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FOREIGN EXCHANGE :: It refers to all currencies other the domestic currency of a given
country.
For example, India’s domestic currency is Indian Rupee and all other currencies like US
Dollar, British Pound, Kuwaiti Dinar, etc. are foreign exchange.
FOREIGN EXCHANGE RATE :: It refers to rate at which one unit of currency of a one
country can be expressed // exchanged for the number of units of currency of another
country .
Thus it is the price of a country’s currency in terms of another country’s currency and thus
represents external value or EXTERNAL PURCHASING POWER OF DOMESTIC
CURRENCY. It can be represented as
________________________
(a) US $ 1 = Rs.50 ( one American dollar can be exchanged for 50 Indian Rupee )
(b) Rs 1 = 1 / 50 Dollar = 2 Cents (one Indian rupee can be exchanged for 2 Amercian
cents
________________________
TYPES
(A) FIXED EXCHANGE RATE :: It means that rate of exchange which is OFFICIALLY
FIXED (or pegged ) in terms of gold ( or any other currency ) by the government and
adjusted only infrequently . Thus it has two variants
https://edurev.in/studytube/Chapter-13-Foreign-Exchange-Rate-Chapter-Notes--Macro-Economics--Class-12/2f64aef5-6432-45d1-9c21-0c146f9df34d_t
5/14/2018 Chapter 13 - Foreign Exchange Rate - Chapter Notes, Macro Economics, Class 12 | EduRev Notes
(1) It ensures STABILITY in international money market by avoiding day to day fluctuations.
(2) It implies low risk and low uncertainty and thus ENCOURAGE INTERNATIONAL
TRADE
(3) It helps in FORMULATION of long term economic policies especially related to exports
and
imports and COORDINATION OF MACRO POLICIES in different countries of the world.
(4) It PREVENTS CAPITAL OUTFLOW and and thus prevent speculation
(5) It PREVENTS MAJOR ECONOMIC DISTURBANCES in the member country .
(B) FLEXIBLE EXCHANGE RATE // FLOATING RATE :: It is the rate which
is determined BY THE DEMAND FOR AND SUPPLY OF THE CURRENCIES in the foreign
exchange market.
R=f(D,S)
https://edurev.in/studytube/Chapter-13-Foreign-Exchange-Rate-Chapter-Notes--Macro-Economics--Class-12/2f64aef5-6432-45d1-9c21-0c146f9df34d_t
5/14/2018 Chapter 13 - Foreign Exchange Rate - Chapter Notes, Macro Economics, Class 12 | EduRev Notes
The exchange rate is called as Par Rate oF Exchange and is Equilibrium rate.
(C) HYBRID SYSTEM OF EXCHANGE RATE :: Those system which are neither fully Fixed
systems nor fully flexible systems.
These are often referred to as ALTERNATIVE SYSTEM OF EXCHANGE RATE which
combine the merit of both Fixed and flexible system of exchange rate. Some of these
system are
(1) WIDER BAND :: Wider band is a system that ALLOWS WIDER ADJUSTMENT in the
fixed exchange rate system.
Acc. to this system a country
- specifies a parity value for its currency and
- allows adjustment upto 10 % around parity between any two currencies.
This is to help the member countries to correct their BOP (balance of payments)
status. In the event of deficit BOP, India, for example, may depreciate its currency (upto 10
per cent). This is expected to increase demand for India’s products. Accordingly, BOP
status is expected to improve.
https://edurev.in/studytube/Chapter-13-Foreign-Exchange-Rate-Chapter-Notes--Macro-Economics--Class-12/2f64aef5-6432-45d1-9c21-0c146f9df34d_t
5/14/2018 Chapter 13 - Foreign Exchange Rate - Chapter Notes, Macro Economics, Class 12 | EduRev Notes
(3) MANAGED FLOATING :: Under this system , the exchange rate is managed or
controlled by the GOVERNMENT OR MONETARY AUTHORITY . Thus it is a system of
gradual adjustment in the exchange rate by a central bank to influence the value of its own
currency in relation to other currency.
