Recollect your memory :

• During your last holiday abroad, what currency did you use? If you spent
your host country’s currency, your parent’s must have obtained it from a
foreign exchange market at a predetermined foreign exchange rate.
6.3 Foreign
exchange rate
 IGCSE®/O Level Economics

6.3 Foreign exchange rates

6.3.1 definition of foreign exchange rate

6.3.2 determination of foreign exchange rate in foreign
exchange market
6.3.3 causes of foreign exchange rate fluctuations
6.3.4 consequences of foreign exchange rate
fluctuations
6.3.5 floating and fixed foreign exchange rates (including
part of 2.11.2)
Have you ever
thought of the idea
how there is no
universal currency?
Instead, different countries have
different currencies (also called
‘monetary units’) and each currency
has its own value. This value is not
set, but fluctuates based on a
variety of factors.

This Photo by Unknown Author is licensed under CC BY-SA-NC

Calculate : Group 1
Let us take the example of a trader who wants to invest in the exchange-
traded funds traded in US markets. The trader has INR 10,000 to invest in
the exchange-traded funds traded in the offshore market. However, the
trader lives in India, and 1 INR corresponds to 0.014 USD.
Help the trader determine the value of INR investment in terms of US
currency.
Calculate : Group 2
• Let us take the example of an individual planning a trip from the USA to
the European Union. He has a planned budget of $5,000. The travel agent
informs the traveler that if he exchanges US dollars to Euro, he will get
€4,517.30.
• Help the traveler determine the exchange rate between the USA and the
Euro.
Calculate : Group 3
• Let us take the example of a trader from the USA to make investments in
the UK financial market. He has a planned budget of $20,000. The offshore
broker informs the trader that if he exchanges US dollars for the British
pound, he will get £15,479.10
• Help the trader determine the exchange rate between the USA and UK.
Answers Group 1
• The value of exchange in terms of US dollars = 0.014*10,000
• Value of Exchange in Terms of US dollars will be:-
• Money in After Exchange = $140.
• Therefore, the trader would get $140 in USD dollars when he approaches a
bank or a foreign exchange institution to convert INR to USD currency.
Answers Group 2
• Exchange Rate (€/ $) = € 4,517.30 / $5,000
• Exchange Rate will be:-
• Exchange Rate (€/ $) = 0.9034
• Therefore, the exchange rate between the US and Euro is 0.9034. Therefore,
if the traveler plans to raise the budget, he can consider the above-
calculated exchange rate.
Answers Group 3
• Exchange Rate (£/ $) = £15,479.10 / $20,000
• Exchange Rate (£/ $) will be:-
• Exchange Rate (£/ $) = 0.77
• Therefore, the exchange rate between the US and the pound is 0.77.
Therefore, if the trader plans to raise the budget, he can consider the
above-calculated exchange rate.
• https://www.wallstreetmojo.com/exchange-rate-formula/#example-1
Foreign exchange market
 IGCSE®/O Level Economics

6.3 Foreign exchange rates

6.3.1 definition of foreign exchange rate

6.3.2 determination of foreign exchange rate in foreign
exchange market
6.3.3 causes of foreign exchange rate fluctuations
6.3.4 consequences of foreign exchange rate
fluctuations
6.3.5 floating and fixed foreign exchange rates (including
part of 2.11.2)
Sometimes, however, the exchange rate doesn’t tell the whole story.
• For instance, a U.S. dollar in 2009 was worth about 34 Thai baht. Still, a
Big Mac (which cost about $3.57 in the United States) could be
purchased for as little as 60 to 80 baht in Thailand, the equivalent of
$1.75 to $2.34.15
• Why would the same Big Mac have a different price in Thailand?
• This difference in price is due to the fact that exchange rates reflect both
the local market conditions and the calculations of currency traders
about the overall prospects of an economy.
• For example, when currency traders predict that a nation is going to
undergo a bout of inflation in the near future, making their currency less
valuable, they are likely to sell their holdings of that currency, just like
any other commodity.
• Because exchange rates are comprised of these two factors, economists
sometimes measure the value of a currency according to the Purchasing
Power Parity (PPP) Index. The PPP rate of a currency can be calculated
by comparing the cost of a basket of goods in one country to the cost of
that same basket of goods in another country.
• The Zambian kwacha is rarely used outside of Zambia. So, when Zambia
wants to buy goods from the United States, it cannot pay with kwachas.
Americans not living in Zambia have no use for kwachas. Rather, when
Zambia exports goods it will be paid in dollars, yen, euros, or another
hard currency. It can then use these hard currencies to purchase imports
from other countries.
 IGCSE®/O Level Economics

