Exchange rate (1)

Where the exchange rate is determined

Foreign exchange market

An exchange rate is the price of one currency in terms of another

Determined by the market forces of supply and demand in the currency market.

If value of currency is high in relation to other currency it is called a 'Strong' currency

high level of demand/fall in supply

If value of currency is low, it is called 'Weak'

low demand

When currency increases value it 'appreciates', when it falls in value it 'depreciates'

Value of currency affects the price of a firm's products abroad- affects sales abroad (i.e. exports)

Change in price abroad (foreign currency) can have an impact on UK firms exporting abroad

also affect cost of buying supplies abroad (imports)

Stronger £ , the more euro's are received in return for a £, fewer £'s spent on buying something abroad; reduces imports prices in £

supply and demand interact to determine the value of one currency against another

When analysing currency changes, managers will focus on change in markets which they sell their products & where they buy materials or resources

The external demand for Uk currency comes from foreign individuals & orgs who want to change their currency into £ to buy UK goods and services

The more expensive the price of £, the more foreign currency has to be changed to buy it

assuming all else remains constant, this will reduce the quantity demanded for the £

The supply of £ to the foreign currency market depends on the desire of individuals & orgs to change their £ into foreign currency

If the value of the £ increases in terms of foreign currency, means the £ has more purchasing power abroad

Makes foreign goods & services cheaper, fewer £'s are required for any given amount of foreign currency

An increase in the value of the £ should lead to an increase in the quantity demanded of foreign products

If demand for foreign products is price elastic, total spending on imports increases- the price is lower in £'s, significant increase in quantity demanded increases the oeral amoutn spent

In a free market, the price of the currency will adjust until the quantity supplied equals the quantity demanded (equilibrium)

Demand for the pound in the foreign currency markets may increase because of:

Increase in incomes overseas, leading to more demand for UK products

Increase in UK interest rates relative to the returns available elsewhere, affects foreign investors searching for high returns in UK banks & other financial institutions, wanting to save £'s in the UK

Belief by speculators that the pound will increase in value against other currencies in the future

Increase in supply of £'s to the foreign currency market may be due to:

Increase in UK incomes, leading to more demand for imports, more £'s will have to be supplied to change into foreign currency to buy products abroad

Increase in overseas interest rates, money flowing out of the UK in search of higher returns abroad

Speculators selling £'s in the belief that the £ is going to fall in value in the future