ASSIGNMENT # 3

SUBMITTED BY

Muhammad Zohaib (10456)

SUPERVISOR

Sir Asim Mumtaz

Spring – 2020
 TABLE OF CONTENTS

FREE FLOATING EXCHANGE RATE REGIME........................................................................3

INTRODUCTION.......................................................................................................................3

HOW DOES A FLOATING EXCHANGE RATE WORK?......................................................3

WHY DOES A FLOATING EXCHANGE RATE MATTER?..................................................4

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 FREE FLOATING EXCHANGE RATE REGIME

INTRODUCTION

A floating exchange rate refers to changes in a currency's value relative to another currency

(or currencies).

Or

A floating exchange rate is a regime where the currency price of a nation is set by the forex

market based on supply and demand relative to other currencies.

HOW DOES A FLOATING EXCHANGE RATE WORK?

As Floating exchange rates mean that currencies change in relative value all the time, for

example, one U.S. dollar might buy one British Pound today, but it might only buy 0.95 British

Pounds tomorrow. The value "floats."

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 In a floating exchange rate system, when the demand for a currency is low, its value

decreases just as with any other product or service. But the result of a devalued currency is that

imported goods seem more expensive to the people holding that currency. What used to require

$5 to buy now requires $10. Because imported goods seem more expensive, people usually start

buying more domestic goods, which tends to create jobs and stimulate the economy in general.

However, the opposite is also true. When the currency becomes more valuable, imported

items seem cheaper, and suddenly people want to buy fewer domestically produced items. This

tends to increase unemployment and slow the economy in general.

Short-term moves in a floating exchange rate currency reflect speculation, rumors, disasters,

and everyday supply and demand for the currency. If supply outstrips demand that currency will

fall, and if demand outstrips supply that currency will rise.

Extreme short-term moves can result in intervention by central banks, even in a floating rate

environment. Because of this, while most major global currencies are considered floating, central

banks and governments may step in if a nation's currency becomes too high or too low.

A currency that is too high or too low could affect the nation's economy negatively,

affecting trade and the ability to pay debts. The government or central bank will attempt to

implement measures to move their currency to a more favorable price.

WHY DOES A FLOATING EXCHANGE RATE MATTER?

Activity in the foreign exchange (forex) markets determines the exchange rates for floating

currencies because those markets reflect the supply and demand for a particular currency. This is

not the case for currencies with fixed exchange rates (often called "pegged" currencies), where a
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country's central bank intervenes and stabilizes or regulates the value of the currency by buying

and selling its own currency reserves in return for the currency to which it is peg Floating

exchange rates create something called exchange rate risk (also called currency risk). This risk is

important to foreign investors, because it means that when exchange rates change, the amount of

money the investor sees at the end of the day changes too.