inflation exhibits a rising currency value. and that it is borrowing capital from foreign sources to make up the deficit 3 . and changing interest rates impact inflation and currency values Current-Account Deficits ± A deficit in the current account shows the country is spending more on foreign trade than it is earning. as its purchasing power increases relative to other currencies Differentials in Interest Rates ± Interest rates. central bank exert influence over both inflation and exchange rates.
What is its Importance? Stable foreign investment With a peg. which results from greater confidence in the stability of the currency 4 . the investor will always know what his or her investment's value is. and therefore will not have to worry about daily fluctuations Inflation A pegged currency can also help to lower inflation rates and generate demand.
Types of Exchange Rate Floating Exchange Rate Fixed Exchange Rate 5 .
its value will decrease. as any differences in supply and demand will be corrected in the market A floating exchange rate is constantly changing If demand for a currency is low. thus making imported goods more expensive and stimulating demand for local goods and services This in turn will generate more jobs. causing an auto-correction in the market 6 .Floating Exchange Rates Determined by the private market through supply and demand Termed "self-correcting".
euro. dollar. the central bank buys and sells its own currency on the foreign exchange market in return for the currency to which it is pegged 7 .Fixed Exchange Rates Sometimes called a Pegged Exchange Rate Government sets and maintains as the official exchange rate Set price will be determined against a major world currency (usually the U.S. the yen or a basket of currencies) In order to maintain the local exchange rate.
the government buys its own currency in the market using its reserves This places greater demand on the market and pushes up the price of the currency If the exchange rate drifts too far above the desired rate.Maintenance Government can maintain a fixed exchange rate by either buying or selling its own currency in the open market This is one reason governments maintain reserves of foreign currencies If the rate drifts too far below the desired rate. thus increasing its foreign reserves 8 . the government sells its own currency.
it automatically fixed its currency·s price to other currencies 9 .History of Exchange Rate System Between 1867 and 1933. most of the world·s economies used the gold standard Gold standard : A system of fixed exchange rates in which the value of currencies was fixed against gold and gold was used as the primary reserve asset By fixing its currency·s price to gold.
History (Contd..) The gold specie flow mechanism was the long-run mechanism that maintained the gold standard Gold flowed out of the country when it experienced a deficit and into the country with a surplus The gold standard determined a country·s monetary policy 10 .
. to partially abandon the gold standard in 1933.S.History (Contd. U. citizens could no longer exchange gold for their dollars.S. but instead were given silver. That ended in the late 1960s In 1971. the U.S.) The Depression led the U. totally cut off the relationship between dollars and gold 11 .
Bretton Woods System An agreement that fixed exchange rates that governed international financial relationships from the period after World War II until 1971 The Bretton Woods system established the International Monetary Fund (IMF) and the World Bank The International Monetary Fund (IMF) arranges short-term loans between countries The World Bank makes longer-term loans to developing countries 12 .
S.Features of Bretton Woods System Obligation to adopt a policy that maintained the exchange rate by tying its currency to the U. dollar A fund was set up to make short-term loans to countries that ran out of currency reserves Exchange rate adjustments were overseen by the IMF 13 .
) The IMF created a type of international money called Special Drawing Rights (SDR) SDRs never became established as an international currency Instead.Features (Contd. U. dollars served as official reserves for individuals and countries 14 .S..
15 . since a peg is difficult to maintain in the long run.S. led to severe financial crises. the number of U. An attempt to maintain a high value of the local currency to the peg resulted in the currencies eventually becoming overvalued.S. The governments could no longer meet the demands to convert the local currency into the foreign currency at the pegged rate. dollars held by foreigners exceeded the amount of U.Collapse of Bretton Woods By the early 1970s. gold Fixed regimes.
the Thai bhat had lost 50% of its as the market's demand and supply readjusted the value of the local currency 16 . and by the end of 1997. the government was forced to devalue the peso by 30% In Thailand. investors scrambled to get their money out and convert it into foreign currency before the local currency was devalued against the peg. the government eventually had to allow the currency to float.Collapse of Bretton Woods With speculation and panic. foreign reserve supplies eventually became depleted In Mexico's case.
