Foreign

Exchange Rate
IGCSE Economics

Tristan
TABLE OF CONTENTS

01 General
Introduction 02 Cause of Change
in the Foreign
Exchange Rate

03 Results of
Fluctuations in 04 Fixed & Floating
Exchange Rates
Exchange Rates

05 Case Studies
06 Kahoot &
Conclusion
01
General
Introduction
 INTRODUCTION
Definition
The price of one currency expressed in terms of another. For
example, if 1 USD = 0.85 EUR, the exchange rate is 0.85.

Importance:
● Affects international trade as it influences the cost of
imports and exports.
● Impacts investments, determining returns on foreign
assets.
● Critical in tourism—travelers need to exchange
currencies when visiting different countries.
The Foreign Exchange Market(FOREX)

Definition: Participants:
A global marketplace where ● Governments and central banks
currencies are traded. It (e.g., Bank of England)
operates 24/7 because of the
● Businesses conducting
different time zones
international trade
worldwide.
● Investors seeking foreign assets

● Speculators aiming to profit from

currency fluctuations
 Fluctuations in the Foreign Exchange Rate
Key Concept:
Exchange rates are determined by the forces of demand and supply for
different currencies.

Appreciation Depreciation

● An increase in demand for a currency or ● In contrast, if the demand for a certain

a decrease in its supply currency falls or the supply of a certain
● Increase its exchange rate against other currency increases
currencies. ● Its exchange rate against other
● This is called appreciation, a rise in the currencies will fall
value of of currency against others ● This is called depreciation, a fall in the
value of a currency against others
Appreciation
Key Concept:
● A decrease in supply of the currency can cause an appreciation
● An increase in demand for the currency can cause a appreciation
Depreciation
Key Concept:
● An increase in supply of the currency can cause a depreciation
● A decrease in demand for the currency can cause a depreciation
 02
Causes of Change in the
Foreign Exchange Rate
(in terms of the USA)
 1. Changes in Demand for Exports & Imports

Appreciation Depreciation

● Residents of other countries buy more ● US residents increase demand for

goods and services produced in the US goods produced overseas
● Increase the demand for US dollars as ● Buy foreign currencies to pay for them
they are bought to pay for them ● US will have to increase currency supply
● Increase in demand for the US dollar in ● Value of the US dollar will fall against
the ForEx market other currencies
● The value of the US dollar will rise
against other currencies
 2. Inflation

Appreciation Depreciation

● Low inflation in the US compared to ● High inflation causes an increase in

other countries can allow for cheaper local prices
prices of goods & services in the US ● These prices can increase to the point
● US goods become more attractive where overseas products are cheaper
● US imports will decrease, as local ● US exports will decrease, as the
products are cheaper products become less attractive
● US exports will increase, as for other ● US imports will increase as, the
countries, they will import from the US products overseas become cheaper
as it is cheaper ● US currency supply will increase
● Increase in the value of the US dollar ● Reduction in the value of the US dollar
 3. Changes in Interest Rates

Appreciation Depreciation

● A rise in the interest rate in the US will ● A rise in interest rates in other countries
cause saving and investing to be relative to the US may lead to
attractive withdrawal of overseas capital from the
● Overseas residents will save in US US
financial institutions ● This causes the US dollar to depreciate
● Demand for the US dollar will increase ● Us residents may also buy foreign
● Rise in value of the US dollar currency to save in overseas financial
institutions
Other Causes
Appreciation of the US dollar Depreciation of the US dollar

● Rise in income abroad ● Rise in domestic income

● Central Bank Interventions ● Speculators - forecast a fall in
● Economic growth - may cause value
demand pull inflation ● Departure of MNCs - job losses,
● Speculators - forecast a rise falling income, reduced exports
● Entry of MNCs - creates jobs,
boosts exports
 03
Results Of
Fluctuations in
Exchange Rates
Consequences of Appreciation
Let's say there is an appreciation in the value of the US dollar
to the Indonesian Rupiah from $1 = Rp 14,000, to $1 = Rp
16,000

Effects:

● International competitiveness of US goods are reduced

● If Indonesian demand for US goods is price elastic,

there is likely to be a fall in the Indonesian demand for
them
● Exports to Indonesia will fall causing exporters to lose
revenue
Benefits of Appreciation
Let's say there is an appreciation in the value of the US dollar
to the Indonesian Rupiah from $1 = Rp 14,000, to $1 = Rp
16,000

Effects:

● International competitiveness of Indonesian goods are

increased

● US firms importing from Indonesia will benefit from a

reduction in costs
● If US demand for Indonesian goods is price elastic
there is likely to be a significant increase in US demand
for them
Consequences of Depreciation
Let's say there is an depreciation in the value of the US dollar
to the Indonesian Rupiah from $1 = Rp 16,000, to $1 = Rp
14,000

Effects:

● Higher costs of imported goods lead to overall price

increases. Called imported inflation

● Imported goods become more expensive, affecting

domestic consumers.

