Chapter 11 Foregin Exchange Rate class 12th Commerce

Concept Meaning of Foreign Exchange Rate

Foreign exchange refers to all currencies other than the domestic  currency of a given country ..

 

Concept Differences between currency appreciations and deprecations

 

Currency depreciation

Currency deprication refers to the decrease in the value of domestic currency in term s of foreign currency.

 

Currency appreciation

It refers to increase in the value of domestic currency in terms of foreign currency. 

 

Concept Demand for foreign exchange

Foreign exchange

1. Import of goods and services
2. Tourism
3. Unilateral transfers sent abroad
4. Purchase of assets in foreign countries
5. Speculation

 

1. Import of goods and services

           ​Foregin exchange is demanded to make the payments for import of goods and services.

2. Tourism

          Foregin exchange is needed to meet expenditure incurred in foregin tours .

3. Unilateral transfer sent abroad

          Foreign exchange is required for making unilateral transfers like sending gifts to other countries.

4. Purchase of assets in foreign countries

          It is demanded to make payment for purchase of assets, like land, shares, bonds, etc. in foreign countries.

5. Speculation

           Demand for foreign exchange arises when people want to make gains from appreciation of currency.

 

So your horizontal line is your x axis and vertical line is your y axis .on xaxis we will show the quantity demand for foreign exchange in dollar and on yaxis we will show the rate of foreign exchange..

And your demand curve slope down ward due to inverse relationship between the demand for foreign exchange and foreign exchange rate .

 

Concept Supply of foregin exchange

1. Exports of goods and services

          Supply of foreign exchange comes through exports of goods and services.

2. Foregin investment

          The amount, which foreigners invest in our home country, increases the supply of foreign exchange.

3. Remittance (unilateral transfers) from abroad

          Supply of foreign exchange increases in the form of gifts and other remittances from abroad.

4. Speculation

           Supply of foreign exchange comes from those who want to speculate on the value of foreign exchange.

 

Concept Determinants of Foregin Exchange Rate

So, Flexible exchange rate is determined by the interaction of the forces of demand and supply the equilibrium exchange rate is determined at a level where demand for foreign exchange is equal to the supply of foreign exchange

 

So horizontal line is x axis and vertical line is y axis. on x axis we will show the demand and supply of foreign exchange (in dollar ) and on y axis we will show the rate of foreign exchange ..

DD is the demand curve and SS is the supply curve of foreign currency

 

Concept - Changes in exchange rate

 

in case 1 Change in demand

Increase in demand..

So horizontal line is x axis and vertical line is y axis on the x axis will show the demand and supply of foriegn exchange. And on y axis will show the rate of foreign exchange.

 

An increase in demand for foreign exchange will shift the demand curve towards the right. It shows that per unit price of US dollar (in terms of rupees) has increased that is domestic currency has depreciated.

 

Decrase in demand

A decrease in demand will shift the demand curve towards left. It shows that when unit price of US dollar in terms of rupees, has decreased i.e, domestic currency has appreciated.

 

Change in supply

Increase in supply

So horizontal line is x axis and vertical line is y axis on the x axis will show the demand and supply of foriegn exchange. And on y axis will show the rate of foreign exchange.

 

If supply supply of foreign exchange increases, it will lead to a right word shift in supply curve this implies that per unit price of US dollar in terms of rupees has reduced and decrease in the price of foreign currency in terms of domestic currency means that the domestic currency has appreciated.

 

Decrease in supply

Dictation

A decrease in supply will shift the supply side towards left. So per unit price of US dollar in terms of rupees has increased and thus the domestic currency has depreciated.

1. Fixed exchange rate system (or pegged exchange rate system )
2. Flexible exchange rate system (or floating exchange rate system)
3. Managed floating rate system

 

1. Fixed exchange rate system (or pegged exchange rate system )

 

 

Fixed exchange rate system (Pegged exchange rate system)

1. The system of exchange rate in which exchange rate is officially declared and fixed by the government is called fixed exchange rate system.
2. When domestic currency is tied to the value of foreign currency, it is known as
   pegging.
3. To maintain stability in fixed exchange rate system, government buy foreign currency when exchange rate appreciates and sell foreign currency when exchange rate depreciates. This process is called Pegging operation, i.e., all efforts made by the central bank to keep the rate of exchange stable.
4. under this system each country keeps value of its currency fixed in terms of some external standard . this external standard can  be gold silver, other precious metal ,another country currency etc..
5. According to this system, value of every currency is determined in terms of gold. Accordingly, ratio between gold value of the two countries was fixed as exchange rate between those currencies.

 

Fixed Exchange Rate System of merits and demerits

Merits-

1. Market stability and mobility of capital
2. It ensures stability, in the international money market/exchange market. Day to day fluctuations are avoided. It helps formulation of long term economic policies, particularly relating to exports and imports

 

2. Growth of International Trade  

Fixed exchange rate system implies low risk and low uncertainty of future payments. It encourages international trade.

