Exchange Rates

The value of a nation’s currency in terms of another currency i.e. £1=$2

An exchange rate is set by demand and supply of a currency

Exchange rates create uncertainty because:

• If a deal is agreed in foreign currency firms may receive more or less than expected due to changes in exchange rates
• Changes to exchange rates can affect prices and sales overseas
• Competitors can respond in unexpected ways to exchange rate changes

Changes in the UK’s interest rates will lead to changes in the exchange value of the pound.

• If interest rates rise the value of the pound will rise so the pound will now buy more US dollars, Japanese Yen, Euros etc.
• If interest rates fall the value of the pound will fall so the pound will now buy less US dollars, Japanese Yen, Euros etc
• If interest rates are higher than rates in other countries the UK will become more of an investment opportunity.

Investors will exchange their currency into sterling to invest it in UK banks to earn high rates of interest on their savings.

This will increase the demand for Sterling which will appreciate in value

If interest rates are lower than rates in other countries the UK will become less of an investment opportunity.

• Investors will exchange their currency from sterling to invest it in Foreign banks.
• They will withdraw £ in the UK to buy foreign currency.
• This means an increased supply of sterling will be available in the world’s currency market causing the £ to depreciate