Foreign exchange rates  (Page 3/4)

What if we were looking at indirect exchange rates, and the exchange rate moved from $0,149 per ZAR (= $\frac{1}{6,71}$ ) to $0,1538 per ZAR (= $\frac{1}{6,50}$ ).

Well now we can see that the R1,00 cost $0,149 at the start, and then cost $0,1538 at the end. The Rand has become more expensive (in terms of Dollars), and again we can say that the Rand has appreciated.

Regardless of which exchange rate is used, we still come to the same conclusions.

In general,

• for direct exchange rates, the home currency will appreciate (depreciate) if the exchange rate falls (rises)
• For indirect exchange rates, the home currency will appreciate (depreciate) if the exchange rate rises (falls)

As with just about everything in this chapter, do not get caught up in memorising these formulae - doing so is only going to get confusing. Think about what you have and what you want - and it should be quite clear how to get the correct answer.

Discussion : foreign exchange rates

In groups of 5, discuss:

1. Why might we need to know exchange rates?
2. What happens if one country's currency falls drastically vs another country's currency?
3. When might you use exchange rates?

Cross currency exchange rates

We know that exchange rates are the value of one currency expressed in terms of another currency, and we can quote exchange rates against any other currency. The Rand exchange rates we see on the news are usually expressed against the major currencies, USD, GBP and EUR.

So if for example, the Rand exchange rates were given as 6,71 ZAR/USD and 12,71 ZAR/GBP, does this tell us anything about the exchange rate between USD and GBP?

Well I know that if $1 will buy me R6,71, and if £1.00 will buy me R12,71, then surely the GBP is stronger than the USD because you will get more Rands for one unit of the currency, and we can work out the USD/GBP exchange rate as follows:

Before we plug in any numbers, how can we get a USD/GBP exchange rate from the ZAR/USD and ZAR/GBP exchange rates?

Well,

Note that the ZAR in the numerator will cancel out with the ZAR in the denominator, and we are left with the USD/GBP exchange rate.

Although we do not have the USD/ZAR exchange rate, we know that this is just the reciprocal of the ZAR/USD exchange rate.

Now plugging in the numbers, we get: