In this PPT exchange rate determination is explained through different methods. this is useful for the students of 12 class CBSE, ICSE, State Board. This is also useful for general awareness about economic concepts.

1. Foreign Exchange Rate
PREPARED BY
HEMANT KUMAR JAIN
PGT ECONOMICS
KV AMBIKAPUR

2. Topics
• Meaning of Foreign Exchange
• Basic concepts
• Exchange Rate Systems
I. Fixed Exchange Rate system
II. Flexible Exchange Rate System
III. Managed floating
• Foreign Exchange Market
• Effective Exchange Rate
Hemant Jain

3. Meaning of Foreign Exchange
• The rate at which foreign currency (say dollar) is
purchased by selling domestic currency (say
rupees), is called exchange rate.
• Suppose $1 can be purchased by 60₹. So the foreign
exchange rate is
$1 = 60 ₹
Hemant Jain

4. Let’s understand this through an example:-
• Suppose an Indian firm ‘X’ imported a machine
from US. In this situation firm ‘X’ has to pay to the
US based firm. But this payment has to be done
in US dollars. So firm ‘X’ will purchase dollars by
selling rupees in foreign exchange market.
• $1 lakh payment has to be done by Indian firm
and present exchange rate is $1 = 60 ₹ .
• firm ‘X’ will purchase $1 lakh by selling 60 lakh ₹.
Hemant Jain

5. Basic concepts:- Depreciation of Domestic
Currency
• Fall in value of domestic currency due change
in demand and supply of foreign exchange, it
is called Depreciation of Domestic Currency.
• Exchange rate is increased from $1 = 60 ₹ to
$1 = 65 ₹ then it is fall in value of domestic
currency because now more rupees have to
pay to buy a dollar.
Hemant Jain

6. Basic concepts:- Appreciation of Domestic
Currency
• Rise in value of domestic currency due to change
in demand and supply (market forces),is known
Appreciation of Domestic Currency.
• Exchange rate is decreased from $1 = 60 ₹ to
$1 = 55 ₹ then it is rise in value of domestic
currency because now fewer rupees have to pay
to buy a dollar.
Hemant Jain

7. Basic concepts:- Devaluation of Domestic
Currency
• When exchange rate increases (fall in value of
domestic currency) due to intervention of
government (govt. increases forcefully) then it
is called devaluation of domestic currency.
Hemant Jain

8. Basic concepts:- Revaluation of Domestic
Currency
• When exchange rate decreases (rise in value
of domestic currency) due to intervention of
government then it is called revaluation of
domestic currency.
Hemant Jain

9. Exchange Rate Systems
• How does exchange rate determinate??
It can be understood under following
conditions:-
I. Fixed Exchange Rate system
II. Flexible Exchange Rate System
III. Managed floating
Hemant Jain

10. Fixed Exchange Rate system
• When value of domestic currency is kept fixed
against foreign currency by government then
exchange rate remain fixed. This is called Fixed
Exchange Rate system.
• Under Fixed Exchange Rate System we can study
two theories:-
a) Gold standards system
b) Bretton woods system.
Hemant Jain

11. a) Gold standards system
In this system exchange rate is determinate on the basis of parity of
gold value of currency. First value of currency is fixed in term of
gold. Then by comparing gold values exchange rate is determinate.
We can understand it through an example:
Suppose 1 gm gold = 3000 ₹ in India
1 gm gold = $ 50 in US
Then exchange will be:-
1 gm gold in US = 1 gm gold in India
$ 50 = 3000 ₹
$ 1 = 60 ₹
Hemant Jain

12. b) Bretton woods system.
• In this system currencies of different countries were pegged with
US Dollar.
• Value of dollar was fixed in gold. It means finally the value of
currency was fixed in term of gold.
• In this system dollar was convertible in gold and gold was
convertible in dollar.
• But in 1970s US printed dollars in exceed of its gold reserves.
• So US was not able to convert dollars in gold. So it was failed 1973.
• In this system some adjustments were possible. So it was also
called ‘wider band system’.
Hemant Jain

13. Flexible Exchange Rate System
• In this system, exchange rate is determinate
on the basis of demand and supply of foreign
exchange (market forces) .
• Where demand and supply of foreign
exchange become equal to each other,
exchange rate is determinate.
Hemant Jain

14. Demand for Foreign Exchange
• Demand for foreign
exchange and price of
foreign exchange both are
inversely related each
other.
• It means at increasing
foreign exchange rate
demand for exchange
reduces and vice versa.
Hemant Jain
Df
ExchangeRate
Df
Q1 Q
R1
R
O

15. Factors of demand for foreign exchange:-
• Imports
• Repayment of loans
• Investment in abroad
• Donations
• Direct purchase ( purchase by tourist in
abroad)
Hemant Jain

16. Supply of Foreign Exchange:-
• Supply of foreign exchange
and price of foreign
exchange both are
positively related with each
other.
• When price of foreign
exchange (means exchange
rate) increases then supply
of foreign exchange also
increases and vice versa.
Hemant Jain
Sf
ExchangeRate
Sf
Q Q1
R1
R
O

17. Factors of supply of foreign exchange:-
• Exports
• Recovery of loans
• Foreign investment
• Direct sale ( to foreign tourist in domestic country)
• Borrowings
• Remittance
• Grants and donations
Hemant Jain

18. Determination of Exchange Rate:-
Hemant Jain
D & S
ExchangeRate
Sf
Df
Q
R E
O
In the diagram
equilibrium is attained
at ‘E’ point and
exchange rate is OR,
demand and supply of
exchange is OQ.

19. Effect of change in Demand and Supply
• If the factors affecting demand for exchange and
supply of exchange, change then it will affect the
exchange rate.
Here four conditions are explained :-
1. Increase in Demand for Exchange
2. Decrease in Demand for Exchange
3. Increase in Supply of Exchange
4. Decrease in Supply of Exchange
Hemant Jain

20. Hemant Jain
To
understand
the
previously
given four
conditions,
watch the
video .

21. If demand for exchange increases:-
• Demand for exchange increases due to increase in imports, direct
purchase by tourist of domestic countries in abroad etc. due to this
• Demand curve for exchange shifts to right hand side→
• Excess demand for foreign exchange→
• Exchange rate tends to increase because people who want foreign
exchange they will ready to pay more rupees for dollars→
• It will create two effects (a) expansion in supply of exchange (b)
contraction in demand for foreign exchange→
• Finally exchange rate increases and demand & supply of exchange
also increases.
Hemant Jain

22. If demand for exchange decreases:-
• demand for exchange decreases due to decrease in imports, less
direct purchase by tourist of domestic countries in abroad etc. due
to this
• Demand curve for exchange shifts to left hand side→
• Excess supply of exchange→
• Exchange rate tends to decrease because people who have foreign
exchange they will ready to sell their dollars for less rupees→
• It will create two effects (a) contraction in supply of exchange (b)
expansion in demand for exchange→
• Finally exchange rate decreases and demand & supply of exchange
also decreases.
Hemant Jain

23. If supply of exchange increases:-
• Supply of exchange increases due to increase in exports, direct purchase
by foreign tourist in domestic countries, higher FDI etc. due to this
• Supply curve of exchange shifts to right hand side→
• Excess supply of foreign exchange→
• Exchange rate tends to decrease because people who have foreign
exchange they will ready to sell their dollars for less rupees to clear their
stock→
• It will create two effects (a) contraction in supply of exchange (b)
expansion in demand for foreign exchange→
• Finally exchange rate decreases and demand & supply of exchange
increases.
Hemant Jain

24. If supply of exchange decreases:-
• Supply of exchange decreases due to decrease in exports, less
direct purchase by foreign tourist in domestic countries, less FDI
etc. due to this
• Supply curve of exchange shifts to left hand side→
• Excess demand for foreign exchange→
• Exchange rate tends to increase because people who want foreign
exchange they will ready to pay more rupees for dollars →
• It will create two effects (a) expansion in supply of exchange (b)
contraction in demand for foreign exchange→
• Finally exchange rate increases and demand & supply of exchange
decreases.
Hemant Jain

25. Foreign Exchange Rate
PREPARED BY
HEMANT KUMAR JAIN
PGT ECONOMICS
KV AMBIKAPUR

26. you can follow me on following links:-
https://www.youtube.com/feed/my_videos
You Tube link
https://economicsstudybyhemantjain.blogspot.com/
Blog link
https://anchor.fm/economicsstudy
Podcast link

27. Managed Floating
• Managed floating is like mixed exchange rate system. In
this system government or central bank interfere in
exchange rate determination as and when it is required.
• Central bank purchase or sell foreign currency/ exchange
in the foreign exchange market according to condition.
• Most of the time government Fixes the limits. In between
limits exchange rate is free. But when exchange rate try
to cross limits then govt. Starts interfering.
Hemant Jain

28. Hemant JainHemant Jain
Df & Sf
ExchangeRate Sf
Df
Q
R
E
O
In the diagram
exchange rate is
free in between
maximum and
minimum limits.
But when it try to
cross limits then
govt. Starts
interfering
MAX.
MIN.

29. Hemant JainHemant Jain
Df & Sf
ExchangeRate Sf
Df
Q
R
E
O
MAX.
MIN.
When exchange rate crosses maximum
limit:-

30. When exchange rate crosses maximum
limit:-
• Suppose exchange rate increases rapidly and cross the
maximum limit fixed by government then central bank
starts selling foreign exchange in market (because
exchange rate increases due to less supply of foreign
exchange and higher demand for exchange).
• Now It will stop increase in exchange rate due to
sufficient availability because of sell of foreign
exchange by monetary authority.
Hemant Jain

31. Hemant JainHemant Jain
Df & Sf
ExchangeRate Sf
Df
Q
R
E
O
MAX.
MIN.
When exchange rate crosses minimum
limit:-

32. When exchange rate crosses minimum
limit:-
• When exchange rate decreases rapidly and cross the
minimum limit fixed by government then central bank
starts purchasing foreign exchange from market
(because exchange rate decreases due to higher
supply of foreign exchange and less demand for
exchange).
• It will stop decrease in exchange rate due to reduced
availability of foreign currency because of purchase of
foreign exchange by monetary authority.
Hemant Jain

33. Foreign Exchange Market
• Foreign exchange market is the market of
currencies where different currencies are
purchased and sold.
• It does not have any physical existence.
• Mainly there are two types of foreign exchange
market according to their operations:-
a) Spot market b) Forward market
Hemant Jain

34. Spot Market
• In this market only spot or
current transaction take
place at prevailing or
current exchange rate (spot
exchange rate).
• This type of market is of
daily nature.
Forward Market
• In this type of market future
delivery transactions take
place at the rate which is
decided by buyer and seller.
• This type of market is used
for Hedging (means control
on rise related to
fluctuations of exchange
rate).
Hemant Jain

35. Thank You
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