6.3 Foreign exchange rates

6.3.1 definition of foreign exchange rate

6.3.2 determination of foreign exchange rate in foreign
exchange market
6.3.3 causes of foreign exchange rate fluctuations
6.3.4 consequences of foreign exchange rate
fluctuations
6.3.5 floating and fixed foreign exchange rates (including
part of 2.11.2)
Define the terms ‘appreciation’ and ‘depreciation’
• Explain how these terms is used to describe the changing value of a
currency.
• Each learner can be responsible for tracking a specific currency and can
give a weekly briefing as to how and why the currency’s value has
changed.
Activity 6.7
Activity 6.7
Study recent reports of currency movements :
• Identify possible reasons for exchange rate changes. This list can be
discussed by the whole class resulting in an agreed list of factors
influencing exchange rates.
• https://www.thenationalnews.com/business/money/2022/09/22/uae
-residents-cash-in-on-weak-euro-and-pound-as-remittances-surge/
Why the value of a currency changes / fluctuates
on the foreign exchange market?
• Changes in demand for exports & imports
• Inflation
• Changes in interest rates
• Speculation
• The entry or departure of MNC
The supply of money in a modern economy and financial
system is determined by three key factors:

1. “Open market operations” – this is effectively the same as Quantitative

Easing. The Central Bank buys government bonds, effectively creating
money
2. The “reserve requirement” imposed on banks – this is the % of deposits
made by customers at the bank that the bank must keep hold of rather than
lending it out
3. The policy interest rate set by the central bank – the rate of interest will
influence how many households and businesses are willing and able to
borrow. Most money in a modern economy is created by commercial bank
lending so the rate of interest ultimately does have a bearing on the supply
of money
Key factors affecting the demand for money
1. The rate of interest on loans

2. The number / value of monetary transactions that we expect to carry out

3. The extent to which we also want to hold other financial assets, such as bonds,
property, saving (this is also influenced by the rate of interest) – this is known as
the speculative motive for holding money
4. Changes in GDP

5. The extent to which it is possible to use debit cards / credit cards i.e. the pace of
financial innovation
6. The extent to which we might have to pay out large unexpected payments, for
example, for i.e. the precautionary motive
7. The rate of anticipated inflation
How changes in exchange rates affect the prices
of imports & exports?
• In the graph below, an increased currency supply from S1 to S2 at
the same demand D1 implies that the currency-pair price will
depreciate. In contrast, increased demand from D1 to D2 at the
same supply S1 will lead to currency appreciation.
• Market sentiment towards the economy of a country affects how
strong or weak the floating currency is perceived. For example, a
country’s currency is expected to depreciate if the market views
the government as unstable. Although the floating exchange rate
is not entirely determined by the government, they can intervene
when the currency is too low or too high to keep the currency at a
favorable price.
 IGCSE®/O Level Economics

6.3 Foreign exchange rates

6.3.1 definition of foreign exchange rate

6.3.2 determination of foreign exchange rate in foreign
exchange market
6.3.3 causes of foreign exchange rate fluctuations
6.3.4 consequences of foreign exchange rate
fluctuations
6.3.5 floating and fixed foreign exchange rates (including
part of 2.11.2)
Consequences of appreciation in the exchange
rate of a currency :
Consequences of appreciation in the exchange
rate of a currency :
Imagine nutfields in Germany places regular order with
Prodiga in Turkey to supply 10 tonnes of hazelnut per
month at a price of 20,000 Turkish lira per tonne.
• Discuss the reasons why a government
might encourage its exchange rate to either
appreciate or depreciate against other
currencies.
Homework :
• Explore how the price elasticity of demand for exports and imports
might influence how an appreciation or depreciation would affect the
total value of exports and imports.
• Consider whether your own currency is currently over- or under-valued
against other countries
• Therefore whether it should be allowed to appreciate or depreciate.
• Now recommend the best strategies for the government to use to enable
the currency value to change.
• Use supply and demand analysis to explain how a government could
manage the supply and demand of its currency, to keep it within a fixed
range (e.g. to explain what the government would do as the exchange
rate weakens and moves towards the bottom of the allowed range).
• As part of this define devaluation and revaluation and explain how these
terms are different to appreciation and depreciation. (I)
 IGCSE®/O Level Economics

6.3 Foreign exchange rates

6.3.1 definition of foreign exchange rate

6.3.2 determination of foreign exchange rate in foreign
exchange market
6.3.3 causes of foreign exchange rate fluctuations
6.3.4 consequences of foreign exchange rate
fluctuations
6.3.5 floating and fixed foreign exchange rates (including
part of 2.11.2)
Define ‘fixed’ and ‘floating’ exchange rates.
• Track recent exchange rate movements using newspapers or a currency
website such as www.xe.com (navigate to ‘Currency Charts’).
• Now decide which currencies are floating and which are fixed (for this
activity it would be useful to study the US dollar-Chinese Yuan ten-year
chart). (I)
Floating Exchange rates :
Fixed exchange rates :