1.

Describe factors leading to changes in the demand for, and supply of, a
currency.

The above diagram depicts the relation between demand, supply and currency in the
foreign exchange markets. There are several factors which affect the demand and supply of
currencies as mentioned below;
● Inflation, if for example inflation is lesser in the UK than in neighbouring nations the
exports from the UK will tend to gain demand, which means the demand for the
Pound will increase because they would like to buy more british goods.
● Interest Rates, if the interest rates are lesser in other nations as compared to the UK,
people from around the globe would like to invest their money in British banks as
they get a higher amount of returns, which again leads to the demand rising. And if
there is a cut in the interest rates the demand for the currency tends to reduce.
● There is another factor called speculations which Forex speculators perform when
they see an imminent rise in a particular currency in the near future they tend to
invest into these currencies which increases the demand so that they can make huge
profits, which is why a few times the forex is not only related to the economics of a
particular nation but also its financial sentiments at the moment.
● Competitiveness is also another factor because if the goods of a country become
more competitive in relation to the goods from other nations the demand for the
currency will rise, and this factor can also be linked to inflation because if there is
low inflation there is high competitiveness.
● Debt, debt which is held by the government is also a factor which determines the
demand and supply of a given currency because if a foreign market feels that the
nation will not be able to pay its government debt back then the forex investors will
usually sell their shares which will result in a fall in demand for the currency.
 2. Define, explain, illustrate, and give examples of a managed exchange rate
system.

The managed exchange rate system is when the government of a particular country is
setting a lower and an upper limit for where its nations exchange rate should be within. If
there are changes to be made to this limit or if the currency is below or above the limit the
government increases or decreases interest rates as deemed best at that point in time.
If the currency is overvalued in this system there are several effects seen such as the
pressure on the inflation rate decreasing due to the cheaper imported goods, or domestic
producers becoming more efficient as there is sufficient competition from the foreign
goods, if the currency is overvalued the exports receive lesser profit due to the fact that the
exports become more expensive now. If the currency is undervalued on the other hand, the
export industry grows as the exports are now cheaper, domestic consumers would prefer
to purchase and consume only domestic goods as imports become costlier, this increase in
costs for imports lead to the raw materials getting more expensive due to cost push
inflation.
Most of the exchange rate systems around the world are managed to an extent as there is
no exchange rate which the nation does not control such as the USD, EUR, GBP, or even the
japanese Yen these are a few but there are many more but what differs between these
countries is the amount of interference from the nation’s central bank into the exchange
rate.
3. Evaluate the advantages and disadvantages of high and low exchange rates.
 4. Explain government measures to intervene in the foreign exchange market.
There are few methods which the government could use to intervene in the forex, such as;
● Borrowing, this is a good way for the government to save a falling exchange rate and
keep its value the same it can tap into other forex reserves for example they can sell
their reserves and buy another currency which is higher than theirs to increase or
keep its value the same.
● Interest rates, as mentioned earlier are directly proportional to the demand for a
currency as if the interest rates increase other countries would like to invest as they
see higher returns but lower interest rates can cause this demand to fall.
 5. Compare and contrast a fixed exchange rate system with a floating exchange

rate system.

DISADVANTAGES OF BOTH ARE MENTIONED BELOW