ASSIGNMENT OF MACROECONOMICS
SUBMITTED BY-;
NAME-JASHANPREET KAUR (A00280165)
NAME-SHARANPREET KAUR (A00280244)
NAME-DOLLAR IQBAL (A00280064)
NAME-HARMANDEEP KAUR (A00279632)
NAME-HARPREET KAUR (A00280418)
Understanding
Exchange Rates
Introduction to Exchange Rates
Exchange rates are the value of one currency for the purpose of conversion to another. They play a crucial role in
international trade and investment.
How Exchange Rates Work Why Exchange Rates Matter
Exchange rates fluctuate based on supply and demand Exchange rates can impact the cost of imports and
in the foreign exchange market. Factors such as exports, influence investment decisions, and affect the
economic stability, political events, and interest rates value of assets held in foreign currencies.
can affect the value of a currency.
Factors that Affect Exchange Rates
Exchange rates are determined by a variety of factors, including economic, political, and social conditions in the
countries involved. Understanding these factors can help investors and businesses make informed decisions about
foreign exchange transactions.
Economic Factors Political Factors Social Factors
Economic factors play a major role Political factors can also impact Social factors, such as
in determining exchange rates. exchange rates. Political instability, demographics and consumer
These include inflation, interest government policies, and trade behavior, can also impact exchange
rates, and the overall health of a agreements can all affect the value rates. For example, countries with
country's economy. Countries with of a country's currency. For aging populations may have weaker
low inflation rates and strong example, a country with unstable currencies due to a decrease in
economic growth tend to have political conditions may have a economic productivity, while
stronger currencies, while those weaker currency, while a country countries with strong consumer
with high inflation rates and weak with strong trade agreements may spending may have stronger
economies tend to have weaker have a stronger currency. currencies due to increased
currencies. demand for their goods and
services.
References
Investopedia. (2021). Factors That Influence Exchange Rates. Retrieved from
https://www.investopedia.com/articles/forex/11/factors-affecting-exchange-rates.aspThe Balance. (2021). Factors
That Influence Exchange Rates. Retrieved from https://www.thebalance.com/factors-that-influence-exchange-rates-
3306258
Types of Exchange Rates
Floating Exchange Rates Fixed Exchange Rates
A floating exchange rate is a type of exchange rate A fixed exchange rate is a type of exchange rate regime
regime where a currency's value is allowed to fluctuate where a currency's value is fixed against another
in response to foreign exchange market mechanisms. currency or a basket of currencies.
Image of a graph showing the fluctuation of a currency's value in a floating Image of two currencies being weighed on a scale, representing the balance of a
exchange rate system. fixed exchange rate system.
Pegged Exchange Rates Managed Float Exchange Rates
A pegged exchange rate is a type of exchange rate A managed float exchange rate is a type of exchange
regime where a currency's value is fixed against another rate regime where a currency's value is allowed to
currency, but with a degree of flexibility. fluctuate within a certain range, but with intervention
Image of a peg being used to hold a currency's value against another currency in a from the central bank to manage the exchange rate.
pegged exchange rate system.
Image of a central bank managing the exchange rate of a currency in a managed
float exchange rate system.
Cross Exchange Rates Forward Exchange Rates
A cross exchange rate is a type of exchange rate that is A forward exchange rate is a type of exchange rate that
calculated from two other exchange rates, rather than is agreed upon today for a transaction that will occur at a
being directly traded in the foreign exchange market. future date.
Image of a calculator showing the calculation of a cross exchange rate using two Image of a contract for a forward exchange rate transaction.
other exchange rates.
Floating Exchange Rates
Floating exchange rates are determined by the market
forces of supply and demand. The exchange rate of a
currency is allowed to fluctuate freely in response to
changing economic conditions, without any intervention
from the government or central bank. This system
contrasts with a fixed exchange rate, where the
government or central bank intervenes to keep the
exchange rate within a certain range.
Fixed Exchange Rates
Fixed exchange rates are a type of exchange rate regime
in which a currency's value is fixed to the value of
another currency or a basket of currencies. This means
that the exchange rate between the two currencies
remains constant and does not fluctuate based on
market forces.
