Exchange Rates and Business by jdw20122

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									                Exchange Rates and Business
Introduction
An exchange rate is the value of one currency expressed in terms of another
currency. So for example the value of the £ can be given as $1.60, or as DM
3.03. This means that £1 can buy $1.60, or £1 can buy DM3.03.
Exchange rates vary on a minute by minute basis, and the main determinant
of short-term changes in exchange rates is the action of currency
speculators. These speculators, working in the main for banks or financial
institutions, essentially gamble on small movements in different exchange
rates. If speculators take the view that a currency is likely to fall in value,
they will sell that currency, weakening demand for the currency and so
reducing its value. The level of interest rates will affect the value of a
currency. A rising interest rate will attract savings from abroad. This will
raise the demand for sterling and its price. Government may intervene on
foreign exchange markets to influence the value of their or another country’s
currency. Recent intervention has occurred to support the value of the Euro.
Investment and capital flows may arise as foreign firms invest in UK
factories, the value of sterling will rise. As British firms invest abroad the
opposite can occur.
In the longer term the main determinants of the value of one currency in
terms of another are the relative strength of the economies concerned, and
the different levels of inflation suffered by the countries.

Effects of Exchange rate Changes on Business.
Fall in the value of a currency.
Importers. In terms of their own currency they will find imports more
expensive to buy. They can react to this in one of two ways. Firstly reduce
their margins and so not pass the increased cost on to the consumer, or
secondly pass increased costs onto the consumer in the form of higher
prices. The decision will come down to; how large are the margins and what
is the price elasticity of demand for the product.
Exporters. Exports will be cheaper in terms of the purchasing businesses
own currency (less $'s to pay), so firms should find winning export markets
easier. They can react by increasing the price in £'s, so maximising their
profits, or keeping their prices the same, and trying to win new markets.

Rise in the value of a currency.
Importers. In terms of their own currency they will find imports less
expensive to buy. They can react to this in one of two ways. Firstly increase
their margins and so not pass the reduced cost on to the consumer, or
secondly pass reduced costs onto the consumer (this can be done by
improving the product e.g. more ram in a computer or air conditioning in
cars or by lowering the retail price). The decision will come down to
balancing short-term profit maximisation against winning consumer loyalty.
Exporters. Exports will be more expensive in terms of the purchasing
businesses own currency (more $'s to pay). Firms will find winning and
keeping export markets a great deal harder. They can react by reducing the
price in £'s, so reducing their profits, or keeping their prices the same, and
trying to retain markets by strength of brand or quality of good.
Worked example.
An importer of mountain bikes from the USA places an order for 400
Muddy Badger bikes at $200 each with the manufacturer. At the time of
order the exchange rate is £1 to $1.60, but when the invoice arrives for
payment the exchange rate is £1 to $1.47. How much extra in £'s has the
change in exchange rate cost the importer?
400 times $200 = $80,000
divide by exchange rate to find the cost in £'s
$80,000 divided by 1.60 = £50,000
at time of invoice exchange rate is £1 to $1.47, so
$80,000 divided by 1.47 = £54,421
So the change in exchange rate has increpased the importers costs by £4,421.

								
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