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ITF Unit 5

An exchange rate is the relative price of one currency expressed in terms of another currency. Exchange rates are affected by several economic factors including inflation rates, interest rates, current account balances, political stability, government debt, and economic performance. Countries with lower inflation and interest rates will see appreciation of their currency, while countries with higher inflation, interest rates, and government debt will experience depreciation of their currency relative to other currencies.

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14 views

ITF Unit 5

An exchange rate is the relative price of one currency expressed in terms of another currency. Exchange rates are affected by several economic factors including inflation rates, interest rates, current account balances, political stability, government debt, and economic performance. Countries with lower inflation and interest rates will see appreciation of their currency, while countries with higher inflation, interest rates, and government debt will experience depreciation of their currency relative to other currencies.

Uploaded by

Nandhini Prabakaran
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Foreign exchange rate

• An exchange rate is a relative price of one


currency expressed in terms of another
currency (or group of currencies). For
economies like Australia that actively engage
in international trade, the exchange rate is an
important economic variable.
Factors Affecting Exchange Rates
Inflation Rates
• Changes in inflation cause changes in currency exchange
rates. a country with a comparatively lower rate of inflation
will see an appreciation in the value of its currency.
• The price of goods and services increases at a slower rate
when inflation is low.
• Countries with a continually low inflation rate exhibit an
increasing currency value, whereas a country with higher
inflation typically experiences depreciation of its currency
and this is usually accompanied by higher interest rates.
Interest Rates
• Interest rates, inflation and exchange rates are all
correlated. Central banks can influence both
inflation and exchange rates by manipulating
interest rates.
• Higher interest rates offer lenders a higher return
compared to other countries.
• Any increase in a country's interest rate causes its
currency to increase in value as higher interest rates
mean higher rates to lenders,
• thus attracting more foreign capital, which in turn,
creates an increase in exchange rates.
• Recession
In the event a country's economy falls into a
recession, its interest rates will be dropped,
hindering its chances of acquiring foreign
capital. The consequence of this is that its
currency weakens in comparison to that of other
countries, thereby lowering the exchange rate.
Current Account/Balance of Payments

• A country's current account reflects its balance of trade and


earnings on foreign investment. It comprises of the total
number of transactions including exports, imports and debt.
• A deficit in its current account comes as a result of
spending more of its currency on importing products than
through exports.
• This has the effect of lowering the country's exchange rate
to the point where domestic goods and services become
cheaper than imports, thereby generating domestic sales
and exports as the goods become cheaper on international
markets.
Political Stability and Performance
• A country's political state and economic
performance can affect the strength of its currency.
• A country with a low risk of political unrest is
more attractive to foreign investors, drawing
investment away from other countries perceived to
have more political and economic risk.
• An increase in foreign capital leads to the
appreciation in the value of the country's currency,
but countries prone to political tensions are likely
to see a depreciation in the rate of their currency.
Government Debt
• Government debt is public debt or national debt
owned by the central government. Countries
with large public deficits and debts are less
attractive to foreign investors and are thus less
likely to acquire foreign capital which leading
to inflation.
• Foreign investors will forecast a rise
government debt within a particular country. As
a result, a decrease in the value of this country's
exchange rate will follow.

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