15. Foreign Exchange Market how is the foreign exchange rate determined

.Foreign Exchange Market.

1. Foreign Exchange Market What Are Foreign Exchange Rates? How Is the Foreign Exchange Rate Determined?

2. A foreign exchange market A foreign exchange market is market where funds are converted from one currency to another A foreign exchange rate is the price of one currency in terms of another

3. Why are foreign exchange important Exchange rates affect the relative price of domestic and foreign goods. Had you imported a laptop for $500 in 2007, it would have cost you Rs.30,000 (60x$500) If you import it now assuming that the price of the laptop has not changed, it would cost you Rs.142000 because the exchange rate of the rupee has depreciated to Rs.284 a dollar

4. When a country’s currency appreciates, the country’s goods abroad become more expensive and foreign goods in that country become cheaper Conversely, when a country’s currency depreciates, its goods abroad become cheaper and foreign goods in that country become more expensive. Why are foreign exchanges important?

5. Appreciation of a currency: can make it harder for domestic manufacturers to sell their goods abroad and can increase competition at home from foreign goods, How Is the Foreign Exchange Rate Determined?

6. How Does the Foreign Exchange Market Work? The foreign exchange market is not a centralized market. It works like an over-the-counter market When you want to convert the rupee into dollars, simply go foreign exchange company, an individual in an informal market, or a bank that specializes in currency business When you want to convert large amounts of rupees into other currencies, open an account with a bank or an exchange company, the bank or the company will trade to buy the required currency for you

7. How Is the Foreign Exchange Rate Determined? To understand exchange rate determination, the concept of “law of one price” is helpful The law of one price states that if two countries produce an identical good, and transportation costs and trade barriers are very low, the price of the good should be the same

8. Example of one price Suppose a 40 kg bale of Pakistani cotton is available for Rs. 3000 whereas a similar bale of Chines-cotton is available for CNY.6000 For one price to maintain, one CNY should be equal to 0.5 rupees or one rupee should be equal to 2 CNY If the exchange rate of CNY to one rupee jumps to 4, Chinese cotton will be sold for Rs.1500 in Pakistan. No one will buy Pakistani cotton which will create an excess supply of Pakistani cotton. This excess supply can only be sold if the exchange rate is brought back to 2 CNY to a rupee.

9. One of the most prominent theories of how exchange rates are determined is the theory of purchasing power parity (PPP). It states that exchange rates between any two currencies will adjust to reflect changes in the price levels of the two countries. PPP suggests that if one country’s price level rises relative to another’s, its currency should depreciate How Is the Foreign Exchange Rate Determined?

10. Purchasing power parity Pak-cotton = Rs.3000 Chin-cott = CYN6000 Parity; rupee = 2CYN If Pakistani cotton price increases by 10%, i.e., Rs. 3300, the new exchange price should be 6000/3300 = 1.8181 which is 10% less than the original price