Foreign Exchange Rates

This section explains the concepts of floating exchange rates, appreciation, and depreciation, which are fundamental to understanding international trade and globalization.

Floating Exchange Rates

A floating exchange rate is a system where the value of a currency is determined by the forces of supply and demand in the foreign exchange market. The government does not intervene to fix or maintain a specific exchange rate.

Factors influencing a floating exchange rate include:

• Economic performance (e.g., GDP growth, inflation)
• Interest rates
• Trade balance (exports and imports)
• Political stability
• Market sentiment and speculation

Appreciation and Depreciation

Appreciation occurs when the value of a currency increases relative to another currency. For example, if the British pound (GBP) appreciates against the US dollar (USD), it means you need fewer pounds to buy one US dollar.

Depreciation occurs when the value of a currency decreases relative to another currency. For example, if the British pound (GBP) depreciates against the US dollar (USD), it means you need more pounds to buy one US dollar.

Understanding Appreciation and Depreciation

Appreciation and depreciation are relative terms. A currency can appreciate or depreciate against any other currency.

Table Summarizing Key Terms

Term	Definition
Floating Exchange Rate	Currency value determined by supply and demand in the foreign exchange market.
Appreciation	Increase in the value of a currency relative to another.
Depreciation	Decrease in the value of a currency relative to another.

Example:

Suppose the exchange rate between GBP and USD is initially 1 GBP = 1.25 USD. If the GBP appreciates, the new exchange rate might be 1 GBP = 1.30 USD. If the GBP depreciates, the new exchange rate might be 1 GBP = 1.20 USD.

The value of a currency is often expressed using the following notation:

$$ \text{Exchange Rate} = \frac{\text{Currency A}}{\text{Currency B}} $$

For example, $$ \text{1 GBP} = \text{1.25 USD} $$