Introduction to Currency Markets

Learning Objectives

To Understand• Foreign Exchange & Foreign Exchange Rate• Foreign Exchange Market

Learning Objective – 1 (Meaning of Foreign Exchange Rate)

Exchange rate is the price of a country’s currencyin terms of another country’s currency.

Learning Objective – 1 (Determination of Exchange Rate)

• Gold Standard System • Introduced in the year 1875• Currency was backed by gold• The difference in price of an

ounce of gold between two currencies became the exchange rate for those currencies.

• Eventually broke down during the beginning of world war I.

Learning Objective – 1 (Determination of Exchange Rate)

• Bretton Wood System • Representatives of different countries, in July 1944 met at Bretton Woods, New Hampshire, USA

Learning Objective – 1 (Determination of Exchange Rate)

• Bretton Wood System • A method of fixed exchange rates.

• The us dollar replacing the gold standard to become a primary reserve currency.

• The US dollar became the only currency that would be backed by gold.

Learning Objective – 1 (Determination of Exchange Rate)

• Bretton Wood System • The creation of three international agencies to oversee economic activity: IMF, IBRD & GATT

• 1971 marked the end of Bretton Wood System.

Learning Objective – 1 (Determination of Exchange Rate)

• Exchange Rate System after Bretton Woods

• Dollarization• Fixed exchange rate • Floating exchange rate

Learning Objective – 1 (Determination of Exchange Rate)

• Exchange Rate System after Bretton Woods

Dollarization

Use of foreign currency in parallel to or instead of

domestic currency

Learning Objective – 1 (Determination of Exchange Rate)

• Exchange Rate System after Bretton Woods

Fixed Exchange Rate

The value of a currency is determined by

the government

Learning Objective – 1 (Determination of Exchange Rate)

• Exchange Rate System after Bretton Woods

Floating Exchange Rate

The value of a currency is determined by

demand for and supply of foreign exchange

Learning Objective – 1 (Factors affecting Exchange Rate)

• Trade Movement• Capital Flow• Granting of Loans• Sale and Purchase of

Securities• Speculation• Protection

• Control of Foreign Exchange• Inflation• Financial Policy• Bank Rate• Peace & Security• Political Conditions

Learning Objective – 1 (Factors affecting Exchange Rate)

• Trade Movement IfImport > Export => Depreciation in the

value of the currency

Import < Export => Appreciation in the value of the currency

Learning Objective – 1 (Factors affecting Exchange Rate)

• Capital Flow When A capital INFLOW take place there is an appreciation in the value of the currency.

When A capital OUTFLOW take place there is a depreciation in the value of the currency.

Learning Objective – 1 (Factors affecting Exchange Rate)

• Granting of Loans

Receiving of loans from a foreign country appreciates the value of the currency

Learning Objective – 1 (Factors affecting Exchange Rate)

• Sale and Purchase of Foreign Securities Sale of foreign securities by a country

appreciates the value of the currency.

Purchase of foreign securities by a country depreciates the value of the currency

Learning Objective – 1 (Factors affecting Exchange Rate)

• Speculation (SAY) SPECULATORS EXPECT VALUE OF DOLLAR ↑

Þ PURCHASE DOLLARS TO EARN PROFIT IN FUTURE

Þ DEMAND FOR DOLLAR INCREASES

Þ RATE OF EXCHANGE OF RUPEE ↓(IN TERMS OF US DOLLAR)

Learning Objective – 1 (Factors affecting Exchange Rate)

• Protection PROTECTION DISCOURAGES IMPORTS

Þ DEMAND FOR FOREIGN CURRENCY DECREASES

Þ RATE OF EXCHANGE OF RUPEE ↑(IN TERMS OF US DOLLAR)

Learning Objective – 1 (Factors affecting Exchange Rate)

• Exchange Control EXCHANGE CONTROL DISCOURAGES IMPORTS

Þ DEMAND FOR FOREIGN CURRENCY DECREASES

Þ RATE OF EXCHANGE OF RUPEE ↑(IN TERMS OF US DOLLAR)

Learning Objective – 1 (Factors affecting Exchange Rate)

• Inflation INFLATION IN INDIA INCREASES

Þ FALL IN THE VALUE OF RUPEE

Þ OUTFLOW OF FOREIGN CAPITAL FROM INDIA(TO AVOID FINANCIAL LOSSES)

Þ DEMAND FOR (SAY ) DOLLAR INCREASES

Þ RATE OF EXCHANGE OF RUPEE ↓(IN TERMS OF US DOLLAR)

Learning Objective – 1 (Factors affecting Exchange Rate)

• Financial Policy DEFICIT FINANCINGÞ INFLATIONARY CONDITIONS

Þ FALL IN THE VALUE OF RUPEE

Þ OUTFLOW OF FOREIGN CAPITAL FROM INDIA(TO AVOID FINANCIAL LOSSES)

Þ DEMAND FOR (SAY ) DOLLAR ↑

Þ RATE OFRATE OF EXCHANGE OF RUPEE ↓(IN TERMS OF US DOLLAR)

Learning Objective – 1 (Factors affecting Exchange Rate)

• Bank Rate BANK RATE INCREASES

Þ INTEREST RATE INCREASES

Þ INFLOW OF FOREIGN CAPITAL(TO EARN HIGH INTEREST INCOME)

Þ SUPPLY OF FOREIGN CURRENCY INCREASES

Þ RATE OF EXCHANGE OF RUPEE ↑

Learning Objective – 1 (Factors affecting Exchange Rate)

• Peace & Security PEACE & SECURITY

Þ ATTRACTS FOREIGN CAPITAL

Þ SUPPLY OF FOREIGN CURRENCY INCREASES

Þ RATE OF EXCHANGE OF DOMESTIC CURRENCY ↑

Learning Objective – 1 (Factors affecting Exchange Rate)

• Political Conditions POLITICAL STABILITY

Þ ATTRACTS FOREIGN CAPITAL

Þ SUPPLY OF FOREIGN CURRENCY INCREASES

Þ RATE OF EXCHANGE OF DOMESTIC CURRENCY ↑