Foreign Exchange Rate

• Foreign exchange refers to foreign currency.
• It is required to make payments in the currencies of other countries.
• It includes foreign currencies and claims on them such as bank deposits, cheques, etc., payable in foreign currencies.

• The foreign exchange market is the market where foreign currencies are bought and sold.
• It is a system, not a place, where foreign exchange transactions take place.
• Buyers and sellers include:
  • Individuals
  • Firms
  • Importers and exporters
  • Foreign exchange brokers
  • Commercial banks
  • Central banks

• Exchange rate is the rate at which one currency is exchanged for another currency.
• It is the price of one currency expressed in terms of another currency.
• It links the currencies of different countries and enables comparison of international costs and prices.
• Exchange rate refers to the rate at which the currency of one country is bought and sold against the currency of another country in the foreign exchange market.
• Exchange Rate = Price of one currency in terms of another currency

• 1 USD = ₹75
• ₹75 per USD

Exchange rate can also be expressed as:

• Domestic currency per unit of foreign currency:
  • 1 USD = ₹75
• Foreign currency per unit of domestic currency:
  • ₹1 = 1/75 USD ≈ 0.013 USD

(In India, exchange rates are generally expressed as domestic currency per unit of foreign currency.)

Foreign exchange is demanded for:

• Imports of goods and services from other countries.
• Sending gifts and transfers abroad.
• Repayment of loans taken from foreign countries.
• Investment in foreign countries.
• Purchase of foreign financial assets.
• Tourism — spending by residents travelling abroad.

Effect of Exchange Rate on Demand

• A rise in the price of foreign exchange increases the cost of imports.
• As imports become more expensive, demand for imports decreases.
• Therefore, demand for foreign exchange also decreases, other things remaining constant.

Foreign exchange is supplied due to:

• Exports of goods and services.
• Foreign Direct Investment (FDI) and portfolio investment received from abroad.
• Remittances received from abroad.
• Loans received from foreign countries or institutions.
• Tourism — spending by foreign tourists visiting the country.
• Gifts and transfers received from abroad.

Effect of Exchange Rate on Supply

• A rise in the price of foreign exchange makes domestic goods cheaper for foreigners.
• This encourages exports.
• Therefore, the supply of foreign exchange may increase, other things remaining constant.

• Foreign exchange refers to foreign currency used for international payments.
• The foreign exchange market is the market (system) where foreign currencies are bought and sold.
• Exchange rate is the price of one currency in terms of another currency (e.g., 1 USD = ₹75).
• Demand for foreign exchange arises from imports, gifts and transfers abroad, loan repayments, investment abroad, purchase of foreign financial assets, and outbound tourism.
• Supply of foreign exchange arises from exports, FDI and portfolio investment, remittances, loans from abroad, gifts and transfers received, and inbound tourism.
• A rise in the exchange rate generally reduces demand for foreign exchange and may increase its supply by encouraging exports.
• The exchange rate is determined by the demand for and supply of foreign exchange in the foreign exchange market.