Exchange Rates Quiz

Exchange Rates: A Detailed Overview

• Exchange rate is the rate at which one currency will be exchanged for another currency

• Currencies can be national, sub-national, or supra-national

• Exchange rate is also considered as the value of one country's currency in relation to another currency

• Each country determines the exchange rate regime that will apply to its currency

• In floating exchange rate regimes, exchange rates are determined in the foreign exchange market

• Retail currency exchange market involves different buying and selling rates quoted by money dealers

• Currency for international travel and cross-border payments is predominantly purchased from banks, foreign exchange brokerages, and various forms of bureaux de change

• Market convention rules the notation used to communicate the fixed and variable currencies in a quotation

• Countries are free to choose which type of exchange rate regime they will apply to their currency

• The real exchange rate (RER) is the purchasing power of a currency relative to another at current exchange rates and prices

• The RER generally reaches a steady level in the long-term and any substantial and persistent RER deviation from its long-run equilibrium level has shown to produce negative impacts on a country's balance of payments

• RER misalignment and, in particular, overvaluation can undermine the country's export-oriented development strategyExchange Rate Summary

• The equilibrium RER is not a fixed value and follows the trend of key economic fundamentals.

• The PPP doctrine has been debated as it may signal a natural RER movement towards its new equilibrium as a RER misalignment.

• Two popular approaches to find an alternative equilibrium RER measure are the Fundamental Equilibrium Exchange Rate (FEER) and the Behavioural Equilibrium Exchange Rate (BEER).

• The FEER represents a RER consistent with macroeconomic balance, characterized by internal and external balances achieved simultaneously.

• The BEER entails an econometric analysis of the RER behavior, considering significant RER deviations from its PPP equilibrium level as a consequence of changes in key economic fundamentals.

• An effective exchange rate is a weighted average of a basket of foreign currencies and can be viewed as an overall measure of the country's external competitiveness.

• A parallel exchange rate (or black market, grey, unregulated, unofficial, etc. exchange rate) responds to excess demand for foreign currency at the official exchange rate.

• The Uncovered Interest Rate Parity Model (UIRP) states that an appreciation or depreciation of one currency against another currency might be neutralized by a change in the interest rate differential.

• The Balance of Payments Model holds that foreign exchange rates are at an equilibrium level if they produce a stable current account balance.

• The Asset Market Model views currencies as asset prices traded in an efficient financial market.

• A country may gain an advantage in international trade if it controls the market for its currency to keep its value low.

• The People's Republic of China has been periodically accused of exchange rate manipulation.