One of the main advantages of fixed exchange rates is
that they provide stability for international trade and
investment. Businesses can plan ahead and make long-
term investments without having to worry about sudden
changes in exchange rates. Additionally, fixed exchange
rates can help to control inflation by limiting the ability of
a country's central bank to print money and devalue its
currency.
Pegged Exchange Rates
Pegged exchange rates are fixed exchange rates that are
set and maintained by central banks. These rates are tied
to the value of another currency or a basket of currencies
and are typically used to stabilize the value of a country's
currency in relation to other currencies. Pegged
exchange rates can be either fixed or adjustable and can
be used to promote stability in international trade and
investment.
Exchange Rate Systems
Fixed Exchange Rate System Floating Exchange Rate System
A system where the value of a country's currency is fixed A system where the value of a country's currency is
to the value of another country's currency or to the price determined by the foreign exchange market through
of gold. supply and demand.
Managed Float Exchange Rate System Pegged Exchange Rate System
A system where the exchange rate is allowed to float, A system where a country's currency is fixed to the value
but central banks intervene to influence the exchange of another currency or a basket of currencies.
rate.
Exchange Rate Regimes
Exchange rate regimes refer to the way in which a country manages its currency in relation to other currencies. There
are different types of exchange rate regimes, each with its own advantages and disadvantages.
Floating Exchange Rate Regime Fixed Exchange Rate Regime Pegged Exchange Rate Regime
Under a floating exchange rate Under a fixed exchange rate regime, Under a pegged exchange rate
regime, the value of a currency is the government sets a specific regime, the government sets a
determined by the market forces of value for its currency in relation to specific value for its currency in
supply and demand. This means another currency or a basket of relation to another currency or a
that the exchange rate can fluctuate currencies. The government then basket of currencies, similar to a
freely, and the government does not intervenes in the foreign exchange fixed exchange rate regime.
intervene to influence the exchange market to maintain that value, However, the government may
rate. buying or selling its currency as allow some flexibility in the
necessary. exchange rate within a certain
range.
References
International Monetary Fund. (2021). Exchange Rates and Exchange Rate Regimes.
https://www.imf.org/external/np/exr/facts/peg.htmInvestopedia. (2021). Fixed Exchange Rate.
https://www.investopedia.com/terms/f/fixedexchangerate.aspInvestopedia. (2021). Floating Exchange Rate.
https://www.investopedia.com/terms/f/floatingexchangerate.asp
Exchange Rate Fluctuations
Exchange rate fluctuations refer to the changes in the
value of one currency relative to another. These
fluctuations occur due to a variety of factors, including
global economic conditions, political stability, and
market speculation.
• Economic factors such as inflation, interest rates,
and trade balance can affect exchange rates. For
example, if a country has high inflation, its currency
may decrease in value relative to other currencies.
• Political instability can also cause exchange rate
fluctuations. If investors perceive a country as
politically unstable, they may sell off its currency,
causing its value to decrease.
• Market speculation can also play a role in exchange
rate fluctuations. Traders may buy or sell currencies
based on their expectations of future economic
conditions, leading to changes in exchange rates.
Exchange Rate Risk
Exchange rate risk is the potential loss that an investor may suffer due to fluctuations in exchange rates. This risk is
particularly relevant for companies that operate in multiple countries and therefore have exposure to different
currencies.
Types of Exchange Rate Risk Transaction Risk
There are several types of exchange rate risk, including Transaction risk is the risk that arises from the
transaction risk, translation risk, and economic risk. settlement of foreign currency transactions. This risk can
be mitigated through the use of hedging strategies such
as forward contracts or options.
Translation Risk Economic Risk
Translation risk is the risk that arises from converting Economic risk is the risk that arises from changes in
financial statements from a foreign currency into the exchange rates that affect a company's competitiveness
reporting currency. This risk can be mitigated through in the global market. This risk can be mitigated through
the use of accounting techniques such as translation strategies such as diversification and product
methods and exposure netting. differentiation.
Exchange Rate Forecasting
Exchange rate forecasting is the process of predicting
future currency exchange rates based on various factors
such as economic indicators, political events, and
market trends. Accurate exchange rate forecasting is
important for businesses and investors who engage in
international trade and finance.
