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Exploring how the value of one currency is determined relative to another in the global market.
Imagine you're a CEO deciding whether to build a factory in Mexico or Germany. A mere 5% shift in the exchange rate could be the difference between a billion-dollar profit and a total collapse—do you know how to predict that move?
In the Foreign Exchange (Forex) Market, currencies are treated like any other commodity. The 'price' of a currency is the exchange rate, determined by the intersection of supply and demand. The demand for a currency (e.g., the US Dollar) comes from foreigners who want to buy that country's goods, services, or financial assets. Conversely, the supply of a currency comes from domestic residents who want to sell their own money to buy foreign products. When the demand for a currency increases, its price rises—a process called appreciation. When the supply increases or demand falls, the price drops, known as depreciation.
Quick Check
If Japanese investors suddenly decide to buy more US Treasury bonds, what happens to the demand for the US Dollar?
Answer
The demand for the US Dollar increases because the investors must sell Yen to buy Dollars to purchase the bonds.
Quick Check
If the exchange rate moves from to , has the USD appreciated or depreciated?
Answer
The USD has appreciated because it can now buy more Yen (110 instead of 100).
Exchange rate fluctuations act as a massive steering wheel for international trade. When a currency appreciates, domestic goods become more expensive for foreigners, causing exports to decrease. Simultaneously, foreign goods become cheaper for domestic consumers, causing imports to increase. This often leads to a trade deficit. Conversely, a depreciating currency makes exports cheaper and more competitive abroad while making imports expensive, which typically improves the net export (NX) component of GDP.
Consider a US company, 'AmeriCorp,' that sells software to the UK for per license. 1. Initial Rate: . AmeriCorp receives per sale. 2. The USD appreciates: The new rate is . 3. New Revenue: AmeriCorp now only receives per sale. 4. Impact: To maintain their profit margin, they must raise the price in the UK to (). This price hike might cause UK customers to switch to a local competitor.
Which of the following would cause the US Dollar to appreciate?
If the Mexican Peso depreciates against the Canadian Dollar, what is the likely result?
A trade deficit is more likely to occur when a nation's currency is significantly appreciated.
Review Tomorrow
In 24 hours, try to explain to a friend why a 'strong dollar' might actually be bad news for a local farmer who exports wheat to Asia.
Practice Activity
Look up the current exchange rate between your local currency and the Euro. Calculate how much a Euro dinner would cost you today versus if your currency depreciated by .