Study Notes
Exchange rates represent the value of one currency in terms of another and are crucial for international trade. They can be floating, determined by market forces, or fixed by government intervention.
- Exchange Rate — the value of one currency in terms of another currency Example: USD/GBP indicates how many British pounds one US dollar can buy.
- Floating Exchange Rate — an exchange rate determined by the forces of demand and supply in the foreign exchange market Example: If demand for a currency increases, its value appreciates.
- Appreciation — when the value of a currency rises relative to another currency Example: If USD appreciates against GBP, you can buy more GBP with one USD.
- Depreciation — when the value of a currency falls relative to another currency Example: If USD depreciates against GBP, you can buy less GBP with one USD.
Exam Tips
Key Definitions to Remember
- Exchange Rate
- Floating Exchange Rate
- Appreciation
- Depreciation
Common Confusions
- Confusing appreciation with depreciation
- Misunderstanding how demand and supply affect exchange rates
Typical Exam Questions
- What is an exchange rate? An exchange rate is the value of one currency in terms of another currency.
- How is a floating exchange rate determined? It is determined by the forces of demand and supply in the foreign exchange market.
- What happens when a currency appreciates? The currency's value rises relative to another currency, allowing you to buy more of the other currency.
What Examiners Usually Test
- Understanding of how exchange rates are determined
- Ability to calculate currency conversions
- Factors affecting demand and supply of currencies