NATIONAL UNIVERSITY OF SCIENCE AND TECHNOLOGY

FACULTY OF COMMERCE

DEPARTMENT OF ACCOUNTING

STUDENT NAMES : MLAWUZI MANDISA N02419281D

GONYORA VANESSA N02420589E

MADEMBO ROY N02422833W

MPOFU BRIDGET NO2424889R

MUSAKWA JOYLINE T. N02419047L

NYATHI BLESSING N02420382D

SIBANDA SAMKELISO N02420909M

LEVEL : 1.2

COURSE CODE : CBA 1205

COURSE TITLE : PRINCIPLES OF MACRO ECONOMICS

4a. Interpret the following exchange rate and illustrate on a diagram
$1= £0.65 and £1= $1.56
Exchange rate is the value of one currency in terms of another currency. It is the rate at which
you can exchange one currency for another.

-The above exchange rates indicate that the British pound is stronger than the US dollar as one
would need fewer pounds to buy the same amount of dollars. This means that the British pound
has a greater value as compared to the US dollar in international trade and transactions.
b.(i) Distinguish between volume quotation and price quotation systems of quoting exchange rate
1. PRICE QUOTATION is a quotations system in which the stronger currency is expressed in
the form of the weaker currency i.e. (Stronger currency: weaker currency. £1=$1.25) whereas
VOLUME QUOTATION is when the weaker currency expressed in terms of the stronger I.e
(weaker currency : stranger currency) e.g. $1=£0.8
(ii). Distinguish between appreciation and depreciation
1. Appreciation refers to an increase in the value of one currency relative to another in the
foreign exchange market e.g. if the US dollar appreciates against the euro, it means that
you can buy more euros with the same amount of dollars whereas depreciation refers to
the decrease in value of a currency relative to other currencies e.g. if the US dollar
depreciates against the euro, it means you need the more dollars to buy the same amount
of euros.
2. With depreciation a currency decreases purchasing power abroad and potential for higher
inflation whereas with appreciation the purchasing power increases and there is potential
for lower inflation.
(iii). Distinguish between devaluation and revaluation
1. Devaluation is the deliberate downward adjustment of a country’s currency value to
another currency, group of currencies or a standard lie gold whereas revaluation is the
deliberate upward adjustment of a country’s currency value relative to another currency
or group of currencies.
2. The purpose of devaluation is to make exports cheaper and imports expensive, aiming to
boost export competitiveness and reduce trade deficits whereas with revaluation the value
of the currency is increased to make imports cheaper and exports more expensive, aiming
to control inflation and reduce trade deficits.

(iv). Distinguish between soft currency and hard currency

Soft currency- is a currency which is not needed in large volumes (is not much demand for the
purpose of international trade)
Soft currency: -
a. Loses value easily as it devalues quickly against other currencies
b. Has high inflation rate: - the country issuing the currency has high inflation rates,
reducing the currency’s purchasing power.
c. Has low demand in the foreign exchange market
d. Is not widely accepted as form of payment or reserve currency
e. Is economically unstable: - the country’s economy is unstable, with factors like political
unrest, trade deficits, or debt issue.
e.g. Bond notes
Hard currency is a currency which is needed in large volumes in international trade
Maintains its value, has low inflation, is widely accepted and has high demand e.g. USD and
Euro
Hard currency Soft currency
1. International -Widely accepted globally -Limited acceptance
acceptance for international trading outside the country of
and transactions, origin, often not freely
investments and a store of convertible
value
1. Exchange rate -Tends to have stable and -Often has a floating
predictable exchange rate exchange rate that can
against other hard fluctuate widely based on
currencies market forces, government
intervention and economic
conditions
2. Demand -High demand from -Lower global demand, as
individuals, businesses and it is perceived as risky and
government world wide less stable
3. Availability -Widely available and easy -May be subject to capital
to obtain through banks, controls, making it more
exchange bureaus or difficult to acquire and
financial markets exchange
4. Stability -Less prone to fluctuation -Is volatile and their
and have more purchasing purchasing power can
power fluctuate significantly

(v). Distinguish between nominal and real exchange rates

1. Nominal exchange rate Is the price of one country’s money in terms of another country’s
money. Nominal exchange rate is basically the exchange rate we see on the foreign exchange
market. For example, how many pounds you can buy with one US dollar whereas real exchange
rate Is the nominal exchange rate but after adjustment for the differences in prices between
countries and it reflects the purchasing power of one currency relative to another. Real exchange
rate is the actual value you get for your money considering the prices in both countries
With real exchange rates it’s like comparing the same product taking into account that prices can
be different in different countries. For example, if a burger costs $2 in Zim and R61 in south
Africa, the real exchange rate would help you understand how much burger you can buy with
one US dollar in South Africa.
Nominal exchange rate reflects short term market forces meaning that it is influenced by short
term supply and demand, interest rates, speculations and it focuses on currency prices while also
not taking into account for inflation whereas real exchange rate which is more stable has long
term focus thereby reflecting long term economic fundamentals such as productivity, trade
balances and it focuses on purchasing power while taking into account inflation.
Formulae = Nominal exchange rate x (Domestic price level/ foreign price level)

c. How do Central banks maintain an exchange rate at a certain peg? What do they do
specifically if they expect their currency will depreciate /appreciate to keep it at the same desired
peg?
1. WHEN THE CURRENCY APPRECIATES:
(i). sell the currency
- The central bank sells its own currency on the foreign exchange market to increase supply and
reduce demand, thus weakening the currency. For example, the central bank of Britain wants to
maintain a peg of 1 (USD) =£0.65 but somehow due to market forces the exchange rate starts to
increase to 1(USD) =£0.60. To maintain the peg the central bank of that country can sell its
currency in the foreign exchange market and flood the market with its currency which reduces its
value and maintains the peg.
(ii). Lowering interest rates
Reducing interest rates makes the currency less attractive to investors, reducing demand and
weakening the currency. Interests’ rates are the percentage at which interest is paid on borrowed
money or invested funds. For example, a country has its currency pegged at 1(USD)= £0.65.
However due to strong economic growth and high interest rates, the pounds start appreciating to
1(USD)= £0.60 to maintain the peg the central bank of Britain could lower its interest maybe
from 5% to 4% which makes borrowing cheaper and it becomes less attractive to investors
leading to a maintained peg.

