Importance of Exchange Rates in International Trade - Desklib

This article discusses the importance of exchange rates in international trade and how it affects businesses. It also explains the impact of currency appreciation and devaluation on importers and exporters. The article further elaborates on the factors that affect exchange rates, such as inflation, interest rates, balance of payment, government debt, and recession. Lastly, it highlights the role of central banks in maintaining forex reserves and the policies they implement to control the currency in the country.

Running head: FINANCE
Finance
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Author’s Note

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Table of Contents
Question 1........................................................................................................................................2
Question 2........................................................................................................................................2
Question 3........................................................................................................................................3
Question 4........................................................................................................................................3
Question 5........................................................................................................................................4
Reference.........................................................................................................................................6

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Question 1
The businesses which are engaged in international trade must consider the impact of
exchange rates and their fluctuations on the profitability of the business. The importance of
Exchange rates which can be identified are listed below in details:
 Exchange rates form a part of the costs of the business which is paid as commission by the
business for converting one currency to another (Blonigen & Piger, 2014).
 In addition to this, for a business or country which is engaged in the international trade, the
exchange rate is very important for the purpose of converting the revenue earned in foreign
currency into domestic currency.
 Exchange rates are subjected to wide range of fluctuations depending on foreign market
conditions and therefore they can create significant risks which businesses needs to
consider and also plan for mitigation.
 The exchange rates fluctuation also has impact on the Balance of Payment of a Country as
export and import prices are depended on such exchange rates.
Question 2
Currency Appreciation refers to rise in the value of currency of a domestic country and
the same has the impact of increasing the imports in a country as the same becomes quite cheap
while exports becomes very much expensive. Therefore, from the question which is provided the
exporters are the losers or the country which is engaged in exporting becomes the loser as the
costs increases as well as the aggregate demand for products fall. Similarly, importers or the
country which is engaged in imports are the gainers as the value of the currency on the rise
means that the products are available in the country at a much cheaper rate (Rogmans & Ebbers,

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2013). This means that the customers can have access to exported products at much lower value.
In addition to this, its causes demand pull inflation and ultimately can reduce inflationary
pressure in the country.
Question 3
Devaluation is a situation where the value of the currency falls in fixed exchange rate
system. In other words, the value of the currency is disclosed which can affect the economy as a
whole. In other words, Devaluation increases the costs of imports and also foreign travel for
customers becomes expensive in such a situation (Ghosh, Ostry & Chamon, 2016). On the other
hand, domestic exports become much cheaper and therefore can be considered to be more
favorable for businesses. In the situation which is given in the question, the importers or
importing nation will be the losers as the overall costs of imports are high and also the quality of
the same is also hampered (Amit, Itskhoki & Konings, 2014). On the other hand, the exporters or
the exporting nation are the gainers as the costs of exports is cheap and therefore this creates
significant demand in international markets. In addition to this, this also makes the exporting
nation more competitive and thereby also has a positive impact to create more employment
opportunities in the country.
Question 4
There are several factors which affect exchange rate of a currency and some of the
important factor which can be identified are listed below in details:
 Inflation: The changes in market inflations can affect the exchange rates causing them to
change as well. A country which has higher currency value also experiences low
inflationary pressures while a country which has lower currency value experiences high

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inflationary pressures. Therefore, there is a indirect link between inflation rates and
currency value.
 Interest Rates: The changes in interest rate is also an important factor which affect
exchange rates of a country. In general interest rates, forex rates and inflation rates are
interrelated (Bussière, Delle Chiaie & Peltonen, 2014). An increase in interest rate of a
business results in higher exchange rates as the lender gets high rates of interest which in
turn attracts foreign investors and thereby there is a rise in the forex rates in the market.
 Changes in Balance of Payment: The balance of Payment consists of a current account
which shows balance of trade and all earnings from foreign investment. This shows all the
imports and exports which are made by a country. If the import is more than the exports
than a deficit would be created which would depreciate forex rates (Moosa, 2016). Thus,
fluctuations in Balance of Payments also has impacts on exchange rates of a business.
 Government Debt: Government debt refers to the debt which is taken by a country from
international source mainly other countries or international banks. In such a case, the
country would not be able to acquire foreign capital and the foreign investors predicting
debt would sell out their holdings which would depreciate the value of currency.
 Recession: In a period of recession, the interest rates of a country falls in normal
circumstances and therefore this hampers the chances of the country to acquire foreign
capital. This results in weakening of the currency value and thereby leads to depreciation in
the valuation of currency.
Question 5
The central bank of a country has a very important role to maintain the foreign exchange
currency in a country. The central bank is engaged in buying and selling of foreign currency in

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order to increase of decrease the value of domestic currency. This activity of the central bank is
known as currency intervention and this has continued over the last few decades in many
countries. The reason for such intervention is to prevent instances where there is continuous
depreciation of the currency.
The central bank of japan plays a vital role in maintaining the forex reserves of a business
by keeping the value of domestic currency which is Yen as low as possible in order to benefit
more from exports and thereby earn more revenue in relative terms. The country is dependent on
exports and any increase in valuation of currency would cause recession.
Another important central bank is Bank of England, which plays a vital role in framing
the policies in the economy. The bank tries to maintain the level of inflation in the country and
thereby also maintain the forex reserves in the country. The country has an effective monetary
policy which controls the currency in the country.
The Swiss Central Bank is known to formulate effective monetary policy with special
consideration to interest rates of the business. The bank also maintains significant amount of
forex reserves which is done by providing attractive interest rates.

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Reference
Amiti, M., Itskhoki, O., & Konings, J. (2014). Importers, exporters, and exchange rate
disconnect. American Economic Review, 104(7), 1942-78.
Blonigen, B. A., & Piger, J. (2014). Determinants of foreign direct investment. Canadian
Journal of Economics/Revue canadienne d'économique, 47(3), 775-812.
Bussière, M., Delle Chiaie, S., & Peltonen, T. A. (2014). Exchange rate pass-through in the
global economy: the role of emerging market economies. IMF Economic Review, 62(1),
146-178.
Ghosh, A. R., Ostry, J. D., & Chamon, M. (2016). Two targets, two instruments: monetary and
exchange rate policies in emerging market economies. Journal of International Money
and Finance, 60, 172-196.
Moosa, I. (2016). Exchange rate forecasting: techniques and applications. Springer.
Rogmans, T., & Ebbers, H. (2013). The determinants of foreign direct investment in the Middle
East North Africa region. International Journal of Emerging Markets, 8(3), 240-257.