The foreign exchange rate, like the price of any other commodity or asset in a market, is fundamentally determined by the interplay of demand and supply.
Foreign Exchange Rate Determination
In the context of the commodity market, the price of one currency in terms of another (the foreign exchange rate) is established where the quantity of foreign currency demanded equals the quantity supplied.
- Demand for Foreign Currency: Arises when domestic residents want to buy foreign goods, services, or assets.
- Supply of Foreign Currency: Arises when foreigners want to buy domestic goods, services, or assets, or when foreign entities invest domestically.
The equilibrium exchange rate is reached at the point where these forces balance. Changes in either demand or supply, driven by factors like trade balances, capital flows, or interest rate differentials, will shift the equilibrium and cause the exchange rate to change.
Market Mechanism
The commodity market operates on the principle of market equilibrium. For foreign currency:
- If demand exceeds supply, the price (exchange rate) of the foreign currency rises (domestic currency depreciates).
- If supply exceeds demand, the price (exchange rate) of the foreign currency falls (domestic currency appreciates).
Therefore, the continuous interaction of buyers (demand) and sellers (supply) of foreign currency dictates its rate in the market.
Important Questions from Foreign exchange market
In which year did the companies IBM and Coca Cola shut down their operations for not being able to comply with the Foreign Exchange Regulation Act that mandated foreign investors cannot own over 40% in Indian enterprises?
Identify the drivers for increased Foreign Institutional Investment flows in Indian stock markets in recent times
A. Covid-19 pandemic driven liquidity outflows from the western capital markets
B. Geopolitical supply chain relocations
C. Increased India weightage in MSCI Emerging Market Index
D. Steep decline in interest rates in large market friendly economies
E. Favourable risk-reward ratios in Indian stock markets
Choose the correct answer from the options given below:
Which of the following constitutes Foreign Direct Investment?
Arrange the following modes of entry in foreign markets starting with the mode of entry having least commitment, risk, control and profit potential:
(A) Company hires a local manufacturer to produce the product.
(B) Company starts exports working through domestic export agents and exports management companies.
(C) Company joins hands with local investor and forms a company in which both share ownership and control.
(D) Company starts export using domestic export department and overseas sales branch.
(E) Company offers a complete brand concept and operating system to an investor in return of certain fee.
Choose the correct answer from the options given below:
Given below are two statements: One is labelled as Assertion A and the other is labelled as Reason R.
Assertion (A): Sustained current account surplus encourages the government to liberalize imports and capital movements.
Reasons (R): The current account and balance of payments positions of a country can significantly influence its economic policies.
In the light of the above statements, choose the correct answer from the options given below:
