This document contains a webinar on exchange rates with multiple choice questions. It discusses Egypt moving from a fixed to floating exchange rate in 2016. It also covers how currency values are determined in floating exchange rate systems and factors that influence currency appreciation and depreciation like interest rates, current account balances, and speculative flows. Examples are provided of Sterling and the Euro against the US Dollar between 2014-2016. The effects of currency depreciations and appreciations on trade balances and the economy are evaluated in the context of concepts like the J-Curve and Marshall-Lerner condition. Different exchange rate regimes like floats, pegs, and currency boards are also classified.

1. Revision Webinar on Exchange Rates

2. @tutor2ugeoff

3. Question 1
In 2016, Egypt removed controls on its fixed exchange to move to a
floating one. Such a change means:
A) The government can now run a fiscal deficit
B) Interest rates will be higher than they were before
C) Fewer foreign exchange reserves need to be held
D) Inflation will be lower than before

4. Question 1
In 2016, Egypt removed controls on its fixed exchange to move to a
floating one. Such a change means:
A) The government can now run a fiscal deficit
B) Interest rates will be higher than they were before
C) Fewer foreign exchange reserves need to be held
D) Inflation will be lower than before

5. Question 2
A fall in the value of a country’s currency would, ceteris paribus, cause
the price of imports to rise in domestic currency terms. Which of the
following would dampen the short term impact on domestic firms?
1. The purchase of currency hedges
2. High levels of stocks of raw materials
3. A high import-to-GDP ratio
4. A lack of comparative advantage in raw materials
A) 1 and 2 only
B) 1 and 2 and 3 only
C) 1 only
D) 1 and 2 and 3 and 4

6. Question 2
A fall in the value of a country’s currency would, ceteris paribus, cause
the price of imports to rise in domestic currency terms. Which of the
following would dampen the short term impact on domestic firms?
1. The purchase of currency hedges
2. High levels of stocks of raw materials
3. A high import-to-GDP ratio
4. A lack of comparative advantage in raw materials
A) 1 and 2 only
B) 1 and 2 and 3 only
C) 1 only
D) 1 and 2 and 3 and 4

7. Question 3
In a free floating exchange rate system, which of the following
should cause the Thai baht to appreciate?
A)
Thai health and safety regulations come under scrutiny for
clothes exported to Europe
B) Increased imports by Thai consumers of Chinese goods
C) An increase in macroeconomic instability in Thailand
D)
Increased remittances by Thai workers in Europe sending
money back home.

8. Question 3
In a free floating exchange rate system, which of the following
should cause the Thai baht to appreciate?
A)
Thai health and safety regulations come under scrutiny for
clothes exported to Europe
B) Increased imports by Thai consumers of Chinese goods
C) An increase in macroeconomic instability in Thailand
D)
Increased remittances by Thai workers in Europe sending
money back home.

9. Question 4
Suppose that Country X conducts 60% of its trade with Country Y
and 40% of its trade with Country Z. The initial value of the trade
weighted exchange rate index of Country X is 100.
What will be its new trade weighted exchange rate index value if its
currency falls in value by 10% against the currency of Y and rises by
15% against the currency of Z?
A) 100
B) 90
C) 92
D) 105

10. Question 4
Suppose that Country X conducts 60% of its trade with Country Y
and 40% of its trade with Country Z. The initial value of the trade
weighted exchange rate index of Country X is 100.
What will be its new trade weighted exchange rate index value if its
currency falls in value by 10% against the currency of Y and rises by
15% against the currency of Z?
A) 100
B) 90
C) 92
D) 105

11. Question 5
Suppose that the sterling exchange rate against the dollar changes
from £1=$1.50 to £1=$1.20. The immediate impact on its terms of
trade and balance of trade will be.
Terms of Trade Balance of Trade
A) Improve Improve
B) Worsen Improve
C) Improve Worsen
D) Worsen Worsen

12. Question 5
Suppose that the sterling exchange rate against the dollar changes
from £1=$1.50 to £1=$1.20. The immediate impact on its terms of
trade and balance of trade will be.
Terms of Trade Balance of Trade
A) Improve Improve
B) Worsen Improve
C) Improve Worsen
D) Worsen Worsen

13. Question 6
If Sterling appreciates against a basket of other currencies, the
value of UK export earnings will increase if
A) The supply of UK exports is price inelastic
B) The price elasticity of demand for exports is unitary
C) The demand for UK exports is price inelastic
D) The demand for UK exports is price elastic

14. Question 6
If Sterling appreciates against a basket of other currencies, the
value of UK export earnings will increase if
A) The supply of UK exports is price inelastic
B) The price elasticity of demand for exports is unitary
C) The demand for UK exports is price inelastic
D) The demand for UK exports is price elastic

15. Choice of Currency Systems
• The choice of exchange rate regime is one of the most
important that a country can make when running their
monetary policy. The main options are:
1. A free-floating currency where the external value of a
currency depends wholly on the market forces of supply
and demand
2. A managed-floating currency when the central bank
may choose to intervene in the foreign exchange
markets to influence the value of a currency to meet
specific macroeconomic objectives
3. A fixed exchange rate system e.g. a currency peg either
as part of a currency board system or membership of
the ERM II for countries intending to join the Euro.

16. Sterling against the US Dollar (Nov 2014 – Nov 2016)
The UK operates
with a floating
exchange rate –
the external
value of the
currency is
determined
purely by market
forces of supply
and demand for
a particular
currency
Source: Office for National Statistics
This chart shows how much sterling can be bought with $1. For
example in Nov 2014, $1 bought 65 pence and in Nov 2016, $1
bought 80 pence. This means the US dollar has appreciated vs the £.
Monthly exchange rate of U.S. dollar to British Pound
(GBP) from November 2014 to November 2016
0.6
0.65
0.7
0.75
0.8
0.85
Nov
14
Jan
15
Mar
15
May
15
Jul
15
Sep
15
Nov
15
Jan
16
Mar
16
May
16
Jul
16
Sep
16
Nov
16
USDGBPexchangerate

17. Euro against UK Sterling – January 2014 to June 2016
0.65
0.67
0.69
0.71
0.73
0.75
0.77
0.79
0.81
0.83
0.85 Jan'14
Feb'14
Mar'14
Apr'14
May'14
Jun'14
Jul'14
Aug'14
Sep'14
Oct'14
Nov'14
Dec'14
Jan'15
Feb'15
Mar'15
Apr'15
May'15
Jun'15
Jul'15
Aug'15
Sep'15
Oct'15
Nov'15
Dec'15
Jan'16
Feb'16
Mar'16
Apr'16
May'16
Jun'16
ExchangerateEuro1buys£
Sterling appreciating
against the Euro – i.e.
Euro 1 buys fewer £s
Sterling depreciates against
the Euro in immediate
aftermath of the June 2016
Brexit vote
“The 11% fall in the two days immediately after the Brexit
referendum, was the sharpest since the devaluation of 1967.
Source: Ben Broadbent, MPC member, November 2016

18. What factors determine a currency’s value?
• In a floating exchange
rate system, the external
value of a currency is
determined by market
demand for and supply
• Much currency dealing is
speculative but trade
and investment flows
also have a key role
• Factors mentioned in the
graphic will usually lead
to a currency
appreciation (i.e. a rising
external value)
Current account
surplus on the
balance of
payments
Strong inward
investment
inflows +
portfolio flows
Relatively high
policy interest
rates
Speculative
currency
demand
A Rising
Currency

19. Currency Market Analysis: Higher Interest Rates
Value of
currency
Quantity of currency traded
D1
Supply
Rise in policy interest
rates by central bank
Currency more attractive
for investors
Attracts inflows of short-
term hot money
Causes outward shift in
currency demand
Currency appreciates in
value in a floating system
P2
P1
D2

20. Currency Market Analysis: The UK Brexit Vote
Value of
currency
Quantity of currency traded
Demand
Supply
Brexit vote created fears of
recession
Expectation that Bank of
England might cut interest rates
Currency traders uncertain
about macro prospects
Sell-off of sterling in global
currency markets
Outward shift of market supply
caused a depreciation
P1
P2
S2

21. Evaluating Effects of a Currency Depreciation
In theory a depreciation of the exchange rate provides stimulates
aggregate demand and GDP growth but this depends on
1. The length of time lags as consumers and businesses respond
2. The scale of any change in the exchange rate i.e. a 5%, 10%, 20%
3. Whether the change in the currency is short-term or long-term –
i.e. is a change in the exchange rate temporary or likely to persist
4. Price elasticity of demand for imports and exports
5. The size of any second-round multiplier and accelerator effects
6. When the currency movement takes place – i.e. Which stage of
an economic cycle (recession, recovery etc.)
7. The type of economy (e.g. small developing v large advanced)
8. The degree of openness of the economy to international trade

22. Marshall-Lerner Condition
The Marshall Lerner condition states that a depreciation /
devaluation of the exchange rate will lead to a net improvement in
the trade balance provided that the sum of the price elasticity of
demand for exports and imports > 1
Ped for exports Ped for imports
Sum of price
elasticity
Will fall in
currency
improve the
trade balance?
Country A 0.4 0.3 0.7 No
Country B 1.2 0.7 1.9 Yes
Country C 0.8 0.2 1.0
Will leave it
unchanged

23. The J Curve Effect
Time period after
depreciation
Trade
surplus
Trade
deficit
Currency
depreciation
here
Trade deficit may
grow in initial
period after
depreciation
Net improvement
in trade provided
certain conditions
are met
The diagram below shows the “J Curve effect” – it shows the time
lags between a falling currency and an improved trade balance

24. Classification of Currency Systems (December 2016)
Exchange Rate System Exchange rate anchor (where relevant)
US Dollar ($) Euro
Composite or Other
Currency Peg
Fixed currency with no
separate legal tender
Ecuador
Zimbabwe
Kosovo, San Marino
Currency Board System Hong Kong Bulgaria
Conventional exchange rate
peg (Fixed currency system)
Bahrain
Qatar
Saudi Arabia
Denmark
Senegal
Kuwait
Nepal
Crawling exchange rate peg
(semi-fixed)
Jamaica Croatia
Botswana
China
Ethiopia
Managed floating currency
Kenya, Brazil, Ukraine, South Korea, India, Zambia, South Africa,
Thailand, Turkey, Sweden
Free floating exchange rate Australia, Canada, Chile, Japan, Norway, UK, USA, Mexico, Euro Zone

25. Evaluating Floating Exchange Rates
Floating Exchange Rates
•Reduces need to hold large
amounts of currency
reserves
•Freedom to set interest
rates to meet domestic
objectives
•Insulation for an economy
after an external shock
especially for export-
dependent countries
•Partial automatic correction
for a current account deficit
Evaluation
• No guarantee that floating
exchange rates will be stable
• Volatility in a floating
exchange rate might be
detrimental to attracting
inward investment
• A lower (more competitive)
exchange rate does not
necessarily correct a trade
deficit - consider J curve
theory and importance of
non-price competitiveness

26. Evaluating Fixed Exchange Rates
Fixed Exchange Rates
• Certainty of currency value gives confidence for inward investment
• Reduced costs for businesses of currency hedging
• Currency stability helps to control inflation – it is a discipline on
businesses to keep unit labour costs low
• Can also lead to lower borrowing costs (i.e. lower yields on bonds)
• Less speculation if the fixed exchange rate is credible in markets
Evaluation
• Reduced freedom to use interest rates for other macro objectives
such as stimulating growth and employment
• Many developing countries do not have the large foreign currency
reserves needed to maintain a fixed exchange rate

27. Question 7
Suppose that the sterling exchange rate against the dollar changes
from £1=$1.50 to £1=$1.20. If the index of import volume falls
from 90 to 81 then the PED for imports must be around;
A) + 0.3
B) + 0.5
C) -0.5
D) -3.3

28. Question 7
Suppose that the sterling exchange rate against the dollar changes
from £1=$1.50 to £1=$1.20. If the index of import volume falls
from 90 to 81 then the PED for imports must be around;
A) + 0.3
B) + 0.5
C) -0.5
D) -3.3

29. Question 8
Which of the following is likely to benefit as a result of a sharp
depreciation of Sterling against the Euro?
A)
UK-based companies who buy their raw materials and
component parts from Europe
B)
UK-based companies with overseas branches whose profits
are repatriated to the UK
C) UK citizens who like to go on holiday to Europe
D)
UK retailers who import manufactured goods from Europe
for sale to UK citizens

30. Question 8
Which of the following is likely to benefit as a result of a sharp
depreciation of Sterling against the Euro?
A)
UK-based companies who buy their raw materials and
component parts from Europe
B)
UK-based companies with overseas branches whose profits
are repatriated to the UK
C) UK citizens who like to go on holiday to Europe
D)
UK retailers who import manufactured goods from Europe
for sale to UK citizens

31. @tutor2ugeoff

32. Revision Webinar on Exchange Rates