Exchange Rates – AS/A LEVELS/IB/IAL

Exchange Rates – AS/A LEVELS/IB/IAL

Courses Info

Exam Boards: Edexcel, AQA, WJEC, CIE, OCR. Level: AS/A LEVELS/IB/IAL

Exchange Rates

The exchange rate is the rate at which one currency exchanges for another e.g. £1 = $2.

Exchange Rate Systems

Floating 

The exchange rate is determined by market forces of supply and demand.

Fixed

This is when a country’s currency is fixed against a currency of another country. The most commonly used currency to fix against is the Dollar.

Managed

This exchange rate system is a floating exchange rate system but is subject to intervention by central banks.

Exchange Rate – Key Terms

Revaluation

This occurs when a country decides to increase the exchange rate of its currency under a fixed exchange rate

Appreciation 

This refers to an increase in the value of a country’s exchange rate under a floating exchange rate. 

Devaluation

This occurs when a country decides to decrease the exchange rate of its currency under a fixed exchange rate.

Depreciation 

This refers to a decrease in the value of a country’s exchange rate under a floating exchange rate. 

What factors influence exchange rates?

Interest Rates

If interest rates are high this will increase the demand for the pound causing the value of the pound to increase. 

Inflation rates

If there is an increase in the inflation rate in the UK. This would make UK goods and services less competitive. This would cause a decrease in demand for the pound leading to a fall in the value of the currency.

Current Account Balance of Payments (BOP)

A persistent deficit on the BOP on the current account means there is excess supply over demand of the currency leading to a fall in the value of the pound.

Foreign Direct Investment (FDI)

If the UK has more inflows of FDI than outflows than it would be a net recipient. Therefore the demand for the UK pound would increase causing the value of the pound to rise.

Speculation/State of the economy

Speculation can occur due to a variety of factors such as the state of the economy. During the Coronavirus pandemic, the demand for the currency reduced as there was less confidence in the country.

Political factors

Political instability due to war, famine, corruption, Brexit can cause uncertainty and instability in a country. This will cause a decrease in demand and the value of the currency.

 

Tushar Depala

Author: Tushar Depala

Economics Tutor

View Profile Hire Tushar Depala