AIM :: Under this system, which is not supported by any international agreement , the
central banks manage to intervene in the international exchange market with a view to keep
the exchange rate within desired limit
Central bank would sell US dollars in the international money market from its reserves
Increase in supply of US dollar in the market is expected to reduce the price of dollar in
relation to the domestic currency ( rupee)
https://edurev.in/studytube/Chapter-13-Foreign-Exchange-Rate-Chapter-Notes--Macro-Economics--Class-12/2f64aef5-6432-45d1-9c21-0c146f9df34d_t
5/14/2018 Chapter 13 - Foreign Exchange Rate - Chapter Notes, Macro Economics, Class 12 | EduRev Notes
____________________________
SOURCES / DEMAND FOR FOREIGN EXCHANGE
___________________________________________
https://edurev.in/studytube/Chapter-13-Foreign-Exchange-Rate-Chapter-Notes--Macro-Economics--Class-12/2f64aef5-6432-45d1-9c21-0c146f9df34d_t
5/14/2018 Chapter 13 - Foreign Exchange Rate - Chapter Notes, Macro Economics, Class 12 | EduRev Notes
______________________________
https://edurev.in/studytube/Chapter-13-Foreign-Exchange-Rate-Chapter-Notes--Macro-Economics--Class-12/2f64aef5-6432-45d1-9c21-0c146f9df34d_t
5/14/2018 Chapter 13 - Foreign Exchange Rate - Chapter Notes, Macro Economics, Class 12 | EduRev Notes
___________________________________
https://edurev.in/studytube/Chapter-13-Foreign-Exchange-Rate-Chapter-Notes--Macro-Economics--Class-12/2f64aef5-6432-45d1-9c21-0c146f9df34d_t
5/14/2018 Chapter 13 - Foreign Exchange Rate - Chapter Notes, Macro Economics, Class 12 | EduRev Notes
_____________________________________
(Ques) Sate whether the following items constitute demand or supply of foreign exchange :
(i) Indian going to USA for medical treatment.
(ii) Donation of 500 Million $ received from Microsoft.
(iii) Import of goods from China.
(iv) Indian students going to Australia for MBA.
(v) Foreign Tourists to India to visit Taj Mahal.
(vi) Purchase of land in England.
(vii) Bought 500 Pounds to sell for speculation.
__________________________________________
The theory of determination of rate of exchange is the Demand and Supply theory.It is the
rate which is determined BY THE DEMAND FOR AND SUPPLY OF THE CURRENCIES in
the foreign exchange market.
R=f(D,S)
https://edurev.in/studytube/Chapter-13-Foreign-Exchange-Rate-Chapter-Notes--Macro-Economics--Class-12/2f64aef5-6432-45d1-9c21-0c146f9df34d_t
5/14/2018 Chapter 13 - Foreign Exchange Rate - Chapter Notes, Macro Economics, Class 12 | EduRev Notes
The exchange rate is called as Par Rate oF Exchange and is Equilibrium rate
There is an inverse relation between foreign exchange rate and demand for foreign
currency and hence Demand curve is downward sloping
There is an positive relation between foreign exchange rate and supply of foreign
currency. Hence supply curve is Upward sloping .
D and S of foreign currency is measured on the OX-axis and rate of exchange on OY-
axis.DD and SS
interest at point ‘E’ and thus OR is equilibrium rate of exchange.
If rate is OR1 there will be excess supply of foreign currency by ‘AB’ amount and this
will cause rate of
exchange to come down to OR
If rate is OR2 there will be excess demand of foreign currency by ‘MN’ amount and
this will cause rate
of exchange to rise to OR
(1) UNFAVOURABLE BOP :: means country receipts is less than payment and hence
demand for foreign currency will increase from DD to D1D1 and will cause exchange rate to
rise to OR1 (let say 1 $ = Rs.55).This cause more domestic currency is to be paid for one
https://edurev.in/studytube/Chapter-13-Foreign-Exchange-Rate-Chapter-Notes--Macro-Economics--Class-12/2f64aef5-6432-45d1-9c21-0c146f9df34d_t
5/14/2018 Chapter 13 - Foreign Exchange Rate - Chapter Notes, Macro Economics, Class 12 | EduRev Notes
unit of foreign currency.which means the value of domestic currency in terms of foreign
currency falls. This is called CURRENCY’S DEPRECIATION.
(2) FAVOURABLE BOP : means country receipts is more than payment and hence supply
of foreign currency will increase from SS to S1S1 and will cause exchange rate to fall to
OR2 (let say 1 $ = Rs.45).This cause less domestic currency is to be paid for one unit of
foreign currency which means the value of domestic currency in terms of foreign currency
rises .This is called CURRENCY’S APPRECIATION.
https://edurev.in/studytube/Chapter-13-Foreign-Exchange-Rate-Chapter-Notes--Macro-Economics--Class-12/2f64aef5-6432-45d1-9c21-0c146f9df34d_t
5/14/2018 Chapter 13 - Foreign Exchange Rate - Chapter Notes, Macro Economics, Class 12 | EduRev Notes
_______________________________________________
(Ques) In the following cases, indicate which currency is appreciating and which one is
depreciating :
_____________________________________________________
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5/14/2018 Chapter 13 - Foreign Exchange Rate - Chapter Notes, Macro Economics, Class 12 | EduRev Notes
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