Question

The exchange rate between the U.S. dollar and the British pound starts at \(\$ 1=£ 0.5 .\) It then changes to \(\$ 1=£ 0.75\) Given this change, we would say that the U.S. dollar has LO39.3 while the British pound has a. Depreciated; appreciated. b. Depreciated; depreciated. c. Appreciated; depreciated. d. Appreciated; appreciated.

Short answer

c. Appreciated; depreciated.

Step-by-step solution

Understand the Initial Exchange Rate

Initially, the exchange rate is given as \( \$1 = \£0.5 \). This means that for every US dollar, one would receive 0.5 British pounds.

Analyze the Change in Exchange Rate

The exchange rate changes to \( \$1 = \£0.75 \). Now, for each US dollar, one receives 0.75 British pounds. This means that the US dollar can now buy more pounds compared to before.

Determine the Impact on the U.S. Dollar

Since the U.S. dollar can now buy more pounds than before (from 0.5 to 0.75), it has increased in value relative to the pound. This is called appreciation.

Determine the Impact on the British Pound

Given that the U.S. dollar now buys more pounds, it means that the British pound buys less U.S. dollars for the same amount. Thus, the British pound has decreased in value, or depreciated relative to the U.S. dollar.

Select the Appropriate Answer Choice

Based on the analysis, the U.S. dollar has appreciated, while the British pound has depreciated. Therefore, the correct answer is choice c: Appreciated; depreciated.

Key concepts

Currency Appreciation

Currency appreciation is when the value of a currency increases relative to another currency. This can happen due to various reasons such as economic growth, increased foreign investment, or higher interest rates. When a currency appreciates, it means that each unit of the currency can now purchase more of another currency than it could before.

In the example of the U.S. dollar against the British pound, we see currency appreciation. Initially, one U.S. dollar was equivalent to 0.5 British pounds. After the change, one U.S. dollar became equivalent to 0.75 British pounds. This indicates that the U.S. dollar appreciated since it can now buy more pounds.

Currency appreciation can have various effects:

• Imported goods may become cheaper as the appreciated currency can purchase more with less.
• Exported goods might become more expensive for foreign buyers, possibly reducing exports.
• Travel to countries with a depreciated currency becomes cheaper for travelers from the country with the appreciated currency.

Currency Depreciation

Currency depreciation occurs when a currency loses value relative to another currency. This means that more units of the depreciated currency are needed to buy a unit of the foreign currency. Depreciation can result from factors like economic instability, political unrest, or lower interest rates.

In our example, the British pound depreciates relative to the U.S. dollar. Initially, £1 can buy more U.S. dollars than it can after the depreciation (0.75 USD now instead of 0.5 USD for each dollar). This means the British pound's purchasing power against the U.S. dollar has decreased.

Currency depreciation impacts include:

• Imported goods may become more expensive, as more of the depreciated currency is needed to purchase the same goods.
• Exports might increase as goods become cheaper for foreign buyers, possibly boosting local production and employment.
• Travel to countries with a stronger currency becomes more expensive for residents of the country with the depreciated currency.

Exchange Rate Impact

Exchange rates represent the value of one currency in terms of another and fluctuate due to market dynamics. These changes impact economies in significant ways, affecting everything from individual financial decisions to national economic strategies.

When an exchange rate changes, as in the case from \(\\(1 = \£0.5\) to \(\\)1 = \£0.75\), the value of the currencies involved shifts as well. A stronger currency will have more buying power internationally, enhancing its ability to purchase foreign goods and services.

The main impacts of exchange rate movements include:

• Businesses dealing in international trade must carefully manage their currency exposure due to changes in costs and revenues.
• Governments might adjust monetary policies to either counteract or take advantage of these fluctuations.
• Consumers living in countries with weaker currencies may face higher prices for imported goods and diminished purchasing power abroad.

Foreign Exchange

Foreign exchange (often abbreviated as Forex or FX) involves the global marketplace where currencies are traded. Being the largest financial market in the world by daily trading volume, it deals with the conversion of one currency into another.

Forex trading is crucial for international commerce and finance. An efficient foreign exchange market ensures that there are fair prices for currency transactions and that exchange rates reflect economic realities.

Key aspects to understand in the foreign exchange market include:

• The Forex market operates 24 hours a day during weekdays due to the time zones of global financial centers.
• Transactions range from large institutional trades to smaller private exchanges, affecting price stability and liquidity.
• Exchange rates are influenced by a variety of factors, such as financial news, geopolitical events, and economic indicators.