6.2 Exchange Rates and the Foreign Exchange Market

• What is an exchange rate?

  Price of one currency
• What is the formula for the real exchange rate?

  $\text{Nominal Exchange Rate} \times \frac{\text{Domestic Price Level}}{\text{Foreign Price Level}}$
• What happens to the demand for a domestic currency if domestic interest rates increase?

  Increases
• The exchange rate between two currencies is determined by the supply and demand for those currencies.
• Match the exchange rate type with its definition:

  Spot Exchange Rate ↔️ Current market price for immediate delivery

  Forward Exchange Rate ↔️ Price for delivery at a specified future date
• Central banks can intervene in the foreign exchange market to influence the exchange rate.
• Steps to calculate the real exchange rate:

  1️⃣ Determine the nominal exchange rate

  2️⃣ Find the domestic price level

  3️⃣ Find the foreign price level

  4️⃣ Apply the formula: Real Exchange Rate = Nominal Exchange Rate × (Domestic Price Level / Foreign Price Level)
• What does the nominal exchange rate represent?

  Ratio of currency trade
• What is the formula for the real exchange rate?

  \text{Nominal Exchange Rate} \times \frac{\text{Domestic Price Level}}{\text{Foreign Price Level}}</latex>
• The real exchange rate is calculated by adjusting the nominal exchange rate for relative prices
• Higher domestic interest rates attract foreign investment
• Higher domestic interest rates can strengthen the domestic currency by attracting foreign investment.


  True
• What is the formula for calculating the real exchange rate?

  \text{Real Exchange Rate} = \text{Nominal Exchange Rate} \times \frac{\text{Domestic Price Level}}{\text{Foreign Price Level}}</latex>
• The real exchange rate reflects the relative purchasing power of each currency
• Higher domestic interest rates attract foreign investment
• Central bank intervention can increase the supply of domestic currency


  True
• The demand curve shows that as the exchange rate falls, demand for the currency rises


  True
• In a floating exchange rate system, the government intervenes to set the exchange rate

  False
• What is one advantage of a floating exchange rate system?

  Automatic stabilization
• Who intervenes in a fixed exchange rate system to maintain the exchange rate?

  Central bank
• Exchange rate stability is an advantage of a fixed
• Match the exchange rate system with its advantage or disadvantage:

  Floating ↔️ Volatility

  Fixed ↔️ Stability
• Capital controls involve restrictions on the flow of money
• What is the nominal exchange rate if 1 USD can buy 0.90 EUR?

  1 USD = 0.90 EUR
• The nominal exchange rate is the direct ratio at which two currencies are traded
• The real exchange rate reflects the relative purchasing power of each currency
• The foreign exchange market is where currencies are traded
• Higher domestic interest rates attract foreign investment, strengthening the domestic currency.
• The demand and supply of currencies in the foreign exchange market determine the exchange rate between them.
• The nominal exchange rate is the direct ratio at which two currencies trade.
• If 1 USD can buy 0.90 EUR, the nominal exchange rate is 1 USD = 0.90 EUR.


  True
• The real exchange rate is the nominal exchange rate adjusted for prices
• Match the exchange rate type with its definition:

  Nominal exchange rate ↔️ Ratio at which two currencies trade

  Real exchange rate ↔️ Nominal rate adjusted for price levels
• What are the key factors that influence exchange rates?

  Relative price levels, interest rates, income, consumer tastes, government policies
• Order the steps involved in the impact of higher domestic income on exchange rates:

  1️⃣ Higher domestic income

  2️⃣ Increased imports

  3️⃣ Higher demand for foreign currency

  4️⃣ Potential depreciation of domestic currency
• What determines the exchange rate between two currencies in the foreign exchange market?

  Supply and demand
• The foreign exchange market is where currencies are traded, and the exchange rate is determined by supply
• What is the formula for the real exchange rate?

  $\text{Real Exchange Rate} =$$\text{Nominal Exchange Rate} \times \frac{\text{Domestic Price Level}}{\text{Foreign Price Level}}$
• Government policies can influence exchange rates through monetary or fiscal adjustments

  True
• Match the curve with its description:

  Demand Curve ↔️ Slopes downward

  Supply Curve ↔️ Slopes upward