Exchange Rates - An Introduction

The exchange rate is one of the most important prices in any economy

An exchange rate is the price of one currency in terms of another – in other words, the purchasing power of one currency against another. Exchange rates are traded in the global currency market.

Key concept – external purchasing power of one currency against another

Over six trillion US$s worth of currencies are traded across global FX markets every day

What is a currency depreciation?

A currency depreciation happens inside a floating exchange rate system and means that one currency (the £) buys less of another currency (the US dollar or the Euro). As an example, the pound falls from £1 buys Euro 1.30 to £1 buys Euro 1.10.

What is a currency appreciation?

A currency appreciation happens within a floating exchange rate system. Currency appreciation is an increase in the external value of one currency in relation to another currency.

What are foreign currency reserves?

Foreign exchange reserves are cash and other reserve assets such as gold held by a central bank that are available to balance payments of the country, influence (managed) the foreign exchange rate of its currency, and to maintain confidence in financial markets.

What are the main types of exchange rate (currency) systems?

• Free floating currency
• Managed floating exchange rate
• Semi-fixed currency (crawling peg)
• Fully-fixed exchange rate (hard peg)
• Currency board system (hard peg)

Make sure you have at least one example of a country for each currency system