Presently there is floating or flexible exchange regime in both India and USA. Hence, the supply of foreign exchange increases as the exchange rate increases which proves the slope of supply curve.
Rate of foreign exchange will rise till demand equals supply. Thus, banks would experience a shortage of dollars to meet the demand. As a result, demand for Indian goods increases.
Purchasing Power Parity Theory: Consequently, imports from the USA would increase resulting in an increase in the demand for foreign exchange, i. The Indian firms who want to invest directly in building factories, sales facilities, shops in the USA.
There are two methods of foreign exchange rate determination. At this rate, quantities of foreign exchange demanded OM equals quantity supplied OM. The demand for dollars varies inversely with rupee price of dollar, i.
This excess demand of dollars would push up the price of dollars to the level of OR or Rs. India and the USA.
Thus, an Indian could buy more American goods at a low price. Interest rate theories use the inflation rates in determining the exchange rates, unlike the price levels used under the PPP theory. Given all other parameters constant, there is a high co-relation between differentials in real interest rate and the exchange rate of a currency.
At any particular time, the rate of foreign exchange must be such at which quantity demanded of foreign currency is equal to quantity supplied of that currency. With the emergence of excess supply of dollars, its price, that is, the exchange rate will again fall to OR or Rs. Besides, the American firms and individuals who want to buy assets in India, such as bonds and equity shares of Indian companies or wish to make loans to the Indian individuals and firms will also supply dollars.
The market is cleared and there is no incentive on the part of the players to change the rate determined. The demand for US dollars comes from the Indian people and firms who need US dollars to pay for the goods and services they want to import from the USA.
The demand curve in Fig.(a) Demand for foreign exchange (currency) (b) Supply of foreign exchange (c) Determination of exchange rate (d) Change in Exchange Rate! In a system of flexible exchange rate, the exchange rate of a currency (like price of a good) is freely determined by forces of market demand and supply of foreign exchange.
Exchange Rate Determination. Foreign exchange markets are amoung the largest markets in the world with an annual trading volume in excess of $ trillion.
It is an over-the-counter market, with no central trading location and no set hours of trading. Prices and other terms of trade are determined by computerized negotiation.
Real interest rate is used to assess exchange rate movements as it includes interest and inflation rates, both of which affect exchange rates. Given all other parameters constant, there is a high co-relation between differentials in real interest rate and the exchange rate of a currency.
A (foreign) exchange rate is the rate at which one currency is exchanged for another. Thus, an exchange rate can be regarded as the price of one currency in terms of another.
An exchange rate is a ratio between two monies. Determination of Foreign Exchange rate - I. 0. plays More.
In this lesson we will be discussing the various factors that affects the exchange rate of a currency. This lesson primarily deals with the demand supply factor of the exchange rate determination.
Vignesh Rajasekaran. FOREIGN EXCHANGE RATE• It is the rate at which one currency will be exchanged for another in foreign exchange.• It is also regarded as the value of one country’s currency in terms of another currency.Download