Exchange Rate:

The value of one country currency expressed in terms of another country currency.

Foreign exchange:

All currencies other than Pakistani rupee is called foreign exchange. It includes dollars, Yen,
Pounds and Euros etc.

Foreign Exchange Rate:

The rate at which you purchase dollars from the market, from the banks, is called foreign
exchange rate

28 December 2021

US Dollars = Rs 179.70

Euro = Rs 200

British Pound = Rs 237.50

UAE Dirham = Rs 49

Kuwaiti Dinar = Rs 481.80

Chinese Yuan = Rs 23.50

Indian Rupee = Rs 2.03

The rate at which one unite of foreign currency is bought in the foreign exchange market

Types of Exchange Rate

1. Fixed Exchange Rate
2. Flexible/Floating exchange Rate

Fixed Exchange Rate

 Fixed for a long term

 Decided by the Govt or the Central Bank of the Govt
 Chinese Yuan is determined by the Chinese Govt

Flexible Exchange Rate:

 This exchange rate change daily, every minute and hours

 It is decided by the market for foreign exchange, not by Govt
 In foreign exchange market you can buy and sell foreign exchange
 Demands for dollars = Price of dollars
  Demands for dollars = Price of dollars
 The price of dollars in Pakistani rupee is determined by the demand and supply of
dollars in Pakistan

Managed floating ER:

 When the central bank influences the foreign exchange rate

 It is a floating ER, which the central bank cannot dictate
 Central bank influences the exchange rate by selling/ buying foreign exchange in the
market
 Central bank does this by its foreign exchange Reserves
 Bringing ER down = Central bank starts selling foreign exchange in the market
 Do it for the interest of imports and exports

How exchange rates effect the trade?

Chinese Yuan depreciates vs US Dollars.

Supply of Yuan = those who are adding Yuan and want to change them into dollars.

Demand for Yuan = those who are adding dollars and want to exchange them into Chinese
yuan.

Depreciation occurs in two ways

 Supply of Yuan shifts rightwards

 Demands for Yuan shifts leftwards
 Impacts on Trade:
In China In USA

American goods more expensive in China Chinese goods are less expensive in USA

American imports into China Chinese imports into USA

Supply of Chinese Yuan to change Demands for Yuan

them into US dollars will Shift demands convert the might

Demands for US dollars American will convert theirs dollars into Yuan

Chinese holding US dollars will convert them into Yuan

It will help appreciate the Chinese Yuan

Case 1
Market for Dollars in Europe
Market for Euros in the US: Case

Appreciation:

Demands for a currency

Supply of a currency

Increase in the value the currency

Deprecation:

Demands

Supply

Who demands a foreign currency?

 Consumers who wish to buy imports. (Pakistanis)

 Investors who want to invest in foreign assets
 Governments and central banks

Who supply a currency in foreign market? (Americans)

 Foreign markets who buy domestic goods ($)

 Foreign investors
 Foreign Govt and central banks

CASE 2

 Suppose American investors wanted to buy more Europeans assorts

 Demand for Euros in US
 Supply of US dollars will in Europe
 Dollars depreciates
  Euro appreciates

2015

$1 = 2.98 TL TL = Turkish Lira

2021

$1 = 9.95 TL Inflation = 20%

How to keep the exchange rate fixed?

Govt will use Foreign Exchange Reserves to influence the supply and demand and keep the
exchange rate stable.

Revaluation:

When a Govt influences to increase the value of its currency relative to another;

Y 02 = $ 01

Y 01 = $ 02

Devaluation:

When a Govt intervenes to decrease the value of its currency

Y 01 = $ 01

Y 02 = $ 01
Market for Chinese Yuan

$1 = Y 8.20

Y = $ 0.12

The Chinese Govt will increase the supply of Yuan in the foreign exchange market

The Yuan will devaluate and Exchange Rate will come down.

If the Govt wants to decrease the ER?

The Govt will sell-off its own currency and buy foreign currency.

Or reduce the interest rate

 People will change their Yuan into dollars and shift them into dollar account
 Net seller of domestic currency

If the Govt wants to increase the ER?

 The Govt will buy its own currency and will increase interest rates with the foreign
exchange reserves.
 Net buyer of domestic currency

Foreign Exchange Market:

$, Y

Foreign Exchange market for Chinese Yuan

Price of Chinese Yuan in term of US dollars

 Suppose Americans increase their imports from china. The demand for Chinese Yuan will rise.
More Americans will supply their dollars into the market to change then into Chinese Yuan.

How Central Bank intervenes in the foreign exchange market;

Country A Country B

A depreciates
A B

B appreciates
A B

A B B currency demand

Something bad happens in B

Investors of A are pulling their investment out

A B

A B

A B
Opposite situation

 Currency A appreciates
 Currency B depreciates
 Demand for A
 Supply for B

How will Central Bank responds?

Bank will start supplying currency A in the exchange market and will buy its domestic currency

Supply of A

Demands of B

Currency balance

Foreign exchange is finite; limited you cannot print foreign currency

$ 1 = Rs 182

$20 = 20×182= Rs 3640

Rs 2500 = 2500/182 = $13.73

Rupees Appreciates

$1 = Rs 150

Rs 2500; 2500/150 = $16.7 Export expensive

$20; 20×150 = Rs 3000; import cheaper