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.
Pages to are hidden for
"Exchange Rates and Business"Please download to view full document