Exchange Rate Hedging
Exchange rate hedging refers to the practice of mitigating the risks associated with fluctuations in currency exchange
rates. This can include a variety of financial instruments and strategies, such as forward contracts, options, and swaps.
Why Hedge? Types of Hedging Strategies
Companies engage in exchange rate hedging to protect • Forward Contracts
themselves from the potential negative impact of • Options
currency fluctuations. This can help to stabilize cash
flows, reduce uncertainty, and improve financial • Swaps
performance.
Conclusion References
Exchange rate hedging is an important practice for Investopedia. (2021). Exchange Rate Hedging. Retrieved
companies that engage in international trade. By using from https://www.investopedia.com/terms/e/exchange-
financial instruments and strategies to mitigate the risks rate-hedging.aspThe Balance. (2021). What Is Exchange
associated with currency fluctuations, companies can Rate Hedging? Retrieved from
protect their cash flows and improve their financial https://www.thebalance.com/what-is-exchange-rate-
performance. hedging-3306256
Exchange Rate Arbitrage
Exchange rate arbitrage is the practice of taking
advantage of differences in exchange rates between two
or more markets to make a profit. This can be done in a
number of ways, including buying and selling currencies,
using derivatives such as futures and options, or
investing in assets denominated in different currencies.
For example, if the exchange rate between the US dollar
and the British pound is $1.30 to £1 in the United States,
but $1.35 to £1 in the United Kingdom, an investor could
buy pounds in the US, transfer them to the UK, and sell
them for a profit. This would result in a risk-free profit of
$0.05 per pound.
Exchange Rate Manipulation
Exchange rate manipulation refers to the practice of artificially altering the value of a country's currency in order to gain
an advantage in international trade. This can be done through various means such as buying or selling large amounts of
currency, changing interest rates, or implementing trade policies.
Effects of Exchange Rate Manipulation Regulations and Enforcement
Exchange rate manipulation can have significant There are international regulations in place to prevent
impacts on both the manipulating country and its trading exchange rate manipulation, such as the International
partners. For example, if a country artificially lowers the Monetary Fund's Articles of Agreement. However,
value of its currency, its exports become cheaper and enforcement of these regulations can be difficult and
more competitive on the global market. However, this countries may still engage in manipulative practices.
can also lead to inflation and reduced purchasing power
for domestic consumers.
International Trade and Exchange
Rates
International trade and exchange rates are closely
related. Exchange rates determine the value of one
currency in relation to another and are affected by a
variety of factors such as inflation, interest rates, and
political stability. These exchange rates have a direct
impact on international trade because they affect the
price of goods and services between countries.
• A strong currency makes imports cheaper but
exports more expensive, which can lead to a trade
deficit.
• A weak currency makes exports cheaper but imports
more expensive, which can lead to a trade surplus.
Investing in Foreign Currencies
Benefits of Investing in Foreign Currencies Risks of Investing in Foreign Currencies
Diversification of portfolio and protection against Exchange rate fluctuations and political instability of
inflation. foreign countries.
How to Invest in Foreign Currencies Factors Affecting Foreign Currency Exchange Rates
Through foreign currency exchange-traded funds (ETFs) • Interest rates
or forex trading. • Inflation
• Political stability
Exchange Rates and the Global
Economy
Exchange rates play a critical role in the global economy.
They determine the value of one country's currency
relative to another, which impacts international trade,
investment, and economic growth.
• A strong currency can make a country's exports more
expensive and less competitive on the global market.
• A weak currency can make imports more expensive,
leading to inflation and reduced purchasing power
for consumers.
• Exchange rate fluctuations can also impact foreign
investment, as investors seek stable currencies and
avoid those with high volatility.
Conclusion
In conclusion, exchange rates are a complex and ever-changing aspect of the global economy. Understanding how
they work and their impact is crucial for businesses and individuals alike.
References
“Exchange Rates.” Investopedia, Investopedia, 16 Apr. 2021,
www.investopedia.com/terms/e/exchangerate.asp.Mishkin, Frederic S. The Economics of Money, Banking, and
Financial Markets. Pearson, 2019.“Exchange Rates.” The Balance, The Balance, 16 Apr. 2021,
www.thebalance.com/exchange-rates-3306252.
