Foreign Exchange Rates

An exchange rate is the price of one currency in terms of another currency.

Example:

• EUR/USD = 1.10 means 1 euro buys 1.10 U.S. dollars.

What usually affects exchange rates:

• Interest rates: higher rates can attract capital and support a currency.
• Inflation: persistently high inflation often weakens a currency.
• Trade balance: strong export demand can raise demand for the local currency.
• Policy intervention: central banks may buy or sell currencies directly.

Why exchange rates matter:

• Appreciation makes exports less competitive and imports cheaper.
• Depreciation makes exports cheaper and imports more expensive.

Two business exposures:

• Translation exposure: accounting effect when foreign statements are converted into the reporting currency.
• Economic exposure: real effect on future costs, revenues, and competitiveness.

This topic connects most directly to Inflation Index and Time Value of Money.