(iii). Implementing capital controls

-Regulating the capital flows to prevent large inflows which can reduce upward pressure on the
currency. They can restrict capital inflows by limiting foreign investment or requiring approval
for inward investments to reduce demand of the currency. They can also impose high taxes on
foreign investment which leads to an increase in the cost of investing in a certain country. For
example, A country’s currency is pegged the US dollar at a rate of 1(USD)= £0.65. Due to
economic growth it starts to appreciate to 1(USD)= £0.60 to maintain the peg, the central bank of
that country may impose a capital control that requires foreign investors to deposit 15 % of their
investment amount in a non-interest bearing account for 5 months before investing in that
country which leads to a reduction in demand for that currency and maintains the peg.
2. WHEN THE CURRENCY DEPRECIATES
(i). Buy the currency
-The central bank will use its foreign exchange reserves (USD, EUR) to buy its own currency
and sell foreign currencies in the foreign exchange market. This increases demand for the
domestic currency, putting an upward pressure on the exchange rate to defend the peg.
(ii). Raising interest rates
The central bank can increase domestic interest rates by utilizing the monetary policy tool. This
would offer a higher relative rate of return and attract foreign depositors. Such depositors would
buy a currency to get the higher interest rates. This resulting capital inflow would increase the
demand and the price of the currency.
(iii) implementing capital controls
-The central banks can restrict the ability of residents and non- residents to convert the domestic
currency or move capital in and out of the country. This reduces downward pressure on the
exchange rate by limiting currency outflows.
d. How is the British Central bank going to maintain a peg of $1 = ₤0.65
1. Tighten monetary policy
-The British Central Bank could implement other contractionary monetary policy measures such
as reducing the money supply or increasing bank reserve requirements. This would make the
Great British Pound more scarce and valuable helping to maintain the 0.65 peg against the dollar.
2. Raising interest rates
-The British Central bank would likely need to raise UK interest rates to makes Great British
Pound more attractive to hold for investors. Higher interest rates would increase the relative
yield of Great British Pound dominated assets, attracting capital inflows and supporting the
exchange rate peg.

3. Communication and policy alignment

-Simply clear communication of the central bank’s commitment throughout the staff and
executives to the peg is crucial. This means that every policy created and decisions made should
be made in alignment with the objective of the peg making it simpler to accomplish.
4. implementing capital controls
-As a last resort, the British Central bank could impose capital controls to restrict to the outflow
Great British Pound from the UK. This would limit the ability to covert Great British Pound to
USD reducing downward pressure on the exchange rate thereby maintain the desired peg.
5. Intervention in the foreign market
-The British Central Bank would immediately buy British pounds and sell US dollars in the
foreign market. This would increase demand for the pound, putting an upward pressure on the
exchange rate to maintain the ₤0.65 peg against the $1.

f. Suppose the American Central Bank wants to maintain the peg at a minimum of ₤1 =
$1.25 and at a maximum of ₤1 = $1.56. Illustrate this on a diagram together with the
original figures and proceed to explain how they will keep the exchange rate within these
boundaries
1. Intervention in the foreign exchange market:

- The American central bank can buy or sell US dollars in the foreign exchange market to
influence the exchange rate. If the exchange rate starts to fall below the minimum of £1 = $1.25,
the central bank can buy US dollars to increase the demand for the US dollar, thereby pushing
the exchange rate back up. Conversely, if the exchange rate starts to rise above the maximum of
£1 = $1.56, the central bank can sell US dollars to increase the supply of the US dollar, causing
the exchange rate to fall.

2. Adjusting interest rates:

- The American central bank can raise or lower its benchmark interest rates to affect the
relative attractiveness of the US dollar. If the exchange rate is falling towards the minimum, the
central bank can raise interest rates. This will make the US dollar more attractive to investors,
leading to an increase in demand for the US dollar and a rise in the exchange rate. Conversely, if
the exchange rate is approaching the maximum, the central bank can lower interest rates. This
will make the US dollar less attractive, leading to a decrease in demand for the US dollar and a
fall in the exchange rate.

3. Coordination with other central banks:

- The American central bank may collaborate with the Bank of England (the central bank of the
United Kingdom) to jointly intervene in the foreign exchange market or coordinate monetary
policy decisions. This can help maintain the desired exchange rate range and provide stability in
the currency market.

4. Communication and guidance:

- The American central bank can use communication and forward guidance to signal its
intention to maintain the exchange rate within the specified range. This can help shape market
expectations and discourage large-scale speculative activities that could push the exchange rate
outside the desired range.

By actively using these monetary policy tools, the American central bank can strive to keep the
exchange rate between the British pound and the US dollar within the specified range of £1 =
$1.25 (minimum) and £1 = $1.56 (maximum).
REFERENCES
1. "International Economics" by Paul Krugman, Maurice Obstfeld, and Marc Melitz
- Publisher: Pearson
- Edition: 10th

2. "International Finance" by Maurice Obstfeld and Kenneth Rogoff

- Publisher: Routledge
- Edition: 4th

3. "Macroeconomics" by N. Gregory Mankiw

- Publisher: Worth Publishers
- Edition: 9th