The document defines exchange rates as the rate at which one currency can be exchanged for another. Exchange rates are determined in the foreign exchange market, where currencies are bought and sold. The foreign exchange market serves several functions, including transferring funds between countries and providing short-term credit to importers. Exchange rates are influenced by factors such as inflation rates, interest rates, current account deficits, public debt levels, terms of trade, and political/economic stability. Various theories aim to determine exchange rates based on these economic fundamentals.

2. DEFINITION
• In finance, an exchange rate (also known as a foreign-exchange
rate, forex rate, FX rate or Agio) between
two currencies is the rate at which one currency will be
exchanged for another
• It is the minimum number of units of one countries
currency required to purchase one unit of the other
countries currency.

3. Why do we need it?
• To pay the country from which the goods are imported.
• Different countries have different currencies with
different values.
• Example: America - Dollar, Japan - Yen
China – Yuan, Yaman – Rial, etc
• Currency of one country is not acceptable in another.

4. Different Currencies

5. FOREIGN EXCHANGE MARKET
• Also called “FOREX” market.
• It is the place were foreign moneys are bought and sold.
• It involves the buying of one currency and selling of
another currency simultaneously.
• Exchange rates are determined here.
• No geographical boundaries.

6. STRUCTURE OF FOREIGN EXCHANGE MARKET

7. FUNCTIONS OF FOREIGN EXCHANGE MARKET
• To transfer funds from one country to
another
• To provide short term credit to
importers
• To stabilize foreign exchange rate

8. TYPES OF MARKET
• Two types of market:
•Spot Market
•Forward Market

9. SPOT MARKET
• Transaction time of 2 days
• Spot Transaction
• Spot Exchange Rate

10. FORWARD MARKET
• Transaction time of more than 90 days
• Forward Transaction
• Forward Exchange Rate

11. FACTORS AFFECTING THE EXCHANGE RATE
• Differentials in Inflation
• Differentials in interest rates
• Current account deficits
• Public Debt
• Terms of trade
• Political stability and Economic Performance

12. Differentials in Inflation
• Lower inflation exhibits rising currency value
• Purchasing power increases

13. Differentials in Interest Rates
• Interest rates, inflation and exchange rates co-related
• Higher interest rates means higher exchange rate

14. Current Account Deficits
• Balance of trade
• Country spends more on foreign trade than its earning
• Excess foreign currency demands decreases exchange
rate

15. Public Debt
• Countries with large public deficits and debts are less
attractive to foreign investors
• If governments prints money, it causes inflation and
decrease in exchange rate

16. Terms of Trade
• More exports than imports means improved terms of
trade

17. Political Stability and Economic Performance
• Foreign investors seeks countries with strong economy
• Political turmoil can be dangerous

18. Theories of exchange rate determination
• Meaning:
Theories which determine the prices of forex rate
considering inflation, interest rate, and elasticity of price
etc..
Methods:
a) Short run theory
b) Long run theory

19. Short Run Theory
• This theories are based more on current information or
immediate performance of economic variables.
• This theories try to take into account the short run factor
which may be eliminated in the long run.

20. Long Run Theory
•This are the theories which predominately take into account the
fundamental changes of economy.
•Here fundamental changes refers to the change which are going to
change the economic performance of the economy Purchasing power
for all times to come.
Types of theory:
Purchasing power parity.
•1) Absolute purchasing power parity.
•2) Relative purchasing power parity.
Interest Rate parity
•1) Covered Interest Rate parity
•2) UnCovered Interest Rate parity

21. Purchasing Power Parity Theory
Founder –Swedish economist Gustav Cassel in 1918.
•Meaning : According to this theory ,the price levels and
the changes in these price levels in different countries
determine the exchanges rates of these countries
currencies.
•The basic principle of this theory is that the exchange
rates between various currencies reflect the purchasing
power of these currencies .This theory is based law of one
price.

22. Absolute form of PPP Theory
•If the law of one price were to hold good for each and
every commodity then the theory is termed as Absolute
form of PPP Theory.
•This theory describes the link between the spot exchange
rate and price levels at a particular point of time

23. Relative form of PPP
• This theory describes the link between the changes in
spot exchange rate and in the price levels over a period
of time.
• According to this theory ,changes in spot rates over a
period of time reflect the changes in the price level over
the same period in the concerned economies.
• This theory relaxes three assumptions of PPP ie Absences
of transportation cost ,transaction costs and tarriffs.

24. Interest Rate Parity Theory
• Definition :
The process that ensures that the annualized forward premium
or discount equals the interest rate differential on
equivalent securities in two currencies.
It represents an equilibrium state under which investers will be
indifferent to interest rates available on bank deposits in 2
countries
• International Fisher effect
• Expected Rate of change = Interest rate of the exchange rate
differential
• Interest Rate = Real Interest Expected Differential Rate +
inflation rate

25. Interest Rate parity
•1) Covered Interest Rate parity
•2) UnCovered Interest Rate parity

27. PERSISTANT DECLINE IN RUPEE
• Imports becoming costlier
• Imports extensive country
• Drives away foreign investors

28. Factors affecting the fluctuation in exchange rate of Indian Rupee
• Using FOREX reserve
• Interest Rate
• Balance Of Trade
• Foreign Debt

29. CONCLUSION

30. THANK YOU!!