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Exchange Rate 1

The document discusses foreign exchange rates, including the definition of exchange rate as the price of one country's currency in terms of another. It explains how exchange rates are determined in floating and fixed systems, with floating rates set by market forces of supply and demand and allowing for fluctuations in the currency's value. Factors like changes in exports, imports, inflation, and interest rates can cause exchange rates to fluctuate in a floating system through shifting demand and supply.

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Bezalel OLUSHAKIN
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20 views19 pages

Exchange Rate 1

The document discusses foreign exchange rates, including the definition of exchange rate as the price of one country's currency in terms of another. It explains how exchange rates are determined in floating and fixed systems, with floating rates set by market forces of supply and demand and allowing for fluctuations in the currency's value. Factors like changes in exports, imports, inflation, and interest rates can cause exchange rates to fluctuate in a floating system through shifting demand and supply.

Uploaded by

Bezalel OLUSHAKIN
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Unit Three

Foreign Exchange Rates


 Definition of Foreign Exchange Rate

 Determination of Foreign Exchange Rate

 Causes and Consequences of Foreign


Exchange rate Fluctuations
 Floating and Fixed Foreign Exchange rates
Objectives

 By the end of this chapter students should be


able to:
• Explain the determination of foreign
exchange rates
• Explain the causes of foreign exchange
rate fluctuations
• Explain the consequences of foreign
exchange rate fluctuations
Definition of exchange rate
 Exchange rate is the price of a country’s
currency in terms of another.

 It is also regarded as the value of one


country’s currency in terms of another
currency.
Reasons for exchange of national
currencies
 Imports of goods and services
 Export of goods and services
 Investments
 Migration
Exchange rate calculation
 The official exchange rate of dollar to naira
today is $1 = #935.49.
 Calculate the price in naira for customers in
Nigeria buying textbooks priced at $15 from
the U.S.
Solution
1 USD = 935.49 NGN
Therefore the book priced at 15 dollar will cost
15 x 935.49 = 14,032.35
(i.e., 15 USD = 14,032.35 NGN)
Exercise
 Suppose that the exchange rate between the
Canadian dollar (CAD) and the British
pound (GBP) is CAD1 = GBP0.65 and the
exchange rate between the Canadian dollar
and the euro (EUR) is CAD1 = EUR0.75.
Calculate the exchange rate of the British
pound against the euro. [2]
Solution
If CAD1 = GBP0.65
and CAD1 = EUR0.75
then, CAD1 = GBP0.65 = EUR0.75
therefore, the exchange rate between the
pound and euro is EUR0.75 = 1.15
GBP0.65
(i.e., GBP1 = EUR 1.15)
Exchange rate determination
 The price or value of one country’s currency
against another country’s can be determined
according to the type of exchange rate
system or regime adopted by the country
 An exchange rate system/regime is how a
country manages its currency in relation to
other currencies.
 There are two types of exchange rate
systems/regime considered here: floating and
fixed.
Floating exchange rate
 In the floating exchange rate system, the
value of a currency is determined by the
market forces of demand for the currency
and supply of the currency

 The price or value of the currency could be


determined by the interaction of demand
and supply, just like the case of any other
product
Floating exchange rate
 The currency being
traded is
represented along
the horizontal axis,
while its price (the
other currency in
terms of which the
one being traded is
expressed is
represented along
the vertical axis)
Floating exchange rate

 Ina free market, the exchange


rate is determined at the point
where the amount of a currency
demanded is equal to the
amount of it supplied.
Reflect
 Recall contraction and extension of demand
and supply. What is the sole factor
responsible for this and what does each
mean?
 Also recall the inward shift and outward
shift of demand and supply curve. What are
the possible causes and their effects on
market equilibrium?
 Apply it to the forex market
Tips
 Higher exchange rate causes a reduction in
demand for the currency, other things being
equal (i.e., the stronger the exchange rate the
lower the demand for the currency and vice
versa)
 Higher exchange rate causes an increase in
supply of the currency, other things being
equal (i.e., the stronger the exchange rate the
more the supply of the currency and vice
versa)
Fluctuations in exchange rate-floating
system

 Fluctuations occur when the price/value of a


currency against another currency falls or
rises.

 In a floating system, the fluctuations are


termed appreciation or depreciation
Fluctuations in exchange rate-floating
system
 Appreciation of a currency occurs when
there is an increase in its value relative to
another currency operating in a floating
exchange rate system.
 Depreciation of a currency occurs when
there is a fall in its value relative to another
currency operating in a floating exchange
rate system.
Causes of fluctuations
 While changes in demand and supply of a
currency are the two general causes of
fluctuations of exchange rate under a
floating system, among the specific causes
are
 Changes in demand for exports
 Changes in demand for imports
 Prices and inflation
 Foreign direct investment
Causes of fluctuations
 Changes in interest rates
 Entry and departure of multinational
companies
 Migration
 Public debt or debt servicing
 Speculation
Homework
1. With the aid of demand and supply diagram
analyze how a fall in interest rate, foreign
direct investment, demand for import, and
demand for export of Nigeria will affect the
exchange rate (hint: use dollar as the price of
naira. Study the table on page 464 for more
understanding)

2. Activity 6.7 on page 461

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