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Exchange Rate Essay

3269 words - 14 pages

Abstract

INTRODUCTION
When first looking at an exchange rates, and foreign exchange, there are a few questions which must be considered. What factors affect the demand and supply of Australian dollars in the foreign exchange markets? Distinguish between the possible causes and effects of currency depreciation and a currency appreciation on the Australian economy. What forces have come into play, if any, in the past few years that have affected the value of the Australian dollar? In addition to looking further into those questions, it is helpful to know what the word Exchange Rate means; it is defined as, “The rate at which one unit of domestic currency is exchanged for a given ...view middle of the document...

Another factor, which can affect the supply and demand of Australian dollars, is intervention in the market by the Reserve Bank of Australia. 

DEMAND 
The demand for Australia’s currency in the foreign exchange market (Forex) is a derived demand. It is derived from the demand for a country’s exports of goods and services and its assets. 
In simple terms, people who may have a demand for the Australian dollar could include: 
_ Foreigners wanting to purchase Australian exports 
_ International tourists visiting Australia 
_ International investors wishing to purchase Australian shares or property 
_ International firms setting up branches or expanding in Australia 
_ Speculators and investors who think the value of the Australian dollar will rise in hope of making a profit. 
The demand for the Australian dollar will be affected by a number of factors. These factors are: 
The Size of financial flows into Australia 
The size of financial flows into Australia from investors who wish to invest in Australia and need to convert their currency into AUD will affect demand for the dollar. The level of Australian interest rates relative to overseas interest rates as well as the level of confidence in the Australian economy will affect the level of capital inflow. If Australia has relatively higher interest rates and stronger confidence, then this will encourage capital inflow and increase demand for the AUD. Using this theory, the Australian dollar at the present looks to be in a relatively strong position. Interest rates are beginning to rise (official interest rate has recently been risen 0.25 points to 4.5% and is expected to raise to 5.25% by September this year, with economic growth expected to be around 3.75% in 2002/03.) Also increasing the confidence in future economic growth is the recent budget. The 2002/03 budget released on 14th May 2002 was a deficit budget. This means that the government has spent more than it has earned. This is an injection of money into the Australian economy and will stimulate economic activity and growth. 
Price Expectations 
Expectations of a future appreciation of the AUD will increase the demand for the AUD by speculators as they expect to make a profit from buying the dollar now and selling at a later date at a higher price. 
The Demand for Australian Exports 
The demand for Australian exports varies for a variety of reasons. One reason is changes in commodity prices. Another is the terms of trade. These two variations tend to have an immediate impact on the AUD. A rise in commodity prices and an improvement in the terms of trade are generally expected to improve the Current Account Deficit (CAD). This will often result in an increase in the value of the AUD because of the expectation that the CAD will improve over the short to medium term. 
The level of international competition and the Australian inflation rate relative to other countries also influences the demand for Australian exports. If...

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