Unit 7

Mechanics of Foreign Exchange (FOREX)

• Foreign Exchange (FOREX)
• The buying and selling of currency
• Ex. In order to purchase souvenirs in France, it is first necessary for Americans to sell their Dollars and buy Euros.
• Any transaction that occurs in the balance of Payments necessitates foreign exchange.
• The exchange rate (e) is determined in the foreign currency market.
  
• 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 decrease the exchange rate of a currency.
• An decrease in the supply of a currency will increase the exchange rate of a currency.
• An increase in the demand of a currency will increase the exchange rate of a currency.
• An decrease in the demand of a currency will decrease the exchange rate of a currency.
• Appreciation and Depreciation
• Appreciation of a currency occurs when the exchange rate of that currency increase (e↑)
• Depreciation of a currency occurs when the exchange rate of that currency decrease (e↓)
• Exchange Rate Determinants
• Consumer Tastes
• Relative Income
• Relative Price Level
• Speculation
• Exports and Imports
• The exchange rate is a determinants of both exports and imports.
• Appreciation of the dollar causes American goods to be relatively more expensive and foreign goods to be relatively cheaper thus reducing exports and increasing imports.
• Depreciation of the dollar causes American goods to be relatively cheaper and foreign goods to be relatively more expensive thus increasing exports and reducing imports.
• Floating/Flexible Rates
• Depends on demand and supply of that currency vs. other currencies.
• It is very sensitive to the business cycle
• Provide options for investment
• Fixed Rates
• Based upon a country's willingness to distribute currency and the ability to control the amounts.