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