foreign exchange market

The foreign exchange marketSupply for poundsif curve is downward slopingproduct is price inelasticincrease in foreign demand smallresult in a drop on total spending of importse.g. 42 suits @ £500 = £21kpurchase power abroad is high when £ increases in valuemore attractive as buying things in foreign currencies is cheapertherefore demand should be highupward sloping supply curveproduct is price elasticcurve will be steepdemand will be significantthis can lead to total spending on imports to increasee.g. 40 suits @ £600 = £24k vs 60 suits @ £500 = £30kshifts in supplyincrease in overseas interest rateshigher returns sought abroadincrease in supply of poundoutflow of poundsincrease in UK incomesincrease demand for importsmore pounds supplied to foreign currencyspeculationselling the pound because the belief is it will fall in value in the futurethis tends to result in the fear happeningcan be done deliberately to encourage others to sell, pushing the price down, thereby allowing the speculator to buy back at cheaper pricereaching equilibrium in currency marketsfree marketexcess demandprice of currency adjusts until demand = supplyvalue of pound fallsprice of currency will riseincreasing quantity supplied but reduces demand until equilibriumsupply and demand fallnormally a result of excess supplyMcBurger Indexdetermines under or over value of currencycompares actual FX rates with what it needs to be to keep prices of burgers in diff countries comparablemcdonalds burger used as its fairly standard across multiple countrieseasier than using PPPpurchasing power paritywhich compares a basket of goods (can be difficult to agree a standard basket across countries)e.g. basket of UK goods = £150, basket of US goods = £300, PPP rate = £1: $2Overall Impactdependent onprice elasticityimports & exportsoverseas market competitionproportion of sales exportedproportion of inputs importeddegree to which currency value has changed, & what direction, relative to exports & importsavailability of alternative markets to export to or import fromdemand for poundsshifts in demandincrease in demandincrease in UK interest rates relative to returns available elsewhereshift curve outwardincrease in pound demand from overseasspeculationdemand curve is downward sloping if the pound is expensive e.g. less demandthereby saving pounds in the UKattracts foreign investors looking for high returns in UK banks etcleading to higher exchange rateincrease in income overseashigher demand for UK productsbig influencer in value of a currencybelieve pound will increase in futurevarious events can lead to speculatione.g. government changesbuy now and sell for higher price laterslope of the curve determined by price elasticity of demand for UK products in foreign currenciesif UK exports = very price sensitiveincrease in pound = increase price of product abroad = significantly decreasing demandsteep slopeelasticity is determined by the productfactors which impact price elasticityreliabilityqualityuniquenessbrand powerhigh increase/ decrease in demand with significant price changeselasticlow increase/ decrease in demand with significant price changese.g. OlympicsEurobenefitsno currency conversion transaction costsdo not need to worry about fluctuations within the Eurozonegreater stabilityeasier planningforce price competitioneasier to compare prices of suppliersconslose control over domestic countryaccepting increases/ decreases in interest rates set by ECBoverviewfloating exchange ratesvalue determined by market or supply & demandanalysis of currency changesmanagers concentrate on markets they sell to and buy fromweak currencylow demandstrong currencyhigh demand or fall in supplyforex is where exchange rate determinedsupply & demand determine price of one currency relative to anotheror can be fixed by the governmentcurrency value impacts price of a firm's product overseasimpacts exportsimpacts importsstronger value means fewer pounds need to purchase from abroadthereby reducing import pricesunderstanding of FX crucial to modern day businessmonitor the fluctuations and anticipate changes important as its not controlled by one personchanges can be rapid leading to big movements in currency valuecan make financial difficult as hard to forecast valuecan also change competitive positionovercoming exchange rate problemsexchange rate is an example of PESTLE factoroutside direct control of firm but significantly influences its successoffset FX changes in one market with anotheroperate in multiple marketsreduce impact of FX changestarget markets with the same currencymay reduce export oppsreduce ability to buy best inputs at best pricesuse future marketsbuy currency in advance at fixed pricespeculate to offset movementsset contracts in own currencyrelative importance of changes in FXpound increases relative to overseas marketpound price remains the same = import costs reduceoversea products are less expensivepound price remains the same = import costs reduceleading to higher profit marginsenable firm to reduce pricesincrease competition if customers choose to purchase overseasscale of effect depended on ease to switch, and similarity of productpound price remains the same = exports are cheaperpound falls relative to overseas marketoverseas price remains same in foreign currencyleading to higher profit marginsThe foreign exchange marketfirms must be able to meet increase in demandGovernment interventioninfluence or stabilizefix valuefixed or pegged FXachieved by buying/ selling currency &/ or using interest ratesincrease valuebuy own currency using foreign currency reservesdemand increasesincreasing equilibrium priceas demand curve shifts rightrestricted by the amount of foreign currency reserves are availableincrease interest rateshigh rates attract overseas investorsdecrease domestic demand as borrowing becomes more expensivechanges in supply of and demand for currencydecrease in supplyincrease the pricedecrease in equilibriumincrease in demandincrease in priceresulting in increased equilibriumif supply is upward sloping