Foreign Exchange Market and Exchange Rate Determination

Definitions:-Exchange rate: the value of one currency for the purpose of conversion to another.
-Inflation: a general increase in prices and fall in the purchasing value of money.

-Prospect: the possibility or likelihood of some future event occurring.

1. Exchange rates are like prices, in that they are determined by supply and demand. But not all exchange rates are allowed to float freely, since the governments or central banks of some countries actively intervene in the market for their currency to manipulate its value. Identify one policy a government or central bank could use to strengthen the value of its currency and one policy that could weaken the value of a currency.
One policy a government or central bank could use to strengthen the value of its currency is the policy in which they use their reserves of foreign currency to purchase its own currency. This will lead to an increase in demand for the currency which will strengthen the value of their currency.

One policy a government or central bank could use to weaken the value of its currency is the policy in which they lower the level of interest rates in their country. By doing so domestic interest rates will be relatively lower than interest rates in other countries, which will lead to less foreign financial investment in the domestic country. This is because financial investment in other countries will be more attractive. Investors that will be investing in other countries will need to exchange the domestic currency for foreign currency, which will increase the supply of the domestic currency in the foreign exchange market. This usually weakens the value of the domestic currency.

2. What are the benefits of having a stronger currency?
The benefits of having a stronger currency are: downward pressure on inflation, more imports can be bought, and improved domestic efficiency. A stronger currency will make imports cheaper, which will increase competition and put pressure on domestic producers to decrease their prices. They can lower prices due to cheaper imports. Cheaper imports reduce their production costs. The increased competitiveness will also lead to increased domestic efficiency so that domestic producers can remain competitive in their industries.

3. What are the benefits of having a weaker currency?
The benefits of having a weaker currency are: increased employment in export and domestic industries. Increased employment in export industries due to a weaker currency occurs because a weaker currency will make exports relatively cheaper. This will increase their competitiveness and will lead to employment in the export industries.

A low exchange rate will make imports more expensive, so domestic producers will be more inclined to purchase goods and services from domestic producers. This will increase demand for domestic good and services, which will lead to an increase in employment.

4. Which determinant of exchange rates presented in the video do you think are most attributable to the fluctuating values of currencies on foreign exchange markets, and why? Relative incomes, relative interest rates, relative inflation rates, speculation or simply the tastes and preferences of global consumers?
I think that the most attributable determinant of exchange rates presented in the video is "relative inflation rates". Inflation rates determine a whole country's price levels, which can have a significant impact on exchange rates. Relatively lower inflation rates than in other countries will increase foreign demand, because the goods/services in the country with the lower inflation rates will be relatively cheaper.

-Lastly, pick one world currency (besides the Euro of the US Dollar). List and explain the factors that might lead to a fall in the supply of the selected currency in relation to the Euro market.

Chosen currency: GBP. In the following text please assume that when I say "other EU countries", I mean all EU countries except: Bulgaria, Croatia, Czech Republic, Denmark, Hungary, Poland, Romania, Sweden, and England.

There are several factors that might lead to a fall in the supply of GBP in relation to the Euro market. If British people decrease their demand for goods and services from other EU countries, they will be exchanging less GBP for Euros, which will lead to a decrease in the supply of GBP. British demand for goods/services from the EU can decrease if incomes in England decrease, if British people change their tastes in favor of non-EU goods/services, and if inflation rates in England are lower than in other countries in the EU. Relatively lower inflation rates in England means that goods/services in other EU countries will be more expensive.

Another factor to consider is the following. If investment prospects worsen in EU countries (except England), the supply of GBP will decrease. Worse investment prospects will make British people less inclined to invest in other EU countries.

Another factor to consider is the following. If interest rates in other EU countries decrease, British people will be more attracted to save in England, which will decrease the supply of GBP.

Another factor to consider is the following. If British people speculate that the value of GBP will increase, they won't convert their GBP's into other currencies to make a financial gain. This will reduce the supply of GBP.

Next, draw a diagram to illustrate the fall in the supply of the the Euro and its effect upon the exchange rate of your selected currency in terms of the euro.

A fall in the supply of the Euro will have the following effect on GBP. For every quantity of GBP, less Euros can be bought. The exchange rate will increase from a fall in the supply of the Euro. The euro will appreciate while GBP will depreciate.