● Foreign-denominated debts become more expensive

to repay.
Benefits of Depreciation
Let's say there is an appreciation in the value of the US dollar
to the Indonesian Rupiah from $1 = Rp 16,000, to $1 = Rp
14,000

Effects:

● Domestic goods become cheaper for foreign buyers,

increasing demand and boosts exports.
● Reduced imports and higher exports help improve the
current account balance.
● The country becomes more affordable for foreign
tourists, increasing tourism revenue.
 04
Fixed & Floating
Exchange Rates
 Floating Exchange Rate
● Definition: The value of the currency is determined by market
forces of demand and supply.
● Self-Adjusting: Automatically adjusts based on changes in
economic conditions.
● Little to no Government Intervention: The government or
central bank does not actively maintain the exchange rate.
● High Volatility: Prone to frequent fluctuations due to changes
in investor sentiment, speculation, and global events.
● Example Countries: United States, Japan, European countries.
Managed Floating Exchange Rate
A managed floating exchange rate system (also known as a dirty float) is
where the currency’s value is primarily determined by market forces of
demand and supply, but with occasional government or central bank
intervention to stabilize the economy or achieve specific economic
objectives.

Usually happening in 2 situations:

1. A steep rise in the currency value
2. A steep fall in the currency value
 Managed Floating Exchange Rate

A Steep RISE
Causes:
● High demand for the currency due to strong economic performance, high interest rates, or foreign investment
inflows.
● Speculation or external factors boosting confidence in the country's economy.
Consequences:
● Exports become more expensive for foreign buyers, leading to a decline in export sales.
● Import volumes increase because foreign goods become cheaper, potentially widening the trade deficit.
● Falling demand for domestic products can lead to reduced production and higher unemployment in export
industries.
Government Actions (Interventions):
1. Selling Reserves of the National Currency:
○ Increases the supply of the currency in the foreign exchange market, causing its value to fall.
2. Buying Foreign Currencies:
○ Adds to foreign currency reserves and reduces the value of the national currency.
3. Cutting Interest Rates:
○ Reduces the incentive for foreign investors to hold assets in the country, lowering demand for the currency.
 Managed Floating Exchange Rate

A Steep FALL
Causes:
● Loss of investor confidence, political instability, economic downturn, or speculative attacks.
● High inflation or widening current account deficits.
Consequences:
● Imports become more expensive, leading to imported inflation.
● Cost of living increases due to higher prices for foreign goods and raw materials.
● If the country has foreign-denominated debt, repayments become more expensive.
● Potential capital flight as investors withdraw money due to uncertainty.
Government Actions (Interventions):
1. Buying Its Own Currency:
○ Using reserves of gold and foreign currencies to purchase the national currency, increasing its value.
2. Selling Foreign Currency Reserves:
○ Reduces foreign currency supply, increasing demand for the national currency.
3. Raising Interest Rates:
○ Attracts foreign investment by offering higher returns, increasing demand for the currency and stabilizing
its value.
Pros & Cons of Floating Exchange Rate
Pros Cons

- Automatic adjustment, little to no - Uncertainty in international trade

need for government intervention - May lead to less foreign direct
- No need for large reserves investment
- Responsive to economics shocks - Currency can be influenced by
- Frees government to focus on other speculation
objectives - May lead to imported inflation, if the
- Interest rates do not need to be currency appreciates significantly
manipulated too often
- The currency is correctly valued
Floating Exchange Rate
 Fixed Exchange Rate
● Definition: The currency’s value is pegged or fixed to another
currency (usually the USD) or a basket of currencies.
● Maintained by Government: The central bank constantly/actively
intervenes in the forex market to maintain the fixed rate.
● Requires Reserves: Large foreign currency reserves are needed to
defend the fixed rate.
● Stability: Provides stability in international transactions, reducing
uncertainty for traders and investors.
● Example Countries: China, Saudi Arabia (pegged to USD).
Pros & Cons of Fixed Exchange Rate
Pros Cons

- Reduces risk and uncertainty - Involves frequent manipulation of

- Government will keep inflation under interest rates
control - Increasing interest rates may lead to
- Prevents currency depreciation lower economic growth and increase
- Attracts foreign direct investment in unemployment
- Defers currency speculation - Sacrifices other macroeconomic
policies
- Requires large foreign reserves
- Restricts international competition
and creates disputes, if other
countries find your exchange rate is
too low
- May lead to overvalued or
undervalued currency
Fixed Exchange Rate
 05
Case Studies
Case Study 1: The 1997 Asian Financial Crisis
(Thailand - Currency Depreciation)

● System: Fixed Exchange Rate

● Event: Sharp depreciation of the Thai Baht

● Cause: Excessive foreign debt, speculative attacks, unsustainable peg

● Results: Regional financial crisis, high inflation, economic recession

● Government Actions: Abandoned fixed rate, IMF bailout, austerity

measures
Case Study 2: The 2011 Swiss Franc Crisis
(Switzerland - Currency Appreciation)

● System: Managed Floating Exchange Rate

● Event: Sharp appreciation of the Swiss Franc (CHF)

● Cause: Eurozone debt crisis, safe-haven demand, speculative inflows

● Results: Decline in exports, deflationary pressures, economic slowdown

● Government Actions: Currency intervention, temporary peg to Euro,

negative interest rates
 06
Kahoot &
Conclusion
Kahoot
Thank You