2. Exchange rate
An exchange rate (also known as a foreign-
exchange rate) between two currencies is the
rate at which one currency will be exchanged for
Exchange rates allow you to determine how much
of one currency you can exchange for another.
3. What Is Exchange Rate Volatility?
Exchange rate volatility refers to the
tendency for foreign currencies to
appreciate or depreciate in value, thus
affecting the profitability of foreign
The volatility is the measurement of the
amount that these rates change and the
frequency of those changes
4. Why Do Exchange Rates Change?
Inflation rates: Generally, countries with lower inflation
rates have higher-valued currencies
Interest rates: Higher interest rates often mean that
investors get a better return in one country than another,
and so sometimes push the value of a country’s currency
up compared to low interest countries
Current account deficits: A current account deficit
means that a country is spending more on foreign trade
(via imports) than it is earning (via exports), and so it will
need to borrow from other countries to finance its deficit –
and generally this means the value of its currency will
5. Level of public debt: If a country is running very large
budget deficits, and borrowing to cover this cost, you will
often see high inflation, which in turn will often mean a
lower currency valuation.
Terms of trade: The terms of trade means the difference
in the price of exports to the price of important – a
positive terms of trade means the prices a country gets
for its exports is higher than the price it pays for its
imports. Generally, the stronger the terms of trade, the
stronger the currency.
Stability and economic growth: Finally, the level of
political stability, and whether an economy is growing at
all, matter to investors. Stable, growing countries are
lower risk, and therefore tend to have stronger currency
6. Impact of Exchange Rate Volatility
Merchandise trade: This refers to a nation’s
international trade, or its exports and imports. In
general terms, a weaker currency will stimulate
exports and make imports more expensive, thereby
decreasing a nation’s trade deficit (or increasing
surplus) over time.
A significantly stronger currency can reduce export
competitiveness and make imports cheaper, which
can cause the trade deficit to widen further, eventually
weakening the currency in a self-adjusting
mechanism. But before this happens, industry sectors
that are highly export-oriented can be decimated by
an unduly strong currency.
7. The inter-relationship between a nation’s imports and
exports, and its exchange rate, is a complicated one
because of the feedback loop between them. The
exchange rate has an effect on the trade surplus (or
deficit), which in turn affects the exchange rate, and
so on. In general, however, a weaker domestic
currency stimulates exports and makes imports more
expensive. Conversely, a strong domestic currency
hampers exports and makes imports cheaper.
8. Economic growth: The basic formula for an
economy’s GDP is
C + I + G + (X – M) where:
C = Consumption or consumer spending, the biggest
component of an economy
I = Capital investment by businesses and
G = Government spending
(X – M) = Exports minus imports, or net exports.
From this equation, it is clear that the higher the
value of net exports, the higher a nation’s GDP. As
discussed earlier, net exports have an inverse
correlation with the strength of the domestic
9. Capital flows: Foreign capital will tend to flow into
countries that have strong governments, dynamic
economies and stable currencies. A nation needs to
have a relatively stable currency to attract
investment capital from foreign investors. Otherwise,
the prospect of exchange losses inflicted by currency
depreciation may deter overseas investors.
10. Inflation: A devalued currency can result in
“imported” inflation for countries that are substantial
importers. A sudden decline of 20% in the domestic
currency may result in imported products costing
25% more since a 20% decline means a 25%
increase to get back to the original starting point.
Interest rates: As mentioned earlier, the exchange
rate level is a key consideration for most central
banks when setting monetary policy.
The exchange rate are of great
importance and can effect the overall
growth and development of the country’s
trade and economy. Thus the country
should try to make their currency strong
and try to stabilize their exchange rate
so as to improve the country’s trade and