4.1.8 - Exchange rates

Question 1

What’s an exchange rate?

Answer 1

he exchange rate is the rate at which one currency trades against another.

Question 2

What’s a floating exchange rate?

Answer 2

Demand and supply determine the exchange rate between currencies (GBP to USD).

Question 3

What’s a Fixed Exchange Rate?

Answer 3

The value between two currencies remains at a static level over time (USD to Saudi Riyal). The monetary authority ties its official exchange rate to another nation’s currency but it doesn’t mean that it will be fixed all the time.

Question 4

What’s a managed exchanged rate?

Answer 4

Allows central bank to intervene (buying and selling currency) in FX markets in order to change the direction of the currency (to minimise fluctuations and keep the currency close to its target)

Question 5

What’s a managed exchanged rate?

Answer 5

Allows central bank to intervene (buying and selling currency) in FX markets in order to change the direction of the currency (to minimise fluctuations and keep the currency close to its target)

Question 6

Name 2 methods on how the exchange rates can be measured

Answer 6

• Real exchange rate
• Bi-lateral exchange rate
• Spot exchange rate
• Forward exchange rate
• Trade weight index

Question 7

What’s the spot exchange rate?

Answer 7

Exchange rate for transactions that took place immediately.

Question 8

What is the bilateral exchange rate?

Answer 8

Rate at which one currency can be traded against another.

Example:

include £/$ (1GBP = 1.23 Dollar as of Jan 2023)

Question 9

Name 2 factors that influence exchange rates

Answer 9

• Relative interest rates
• Relative inflation rates
• Current account deficit/surplus
• Speculation

Question 10

What’s a current account deficit?

Answer 10

When

Imports > Exports

Question 11

What’s a current account surplus?

Answer 11

When

Imports < Exports

Question 12

Why do relative inflation rates affect the exchange rate?

Answer 12

If inflation is lower in the UK than anywhere else, UK exports become more competitive (cheaper) which means an increase in demand for the £ to buy UK goods.

Question 13

How does speculation affect the exchange rate?

Answer 13

If people speculate that the value of £ will fall, they will sell their £ for another currency with a higher value. As demand for £ decreases, it depreciates leading to a self-fulfilling prophecy.

Question 14

What’s the exchange rate mechanism (ERM) ?

Answer 14

A system introduced by the European Economic Community to reduce exchange rate variability and achieve monetary stability in Europe.

Question 15

When was the UK part of the ERM?

Answer 15

1990

Question 16

Why did the UK join the ERM?

Answer 16

Attempt to stabilize their currency

Question 17

Why did the UK leave the ERM?

Answer 17

They were unable to keep the pound above he specified level

Question 18

Name 2 pros of a floating exchange rate

Answer 18

• Useful monetary policy tool to stimulate growth
• Reduced need for currency reserves

Question 19

Name 2 cons of floating exchange rates

Answer 19

• Investment volatility
• Can attract speculation

Question 20

Name 2 pros of a fixed exchanged rate

Answer 20

• Removes currency fluctuations
• Exports and imports remain stable

Question 21

Name 2 cons of a fixed exchange rate

Answer 21

• Clashes with other macroeconomic objectives
• Non-maneuverable

Question 22

What are Robert Mundell’s 3 impossibles?

Answer 22

• Free traded currency
• Independant monetary policy
• Fixed exchange rate

Question 23

How many of Robert Mun dell’s impossibles can occur at one time?

Answer 23

2 out of the 3

Question 24

What’s monetary policy?

Answer 24

Monetary policy involves the use of interest rates and changes to the money supply to achieve relevant economic objectives

Question 25

What's monetary policy?

Answer 25

Monetary policy involves the use of interest rates and changes to the money supply to achieve relevant economic objectives