It explains the following topics Factor Affecting the exchange rate CURRENCY DEPRECIATION VS.CURRENCY APPRECIATION Foreign exchange Theories of exchange rate

1. • FACTORS
AFFECTING
EXCHANGE RATE
• THEORIES OF
EXCHANGE RATE
▪ Submitted By:
▪ 005 Manpreet
▪ 041 Jatin Goyal
▪ 044 Mehak Rastogi
▪ 059 Shivani Mukhija
Submitted To:
Dr. Phool Chand

2. • Foreign Exchange refers to the mechanism of the ways and means by which
payment in connection with International Trade are effected. It refers to all
currencies other than the domestic currency of a given country.
• Exchange Rate: The rate of exchange is the price of one currency expressed
in terms of another currency, it is the reflection of the external value of the
domestic currency.
• It should also be noted here that exchange rate is not always constant, it goes
on changing from time to time o account of change in demand for and supply
of foreign currency.

3. 1. Differentials in Inflation
2. Differentials in Interest Rates
3. Balance of Payment
4. Government Debt
5. Terms of Trade
6. Monetary Policy
7. Economic Strength
8. Resource Discovery
9. Speculation
10. Recession
11. Market Factor
12. Political Stability And
EconomicPerformance

4. CURRENCYDEPRECIATION VS.CURRENCY APPRECIATION
▪ CURRENCY APPRECIATION
I. It refers to increase in the value of
domestic currency in terms of
foreign currency.
II. It makes foreign goods cheaper in
domestic country as more and
more of goods can now be
purchased with same amount of
domestic currency. So, it leads to
increase in imports.
III. A change from $1=60 to
▪ $1=55 represents that Indian
Rupees is appreciating.
CURRENCY DEPRECIATION
I. It refers to decrease in the value of
domestic currency in terms of
foreign currency.
II. It makes domestic goods cheaper
in foreign country as more and
III.
more of goods can now be
purchased with same amount of
foreign currency. So, it leads to
increase in exports.
A change from $1=55 to $1=60
represents that Indian Rupees is
depreciating.

5. It refers to the rate at which one currency is exchanged forthe
other.
It represents the price of one currency in terms of another
currency.
Types-
1. Fixed exchange rate system
2. Flexible exchange rate system
3. Managed floating rate system

6. It refers to a system in which exchange rate for a currency is fixed by the
government.
Basic purpose of adopting this system is to ensure stability in foreign trade and
capital market.
Under this system, each country keeps value of its currency fixed in terms of
some ‘external Standard’.
• It refers to a system in which exchange rate is determined by forces of
demand and supply of different currencies in foreign exchangemarket.
•There is no official (government) intervention in foreign exchangemarket.
•Also known as ‘floating exchange rate’.

7. It refers to a system in which foreign exchange rate is determined
by market forces and central bank influences the exchange rate
through intervention in foreign exchange market.
It is a hybrid of a fixed exchange rate and a flexible exchange rate
system.
Aim is to keep exchange rate close to desired targets value.
Also known as ‘Dirty floating’.

8. The demand (or outflow) of foreign exchange comes from those
people who need it to make payment in foreign currency.
It is demanded by the domestic residents for the following reasons :
1. Imports of Goods and services.
2. Tourism
3. Unilateral transfer sent abroad
4. Purchase of assets in foreign countries
5. Speculation

9. DEMAND CURVE OF FOREIGN EXCHANGE SLOPES DOWNWARDS
DUE TO INVERSE RELATIONSHIPS BETWEEN DEMAND FOR
FOREIGN EXCHANGE AND FOREIGN EXCHANGE RATE.

10. The supply (or inflow) of foreign exchange comes from those
people who receive it due to following reasons.
1. Exports of Goods and services.
2. Foreign investment
3. Unilateral transfer from abroad
4. Speculation

11. SUPPLY CURVE OF FOREIGN EXCHANGE SLOPES UPWARDS DUE
TO POSITIVE RELATIONSHIPS BETWEEN SUPPLY FOR FOREIGN
EXCHANGE AND FOREIGN EXCHANGE RATE.

12. 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.

13. •If the exchange rate rises to OR₂, then demand for foreign
exchange will fall from OQ₂ and supply will rise to OQ₁. It will
be a situation of excess supply. As a result, exchange rate will
fall till it again reaches the equilibrium level of OR.
•If the exchange rate falls to or₁, then demand for foreign
exchange will rise from oq₁ and supply will fall to oq₂. It will be
a situation of excess demand. It will push up the exchange rate
till it reaches OR.

17. ▪ Law of one price
▪ dollar price of good i is the same
wherever it is sold (EPPP
$/€ = PUS/PE)
▪ Theory of Purchasing Power Parity
▪ Absolute Purchasing power Parity
▪ Relative Purchasing power parity
▪ Interest Rate parity
▪ Covered interest rate parity
▪ Uncovered Interest rate parity
▪ International Fisher Equation
▪ Monetary Models of Exchange rate
▪ Sebastian Edward Model of Exchange
rate

18. Law of one price
dollar price of good i is the same wherever it is sold (EPPP
$/€ = PUS/PE)

19. ▪ Theory of Purchasing Power Parity (PPP)
▪ The exchange rate between two counties’ currencies equals the
ratio of the counties’ price levels.
▪ It compares average prices across countries.
▪ It predicts a dollar/euro exchange rate of:
EPPP
$/€ = PUS/PE
where:
PUS is the dollar price of a reference commodity
basket sold in the United States
PE is the euro price of the same basket in Europe

20. Co
pyr
igh
t ©
200
3
Pea
rso
n
▪ Absolute PPP and Relative PPP
▪ Absolute PPP
▪ It states that exchange rates equal relative price levels.
▪ Relative PPP
▪ It states that the percentage change in the exchange rate between two currencies
over any period equals the difference between the percentage changes in national
price levels.
▪ Relative PPP between the United States and Europe would be:
(E$/€,t - E$/€, t –1)/E$/€, t –1 = US, t - E, t
where:
t = inflation rate

21. Covered Interest Rate Parity

22. Un-Covered Interest Rate Parity

25. DEMAND AND SUPPLY
OF EXCHANGE RATE
GROWTH THEORY OF
EXCHANGE RATE
BALANCE OF
PAYMENT(BOP) THEORY
OF EXCHANGE RATE