Exchange Rate

• Exchange rate


  The price of one currency in terms of another currency
• The dollar($), the euro (€), and the yen (¥) are three world's monies and most international payments are made using one of them

  
• Foreign exchange rate


  The price at which one currency exchanges for another
• Currency depreciation


  A fall in the value of one currency in terms of another currency
• Currency appreciation


  A rise in value of one currency in terms of another currency
• The exchange rates fluctuates - rises and falls

  
• Appreciation of the dollar

  A rise in exchange rate
• Depreciation of the dollar


  A fall in the exchange rate
• Foreign currency


  Money of other countries regardless of whether that money is in the form of notes, coins or bank deposits
• Gold standard


  Prior to 1930's, the values of all currencies were directly fixed to gold and have a fixed relationship to each other
• The Ringgit Malaysia is demanded and supplied by thousands of traders every hour of every day
• With many traders and no restrictions, the foreign exchange market is a competitive market
• Demand for one money


  Supply of another money
• Factors influencing demand for RM

  • Exchange rate
  • World demand for RM exports
  • Interest rates in Malaysia and other countries
  • Expected future exchange rate

  
• Law of demand for foreign exchange

  Other things remaining the same, the higher the exchange rate, the smaller is the quantity of RM demanded in the foreign exchange market
• Reasons exchange rate influences quantity of RM demanded

  • Exports effect
  • Expected profit effect

  
• Exports effect


  The larger the value of RM exports, the greater is the quantity of RM demanded in the foreign exchange market
• Expected profit effect


  The larger the expected profit from holding RM, the greater is the quantity of RM dollars demanded today
• The Demand Curve for U.S. Dollars illustrates the demand curve for U.S. dollars on the foreign exchange market

  
• Factors influencing supply of RM

  • Exchange rate
  • World demand for RM Imports
  • Interest rates in Malaysia and other countries
  • Expected future exchange rate

  
• Law of supply of foreign exchange

  Other things remaining the same, the higher the exchange rate, the greater is the quantity of RM supplied in the foreign exchange market
• Reasons exchange rate influences quantity of RM supplied

  • Imports effect
  • Expected profit effect

  
• Imports effect


  The larger the value of Malaysia imports, the larger is the quantity of RM supplied on the foreign exchange market
• Expected profit effect


  For a given expected future RM exchange rate, the higher the exchange rate today, the larger is the expected profit from selling RM today and holding foreign currencies, so the greater is the quantity of ringgit supplied

  
• The Supply Curve for U.S. Dollars illustrates the supply curve of U.S. dollars in the foreign exchange market

  
• Figure 9.3 shows how demand and supply in the foreign exchange market determine the exchange rate

  
• If the exchange rate is too high, a surplus of U.S. dollars drives it down

  
• If the exchange rate is too low, a shortage of U.S. dollars drives it up

  
• The market is pulled (quickly) to the equilibrium exchange rate at which there is neither a shortage nor a surplus
• Changes in the Demand for U.S. Dollars

  • World demand for U.S. exports
  • U.S. interest rate relative to the foreign interest rate
  • The expected future exchange rate

  
• World demand for U.S. exports

  At a given exchange rate, if world demand for U.S. exports increases, the demand for U.S. dollars increases and the demand curve for U.S. dollars shifts rightward

  
• U.S. interest rate differential


  The U.S. interest rate minus the foreign interest rate

  
• U.S. interest differential


  If the U.S. interest differential rises, the demand for U.S. dollars increases and the demand curve for U.S. dollars shifts rightward

  
• Expected future exchange rate

  At a given current exchange rate, if the expected future exchange rate for U.S. dollars rises, the demand for U.S. dollars increases and the demand curve for dollars shifts rightward

  
• Figure 9.4 shows how the demand curve for U.S. dollars shifts in response to changes in U.S. exports, the U.S. interest rate differential, and the expected future exchange rate

  
• Changes in the Supply of Dollars

  • U.S. demand for imports
  • U.S. interest rates relative to the foreign interest rate
  • The expected future exchange rate

  
• U.S. demand for imports

  At a given exchange rate, if the U.S. demand for imports increases, the supply of U.S. dollars on the foreign exchange market increases and the supply curve of U.S. dollars shifts rightward

  
• U.S. interest differential


  If the U.S. interest differential rises, the supply for U.S. dollars decreases and the supply curve of U.S. dollars shifts leftward

  
• Expected future exchange rate

  At a given current exchange rate, if the expected future exchange rate for U.S. dollars rises, the supply of U.S. dollars decreases and the supply curve for dollars shifts leftward

  
• Figure 9.5 shows how the supply curve of U.S. dollars shifts in response to changes in U.S. demand for imports, the U.S. interest rate differential, and the expected future exchange rate