PV System Performance Modeling

1 .0 Introduction 2 .0 Objectives 3 .0 Main Content

3.1 Role of Foreign Exchange Defined 3.2 Types of Exchange rate

3.3 Exchange Rate Determination 3.4 Theories of Exchange Rate

3.4 .1 Mint Parity Theory

3.4 .2 Purchasing Power Parity Theory

3.4 .3 Balance of Payment or Modern Theory 3.5 Exchange Rate System

3.6 Factors Influencing Rate of Exchange 4 .0 Conclusion

5 .0 Summary

6 .0 Tutor Marked Assignment 7 .0 References/Further readings

1.0 INTRODUCTION

In the international business arena, understanding of currency rate of exchange is very important in determining the volume of trade and goods to be bought. This unit provides a comprehensive explanation of foreign exchange that the rate at which one specific foreign currency is exchange with the order.

2.0 OBJECTIVES

At the end of this study unit, student should be able to:

Understand the different rates of exchange Know theories of foreign rates of exchange Explain factors influencing rate of exchange

3.0 MAIN CONTENT

3.1 Rate of Foreign Exchange Defined

The rate at which one currency is exchanged for another is called the rate of exchange. The rate of exchange is the price of one currency stated in terms of another currency. In other words, the rate of exchange expresses the external purchasing power of a home currency. According

MBA 843

INTERNATIONAL BANKING

to Growther, the rate of exchange ³measures the number of units of one currency which will exchange in the foreign exchange market for another´. In the words of Anatol ³The ratio at which one country¶s currency can be exchanged for another is the rate of exchange between these two currencies´. According to Sayers, ³the prices of currencies in terms of each other are called foreign exchange rate´.

3.2 Types of Exchange Rate

In the foreign exchange market, at particular time, there exists, not one unique exchange rate, but a variety of rates, depending upon the credit instruments used in the transfer function. Major types of exchange rates are as follows:

Spot Rate

Spot rate of exchange is the rate at which foreign exchange is made available on the spot. It is also known as cable rate or telegraphic transfer rate because at this rate cable or telegraphic sale and purchase of foreign exchange can be arranged immediately. Spot rate is the day-to- day rate of exchange. The spot rate is quoted differently for buyers and sellers. This difference is due to the transport charges, insurance charges, dealers¶ commissions, etc. These costs are to be born by the buyers.

Forward Rate

Forward rate of exchange is the rate at which the future contract for foreign currency is made. The forward exchange rate is settled now but the actual sale and purchase of foreign exchange occurs in future. The forward rate is quoted at a premium or discount over the spot rate.

Long Rate

Long rate of exchange is the rate at which a bank purchases or sells foreign currency bills which are payable at a fixed future date. The basis

of the long rate of exchange is the interest on the delayed payment. The long rate of exchange is calculated by adding premium to the spot rate of exchange in the case of credit purchase of foreign exchange and deducting premium from the spot rate in the case of sale.

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INTERNATIONAL BANKING

Fixed Rate

Fixed or pegged exchange rate refers to the system in which the rate of exchange of a currency is fixed or pegged in terms of gold or another currency.

Flexible Rate

Flexible or floating exchange rate refers to the system in which the rate of exchange is determined by the forces of demand and supply in the foreign exchange market. It is free to fluctuate according to the changes in the demand and supply of foreign currency.

Multiple Rates

Multiple rates refer to a system in which a country adopts more than one rate of exchange for its currency. Different exchange rates are fixed for importers, exporters, and for different countries.

Two-Tier Rate System

Two-tier exchange rate system is a form of multiple exchange rate system in which a country maintains two rates, a higher rate for commercial transactions and a lower rate for capital transactions.

3.3 Exchange Rate Determination

Rate of exchange is the price of one currency in terms of another currency. Therefore, like other prices, the rate of exchange is also determined in accordance with the general theory of value, i.e., by the interaction of the forces of demand and supply. In other words, the exchange rate in a free exchange market is determined at a level where demand for foreign exchange is equal to the supply of foreign exchange.

Supply of Foreign Exchange: The supply of foreign exchange comes from the domestic exporters who receive payment of foreign currency;

the foreigners who invest and led in the home country; domestic residents who repatriate capital funds previously sent abroad; and the domestic residents who receive gifts from abroad.

The supply schedule for foreign exchange represent a functional relationship between different rates of exchange and the corresponding amounts of foreign exchange supplied. The supply schedule slopes upward to the right, indicating that at higher exchange rates larger amounts of foreign exchange are offered for sale.

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INTERNATIONAL BANKING

Demand for Foreign Exchange

Foreign exchange is demanded by the domestic residents to import goods and services from abroad; by the domestic residents investing and lending abroad; by the foreign residents to repatriate funds previously invested in the home country; and for sending gifts to foreign countries.

The demand schedule for foreign exchange shows a functional relationship between different rates of exchange and the corresponding amounts of foreign exchange demanded. The demand schedule slopes downward to the right, indicating that greater amounts of foreign currency are demanded at lower rates of exchange.

3.4 Theories of Rate of Exchange

Different theories have been developed to explain the determination of rate of exchange. They are: Mint Parity theory, Purchasing power parity theory, and Balance of payments theory.