Question

What are Forces that determine exchange rates ?

define:

Short-run: domestic and foreign interest rates

current spot rate

expected future spot rate

Long-run: inflation

Answer 1

Changes in market inflation contribute to currency exchange rate changes. A nation with a lower rate of inflation than another will see the benefit of its currency appreciation. Goods and services prices are rising at a slower rate, with low inflation. A country with a consistently lower inflation rate has a rising currency value, whereas a country with higher inflation typically sees depreciation in its currency and is usually accompanied by higher interest rates Interest rate changes have an effect on euro and dollar exchange rates. All of these are associated with forex prices, interest rates and inflation. Increases in interest rates cause the currency of a country to appreciate, because higher interest rates provide higher rates for lenders, attracting more foreign capital, leading to higher exchange rates.

The current account of a country reflects trade balance and foreign investment earnings. It is made up of a total number of transactions including exports, imports, debt, etc. A current account deficit causes depreciation because it spends more of its currency on importing products than it earns by selling exports. Payment balance fluctuates the domestic currency's exchange rate. Government debt is the central government's public debt or national debt. It is less likely that a country with government debt will acquire foreign capital, resulting in inflation. If the market expects government debt within a certain region, foreign investors may sell their bonds on the open market. As a result, its exchange rate value will decline.

Short-run: domestic and foreign interest rates- Interest rates on their own do not determine a currency's value. Two other factors political and economic stability and demand for the goods and services of a country— are often more significant. Factors like a country's trade balance between imports and exports can be a crucial factor in determining the value of the currency. This is because higher demand for the products of a country also means greater demand for the currency of the country.

Although interest rates may be a major factor affecting currency value and exchange rates, the final determination of the exchange rate of a currency with other currencies is the result of a number of interrelated elements which represent a country's overall financial position in relation to other nations.

current spot rate- The spot rate is the price quoted on a product, security or currency for immediate settlement. The spot rate, also known as the "spot price," is an asset's current market value at the time of quotation. In turn, this value is based on how many buyers are willing to pay and how many sellers are willing to accept it, which usually depends on a mix of factors including current market value and expected future market value. In other words, the spot rate reflects the market supply and demand for an asset. As a result, spot rates often change and can sometimes swing dramatically, especially if significant events occur or headline news is relevant.

A spot rate, or spot price, is a contract price for buying or selling a product, security, or currency for immediate delivery and payment on the spot date, which is usually one or two business days after the date of trade. The spot rate is the existing asset value quoted for the spot contract to be settled immediately.For instance, if a wholesale company wants to deliver orange juice immediately in August, it will pay the seller's spot price and deliver orange juice within two days. However, if the company needs orange juice to be available at its stores in late December, but believes that the commodity will be more expensive due to higher demand than supply during this winter period, it can not make a spot purchase for this commodity as the risk of spoilage is high. Because the product would not be needed until December, it would be easier for the investment to have a forward contract.

Long-run: inflation- The cycle of business. Industries have to compensate for jobs by paying higher wages during rapid economic expansions when the economy runs almost at capacity and unemployment is very weak. Often, they pay more for different inputs such as raw materials. Real estate is becoming scarcer and fees for rent are rising. Some of those price increases are passed on to the inflation-causing retail level. When the economy is cooling down, the price is falling.

Petroleum or other commodity cost. An increase in a major product's price can bump up all the economy's prices. For example, if oil prices rise, this affects the vast majority of businesses as their transport costs rise. On the retail level that causes inflation, that could be passed on to consumers.

Exchange rates. Another cause of inflation may be changes in exchange rates. Most countries import many of their products: food, home appliances, cars, etc. If the exchange rate depreciates, then it would tend to increase the costs of all those goods by increasing the overall price point.