Exchange Rate determination &

Foreign exchange Market

Syeda Sarah Alif
Lecturer, DBA
 What is an Exchange Rate?

• An exchange rate is the value of one nation's 

currency versus the currency of another
nation or economic zone. For example, how
many U.S. dollars does it take to buy one euro
? As of July 31, 2020, the exchange rate is
1.18, meaning it takes $1.18 to buy €1.
 What is currency appreciation and depreciation?

• Currency appreciation is an increase in the value of currency

comparing to another currency. There are number of reasons that
contribute currency appreciation, including government policy,
interest rates, trade balances and business cycles. Currency
appreciation happens in a floating exchange rate system, so a
currency appreciates when the value of one goes up compared to
another. In other word, appreciation takes place when exchange rates
change, allowing for the purchase of more units of a currency.
• Currency depreciation is an opposite of currency appreciation, it is a
fall in the value of a currency in a floating exchange rate system.
Currency depreciation can occur due to any number of reasons –
economic fundamentals, interest rate differentials, political instability,
risk aversion among investors and so on.
 Example of Currency Appreciation &
Depreciation
• Appreciation and depreciation of the currency can be very simple to
identify. For example, USD/BDT = 85. The first of the two currencies
(USD) is the base currency and represents a single unit, or the
number 1 in the case of a fraction such as 1/85. The second is the
quoted currency and is represented by the rate as the amount of that
currency needed to equal one unit of the base currency. The way this
quote reads is: One U.S. dollar buys 85 units Bangladeshi Taka.
• For the purposes of currency appreciation, the rate directly
corresponds to the base currency. For example, If the rate increases
to 90, then one U.S. dollar now buys 90 units of BDT and if the
currency depreciate that means one U.S. dollar can only buy BDT in
the value of less than 85. Therefore, the currency depreciation and
appreciation can have a part in contributing exports and imports.
 Asking and Bidding price
There are 2 types of currency prices at Forex
are Bid and Ask.
• The price we pay to buy the pair is called Ask. It is always
slightly above the market price.
• The price, at which we sell the pair on Forex, is called Bid. It
is always slightly below the market price.
• The price we see on the chart is always a Bid price. Ask
price is always higher than the Bid price by a few
pips. Spread is the difference between these two prices. In
other words, it is a commission you pay to your broker for
every transaction.
International Currency Markets:
The International Currency Market is a market
in which participants from around the world
buy and sell different currencies, and is
facilitated by the foreign exchange, or forex,
market.
 Participants in Currency Market
• Central Banks
Central banks hold large currency reserves of their domestic currency as well as that of
important trading partners. Moreover, central banks efforts to manage domestic
economic performance by monetary policy, including raising or lowering short-term
interest rates, has immediate and powerful effects on currency prices.
• Global FX Banks
A small number of global banks sit atop the FX market paradigm. These banks deal with
central banks, major corporations and fund managers. These banks provide pricing on
large FX trades as well as economic and market commentary and expertise on executing
and clearing trades in major and emerging market currencies around the world.
• International Companies (Importing & Exporting companies)
Companies that do business internationally are important foreign exchange market
participants. For example, if Atlanta-based Coca Cola were to sell a product in the United
Kingdom they trade pounds for dollars in the FX market to repatriate it back to the United
States.
• Fund Managers
Across the board, fund managers are active foreign exchange traders. They
access the market to acquire foreign currencies required to fund cross-border
investments. For example, the purchase of shares in Tokyo requires a US-based
investment manager to have the correct sum of Japanese yen in an account in
order to settle the stock transaction. Depending on their FX market view, the fund
manager might seek to hedge the currency risk that comes with holding an
overseas investment. The manager would enter into a swap or forward FX trade
to lock in the current USD/JPY rate into the future. Some fund managers,
especially hedge funds, are also very active speculators in the foreign exchange
markets.
• Retail Traders
Retail traders are individuals who trade their own money in order to make a
profit. Retail traders make up a significant and fast growing proportion of the FX
market.
 Exchange Rate Determination

• A flexible or floating exchange rate is where the

market forces of supply and demand determine the
exchange rate.
• A fixed exchange rate is where the government
determines the exchange rate for a period of time
based on the value of another country’s currency such
as the US dollar.
• A managed exchange rate is where the government
intervenes in the market to influence the exchange rate
or set the rate for short periods such as a day or week.
Currency conversion Risk/Exposure
• Transaction exposure arises from the effect that exchange rate fluctuations have on
a company’s obligations to make/pay or receive payments denominated in foreign
currency. This type of exposure is short-term to medium-term in nature.

• Translation exposure arises from the effect of currency fluctuations on a company’s 

consolidated financial statements, particularly when it has foreign subsidiaries.
Easily, when MNCs’ or International business holders remitted money from the
subsidiaries. This exposure may happen. This type of exposure is medium-term to
long-term.

• Economic (or operating) exposure is lesser-known than the previous two but is a
significant risk nevertheless. It is caused by the effect of unexpected currency
fluctuations on a company’s future cash flows and market value and is long-term in
nature.