the impact of exchange rates
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5.3_the_impact_of_changing_exchange_starter_activity.docx | |
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Key term: EXCHANGE RATE - the exchange rate is the price of buying foreign currency. It tells you how much of the foreign currency you will get for every pound or how many pounds you have to give up to acquire a foreign currency.
Exchange rates are important both to businesses and consumers. Many people take foreign holidays. They then have to buy foreign currency. The exchange rate is the amount of currency you can buy with one unit of another currency. E.g. if £1 = €1.20, it means you can buy 1.20 euros in exchange for 1 British pound. The British pound is often called the pound sterling.
Key term: IMPORT - the purchase of a good or service from a foreign business that leads to a flow of money out of the UK. The UK buyer will have to change pounds into the seller's currency to make the transaction.
A business may have to buy materials from other businesses which are located in foreign countries. When UK businesses buy imports, they have to pay the foreign firm with their own currency. So UK businesses have to buy foreign money.
Key term: EXPORT - the sale of a good or service to a foreign buyer that leads to a flow of money into the UK. The foreign buyer will have to change their currency into pounds to complete the purchase.
When a business sells it products abroad, it expects to be paid in pounds for these sales. When UK businesses export goods, foreign buyers have to buy pounds to pay for them. They buy these pounds with their own local currency.
To calculate the cost of a foreign exchange transaction, you need to know the exchange rate. E.g:
UK business sells £10,000 of products to a French business
The exchange rate is £1 = €1.20
10,000 x 1.2 = €12,000
UK business sells £20,000 of products to a US business
The exchange rate is £1 = $1.5
20,000 x 1.5 = $30,000
In practice, the cost would actually be slightly higher as banks who specialise in buying and selling foreign exchange also charge commission (a small fee).
Calculate the cost of the following:
UK business sells £25,000 to a German business and the exchange rate is:
a) 1.5 b) 2 c) 1.75
UK business sells £10,000 of products to a French business
The exchange rate is £1 = €1.20
10,000 x 1.2 = €12,000
UK business sells £20,000 of products to a US business
The exchange rate is £1 = $1.5
20,000 x 1.5 = $30,000
In practice, the cost would actually be slightly higher as banks who specialise in buying and selling foreign exchange also charge commission (a small fee).
Calculate the cost of the following:
UK business sells £25,000 to a German business and the exchange rate is:
a) 1.5 b) 2 c) 1.75
The exact price of foreign currencies goes up and down on a minute-by-minute basis. Changes in the exchange rate of a currency affect the amount of another currency that has to be given up to acquire an amount of another. This, therefore, changes the price of imports and exports. E.g. In the green example above, what would happen if the exchange rate fell to £1 = $1?
This example shows that if the value of the pound falls, the price of goods to foreign customers will also decrease. A fall in the value of the pound means a fall in the export prices of UK firms. The reverse is also true. The same calculation also applies to imports.
The impact of a fall in the value of the pound on small firms
- Good news for firms that export goods. They become cheaper to foreign businesses. This may mean the business can sell more
- A fall in the value of the pound makes imported goods more expensive. Good for UK firms trying to compete against foreign imports
- Bad for businesses that import a lot of goods. This will make imports more expensive. They can raise their prices and pass this cost on, but risk losing sales
The impact of a rise in the value of the pound on small firms
- Bad for businesses that export goods. They become more expensive to foreign businesses. This means they may sell less
- Bad news for UK firms that compete against foreign imports. The price of imports into the UK will fall. This means they become less price competitive and may lose sales
- Good for UK businesses that use imported materials. The price of imports will fall. They can pass on these lower costs to customers or keep prices the same and raise profits
5.3_the_impact_of_changing_exchange_activity.docx | |
File Size: | 37 kb |
File Type: | docx |