Explains the rate of exchange in detail

1. {
Determination of rate
of exchange
The term exchange rate is the price of one
currency in terms of another currency

2. 1. Inflation
Rates
2. Interest
Rates
3. Country’s
BOP
4. Government
Debt
5. Terms of
trade
6. Political
stability &
performance
8. Speculation
7. Recession

3.  A country with a consistently lower inflation
rate exhibits a rising currency value, as its
purchasing power increases relative to other
currencies.
 Those countries with higher inflation typically see
depreciation in their currency about the currencies
of their trading partners. This is also usually
accompanied by higher interest rates.
1. Inflation Rates
(lower inflation rates tend to see an appreciation)

4.  Higher interest rates offer lenders in an economy a
higher return relative to other countries. Therefore,
higher interest rates attract foreign capital
and cause the exchange rate to rise.
 Decreasing interest rates – that is, lower interest
rates tend to decrease exchange rates.
2. Interest Rates
(Higher interest rates cause an appreciation.
Cutting interest rates tends to cause a depreciation)

5.  A disequilibrium in the BOP means it is condition of
Surplus Or deficit
 Surplus in the BOP occurs when Total Receipts
exceeds Total Payments.
 Deficit in the BOP occurs when Total Payments
exceeds Total Receipts.
3. Country’s BOP
(Favourable BOP = CREDIT>DEBIT
Unfavourable BOP=CREDIT<DEBIT)

6.  Government debt is public debt or national
debt owned by the central government.
 Under some circumstances, the value of
government debt can influence the exchange
rate.
*If markets fear a government may default on its debt, then
investors will sell their bonds causing a fall in the value of the
exchange rate. For example, Iceland debt problems in 2008, caused
a rapid fall in the value of the Icelandic currency*
4. Government Debt
(a decrease in the value of public debt – will bring
increase in exchange rates)

7.  The terms of trade is the ratio of export prices to
import prices.
 A country's terms of trade improves if its exports
prices rise at a greater rate than its imports prices.
 This results in higher revenue, which causes a higher
demand for the country's currency and an increase
in its currency's value.
 This results in an appreciation of exchange rate.
5. Terms of Trade

8.  A country with less risk for political confusion is
more attractive to foreign investors, Increase in
foreign capital, in turn, leads to an appreciation in the
value of its domestic currency.
 On the other hand, where the political situation in the
country is unstable, it makes the investors withdraw
their investments. The outflow of capital from the
country would weaken the currency.
6. Political Stability &
Performance

9.  When a country experiences a recession (a period
of temporary economic decline during which trade and
industrial activity are reduced, which impacts fall in GDP), its
interest rates are likely to fall, decreasing its
chances to acquire foreign capital.
 As a result, its currency weakens in comparison
to that of other countries, therefore lowering
the exchange rate.
7. Recession

10.  If a country's currency value is expected to
rise in future, investors will demand more of that
currency in order to make a profit in the near future.
 As a result, the value of the currency will rise due to
the increase in demand. With this increase in
currency value comes a rise in the exchange rate
as well.
8. Speculation
(price will rise in the future, they will demand more now)