3. Stable macroeconomics policies

Fixed exchange rate helps co-ordination of macro policies across different countries of the world. Long term economic policies can be drawn in the area of international trade.

 

Demerits-

1. Huge foreign exchange reserves required  

Governemnt has to maintain Huge foreign exchange reserves to keep exchange rate fixed for long term. Also it helps to maintain capital movement in the conomy.

2. Difficulty in fixing the exchange rate
3. It is very difficult to keep exchange rate fixed. While decide the exchange rate , generally situaions like overvaluation and undervaluation of cuurency is seen.
4. Fixed exchange rateFixed exchange rate restricts the movement of capital across different parts of the world. Accordingly, international growth process suffers.

 

Flexible Exchange Rate System

Flexible exchange rate is just opposite to the fixed exchange rate system …

flexible exchange rate system refers to a system in which exchange rate is determined by forces of demand and supply of different currencies in the foreign exchange market .

 

• The value of currency is allowed to fluctuate freely according to change in demand and supply of foreign exchange .
• There is no official intervention of government in the foreign exchange market. flexible exchange rate is also known as floating exchange rate.
• The exchange rate is determined by the markets i.e, through interaction of thousands of banks , firms, and other institutions seeing to buy and sell currency for purpose of making transaction in foreign exchange .

Merits-

1. Maintain equilibrium level

System is so flexible that it can adjust its equilibrium by its ownself and also it adjust the situation of disequilibrium in BOP by ownself. Also it eliminates the problem of overvaluation and undervaluation of currencies.

2. No need for huge foreign exchange reserves

as we know that exchange is flexible so that’s why government maintain reserves. so now if there is no need for reserves then it result in movement of capital and also international movement got encouraged.

3. Optimum resource allocation

flexible exchange rate system ensures that the resources have optimum utilization and moreover, it also have the efficiency to enhance the resource allocation as it leads to equilibrium exchange rates of different currencies.

 

Demrits of Flexible exchange rate system

1. Instablity in the exchange rate

demand and supply, forces ki vjha se exchange rate fluctuation aati rheti hai jis se instability aa jati hai and consequently it hampers foreign trade.

 

IIt causes instability in the international money market. Exchange rate tends to fluctuate like price of goods in the commodity market.

 

2. Policy formulation becomes difficult- long term export and import policies banana bhot difficult hota hai because of instability in the market.

 

Policy formulation becomes difficult that causes instability in the market.

3. Managed floating rate system

Foreign echange rate is determined by market forces that is demadn and supply of forceign exchange and govt intervien karti hai to influence the exchange rate.

Ye limits kuch bhi ho skti hai but aim is to control fluctauations and to keep at desired targeted value.

 

It refers to the system in which foreign exchange rate is determined by markets forces and central bank influence the exchange rate through intervention in the foreign exchange market .

• It is also known as dirty floating.
• In this system, central bank intervein in the foreign exchange market to restrict the fluctuation in the exchange rate within certain limits. the aim is to keep exchange rate close to desired target values.
• For this, central bank maintains reserves of foreign exchange to ensure that the exchange rate stays within the targeted value …

 

Meaning of Foreign Exchange Market

So, we can say that foreign exchange market is the market where foreign currencies are bought and sold.

 

Foregin Exchange Market

foreign exchange market is the market where foreign currencies are bought and sold....

1. Transfer Function
2. Credit Function
3. Heging Function

 

1. Transfer Function

Transfer function refers to transferring of purchasing power among countries.

1. Credit Function

It implies provision of credit in terms of foreign exchange for the export and import of goods and services across different countries of the world.

2. Hedging function

Hedging function pertains to protecting against foreign exchange risks. Where Hedging is an activity which is designed to minimize the risk of loss.

 

Concept kinds of foregin exchange market

 

1. Spot market

If the operation is of daily nature,in other words it is the market in which receipt and payments are made immediately . it is called spot market or current marke

 

2. Forward Market

A market for foreign exchange for future delivery is known as forward market.

 

• In exam question may come like
• Why forward transactions contracted
• Answer will be to avoid adverse change in exchange rate
• And to make profit

 

Concept Differences between deprication and devaluation appreciation and revaluation.

RESHOOT BUT PHLE CORRECT KRO

Devaluation: It refers to decrease in the value of domestic currency in terms of foreign currency by the government. It is a part of fixed exchange rate.

Depreciation:

It refers to decrease in the value of domestic currency in terms of foreign currency.

 

Appreciation:

It refers to increase in the value of domestic currency in terms of foreign currency.

 

Revaluation: It refers to increase in the value of domestic currency by the central government. It is a part of fixed exchange rate.