Unit 7

           

April 15, 2015

Currency Exchange

Ø  Foreign Exchange (FOREX

·         The buying the selling of currency

·         The exchange rate € is determined in the foreign currency markets

·         Simply put. The exchange rate is the price of a currency.

·         Do not try to calculate the exact exchange rate

Ø  Tips

·         Always change the D line on one currency graph, the S line on the other currency’s graph

·         Move the lines of the two currency graphs in the same direction (right or left) and you will have the correct answer.

·         If D on one graph increases, S on the other will also increase

·         If D moves to the left, S will move to the left on the other graph

Ø  Changes in Exchange Rates

·         Exchange rates (e) are a function of the supply and demand for currency

·         An increase in the supply of a currency will make it cheaper to buy one unit of that currency

·         A decrease in supply of a currency will make it more expensive to buy one unit of that currency

Ø  Changes in Exchange Rates

·         An increase in demand for a currency will make it more expensive to buy one unit of that currency

·         A decrease in demand for a currency will make it cheaper to buy one unit of that currency

Ø  Appreciation

·         Appreciation of a currency occurs when the exchange rate of that currency increases (e­)

Ø  Depreciation

·         Depreciation of a currency occurs when the exchange rate that currency decreases (e¯)

Ø  Exchange Rate Determinants

·         Consumer tastes

o   Ex. Japanese goods create increase in D of Yen and an increase in S of dollars in the currency exchange market.

o   The increase in demand of the Yen leads to the appreciation of the Yen

o   The increase in supply of dollars leads to the depreciation of the Dollar

·         Relative Income

o   Imports tend to be normal goods

o   Ex. If Mexico’s economy is becoming stronger and the U.S. economy is in recession, then Mexicans will buy more of everything, including American goods

·         Relative price level

·         Speculation

o   IF U.S. investors expect that Swiss interest rates will climb in the future, then Americans will demand Swiss francs in order to earn the higher rates of return in Switzerland

o   This will cause the Swiss Franc to appreciate as demand for it will increase

o   Supply of the Dollar will increase causing it to depreciate