S. governments buy or sell their own currencies to affect the exchange rate 17 . the U.Collapse of Bretton Woods When France and other countries demanded gold for their dollars. ended its policy of exchanging gold for dollars in 1971 With that change. the Bretton Woods system was dead The exchange rates of most Western countries are now allowed to fluctuate At various times.
Time Table of Collapse Dec 1958 Mar 1961 Oct 1961 Jan Mar 1962 Fourteen European countries start convertibility of their currencies for current account transactions Basle Agreement among central banks to hold each other s currency and to lend to each other.40 Oct 1963 Oct Nov 1967 Mar Nov 1968 Gold Pool interventions end. Germany. Establishment of the London Gold Pool. and the United Kingdom 18 .80 to $2. Start of persistent French gold purchases from the United States Beginning of the swap facilities to provide reciprocal lines of credit among central Banks Beginning of the GAB Start of technical studies and discussions that would lead to the establishment of the SDR End of persistent French gold purchases from the United States The United Kingdom devalues the pound sterling from $2. the two-tiered market for gold begins SDR amendments are sent to IMF members for approval Exchange pressure on the French franc because of internal political crisis Exchange crisis closes markets in France.
suspends the use of swaps.Time Table of Collapse Mar ± Nov 1968 Gold Pool interventions end.273 First SDR allocation Second SDR allocation The deutsche mark and the Dutch guilder float The United States suspends convertibility of the dollar into gold for official transactions.25 to $0. Germany.18 grams of gold per franc to . the two-tiered market for gold begins SDR amendments are sent to IMF members for approval Exchange pressure on the French franc because of internal political crisis Exchange crisis closes markets in France. impose exchange controls. and the United Kingdom SDR amendments are in force The French franc is devalued from . all countries with major currencies except France start to float. and imposes price controls and a 10 percent import surcharge. and undertake major interventions19 to buy Dollars Jul ± Oct 1969 Jan 1970 Jan ± Aug 1971 .16 grams The deutsche mark is revalued from $0.
Exchange Rate Regimes Main Features Independent Float Exchange Rate in market Monetary Authority does not intervene Can be used freely to steer domestic economy Country Circumstances Advantages Appropriate for large industrialized countries some emerging market economies that are relatively closed to international trade but fully integrated in the global capital markets Appropriate for emerging economies with strong financial sector. 20 . Direct or Indirect Intervention through change of exchange rates Limited flexibility for partial shock absorption Low vulnerability to currency crises. Not prone to currency crisis Managed Float Monetary Authority intervention. More easily deflect or absorb adverse shocks.
Monetary authority is not committed to peg indefinitely. Country Circumstances Appropriate for developing economies with limited link to global financial markets. 21 Currency Union Dollarization Appropriate for countries that have already developed extensive trade and other economic ties (EMU). The peg is adjusted when misalignment Another country's currency is used as only legal tender No scope for independent monetary policy. Lower interest rates Provides a clear and easily monitor able nominal anchor Maximum credibility for the economic policy. Advantages Can maintain stability and competitiveness if the peg is credible. Facilitate disinflation Not prone to currency crisis.Exchange Rate Regimes Main Features Fixed Peg Ex Rate is pegged at fixed rate to major currency or basket of currency or to SDR. .
this automatic rebalancing does not occur 22 .Criticism of Fixed Exchange Rate System Flexible exchange rates serve to automatically adjust the balance of trade During trade deficit there will be increased demand for the foreign currency which will increase the price of the foreign currency in terms of the domestic currency Makes the price of foreign goods less attractive to the domestic market and thus pushes down the trade deficit Under fixed exchange rates.
Capital Control Fixed Exchange Rate speculative attacks tend to target currencies with fixed exchange rate regimes A fixed exchange rate regime should be viewed as a tool in capital control Capital Control the stability of the economic system is maintained mainly through capital control Capital Control includes fixed exchange rate 23 .Fixed Exchange Rate Regime Vs.
Conclusion Although the peg has worked in creating global trade and monetary stability. it was used only at a time when all the major economies were a part of it And while a floating regime is not without its flaws. it has proved to be a more efficient means of determining the long-term value of a currency and creating equilibrium in the international market 24 .
investopedia.investopedia.com/articles/03/020603.References http://en.org/wiki/Bretton_Woods_system http://www.com/terms/f/fixedexchangerate.asp http://www.asp 25 .wikipedia.
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