Speculation plays a significant role in causing fluctuations in foreign exchange rates. Speculators are individuals or institutions who buy or sell currencies with the aim of making a profit from short-term price movements. Their actions are driven by expectations about future exchange rate changes.

Expectations are crucial. If speculators believe a currency is likely to appreciate (increase in value), they will buy that currency, increasing demand. This increased demand pushes the exchange rate up. Conversely, if speculators expect a currency to depreciate (decrease in value), they will sell that currency, increasing supply and pushing the exchange rate down.

The potential for self-fulfilling prophecies is important to consider. If enough speculators believe a currency will fall, they will sell it. This selling pressure can actually cause the currency to fall, confirming their initial belief and encouraging further selling. This creates a feedback loop.

Furthermore, speculative activity can be amplified by news and events. For example, rumours of changes in interest rates or government policy can trigger large volumes of speculative trading, leading to rapid and potentially volatile exchange rate movements. The speed and scale of speculation can often outpace fundamental economic factors, contributing to significant fluctuations.

In summary, speculation influences exchange rates by creating demand and supply imbalances based on expectations, and the potential for these expectations to become self-fulfilling.

Answer: A devaluation of a country's currency (e.g., the GBP) makes its exports cheaper and imports more expensive. This has a direct impact on the balance of payments, specifically the current account.

Exports: Devaluation increases the competitiveness of exports, leading to higher export volumes. This increases export revenue.

Imports: Devaluation increases the cost of imports, leading to lower import volumes. This reduces import expenditure.

Current Account: The current account is the sum of the balance of trade (exports minus imports) and net income (income from abroad minus income paid to abroad). A devaluation of the currency generally improves the balance of trade (positive balance of trade). This, in turn, improves the current account. However, the impact on net income is less direct and depends on factors such as the amount of foreign investment in the country.

Foreign Investment: Devaluation can make a country more attractive to foreign investors. This is because assets denominated in the devalued currency become cheaper for foreign investors to acquire. Increased foreign investment can improve the capital account, further supporting the balance of payments. However, devaluation can also increase uncertainty and potentially deter investment if it is perceived as a sign of economic instability.

Table illustrating the effects:

Businesses sell foreign currencies for various reasons, primarily related to managing their finances and profits from international trade. Here are three reasons:

• Repatriating Profits: When a business earns profits from exporting goods or services, these profits are often in a foreign currency. The business needs to convert these profits back into its domestic currency to pay dividends to shareholders, reinvest in the domestic business, or cover expenses. Example: A German engineering firm exporting machinery to Australia receives AUD. They would sell the AUD to buy Euros (EUR) to pay their European suppliers.
• Covering Import Costs: If a business has paid for imports in a foreign currency, and now needs to pay back that currency to the supplier, it will sell the foreign currency to obtain the required amount. Example: A US company that has paid a Japanese supplier in Yen (JPY) will sell the JPY to get USD to pay the supplier back.
• Taking Advantage of Favorable Exchange Rates: Businesses may sell foreign currencies if they believe the exchange rate is likely to fall. By selling the foreign currency now, they can secure a better rate than they might get later. Example: A British company holding a large amount of US Dollars might sell them if they anticipate the Pound Sterling will strengthen against the Dollar.