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 _______ while the British pound has _______. a. Depreciated; appreciated. b. Depreciated; depreciated. c. Appreciated; depreciated. d. Appreciated; appreciated.

Short answer

The U.S. dollar has appreciated, and the British pound has depreciated, so the answer is c.

Step-by-step solution

Understanding Exchange Rates

Exchange rates indicate the value of one currency compared to another. The exchange rate from U.S. dollars to British pounds is given as the amount of pounds received for each dollar.

Compare Initial and New Exchange Rates

Initially, the rate is \(\\(1 = £0.5\). Which means, for every \(\\)1\), we receive half a British pound. The new rate is \(\\(1 = £0.75\), implying that for every \(\\)1\), we now receive three-quarters of a British pound.

Determine Currency Appreciation or Depreciation

A currency appreciates when its value increases relative to another currency. Since initially \(\$1\) traded for \(£0.5\) and now it trades for \(£0.75\), the U.S. dollar has appreciated. Conversely, fewer U.S. dollars are now needed to exchange for pounds, indicating that the British pound has depreciated.

Select the Correct Option

Based on the analysis, the U.S. dollar has appreciated and the British pound has depreciated. The correct choice to fill in the blanks would be "c. Appreciated; depreciated."

Key concepts

Currency Appreciation

Currency appreciation occurs when a currency increases in value compared to another currency. This means you can receive more of a foreign currency for one unit of your national currency. Let's say the exchange rate changes from \(1 = £0.5\) to \(1 = £0.75\). This transformation illustrates currency appreciation for the U.S. dollar, as you now get more British pounds per dollar than you initially did.

• Higher purchasing power: A strong currency allows you to buy more foreign goods or services.
• Good for imports: It benefits consumers and businesses who rely on imports, as goods become cheaper.
• Impact on exports: It might hurt national exporters because foreign buyers find local goods more expensive.

In financial markets, currency appreciation can influence the balance of trade, inflation rates, and economic performance. It's essential to understand these dynamics to grasp how shifts in exchange rates affect economies broadly.

Currency Depreciation

Currency depreciation is the opposite of currency appreciation. It takes place when a currency loses value compared to another currency. This means you receive less of a foreign currency for the same amount of national currency. For instance, if the rate changes from \(1 = £0.5\) to \(1 = £0.75\), the British pound has depreciated, as you now get fewer pounds per dollar.

• Decreased purchasing power: It means higher costs for imported goods and foreign travel.
• Beneficial for exports: Local products could become cheaper for foreign buyers, potentially boosting sales abroad.
• Effect on inflation: It may lead to higher inflation, as imported goods become more expensive, driving up domestic prices.

Understanding currency depreciation's impact on the economy is crucial for businesses and policymakers. It's all about balancing the positives for exporters with the downsides of increased import costs.

Foreign Exchange

Foreign exchange, often abbreviated as Forex or FX, is the global marketplace for trading national currencies against one another. This market is essential as it sets the exchange rates that dictate how much one currency is worth relative to another.

• 24-hour Market: Forex is open 24 hours a day, five days a week, allowing for continuous currency trading worldwide.
• Trading Volume: It is the largest and most liquid market in the world, with trillions of dollars exchanged daily.
• Pairs and Quotes: Currencies are traded in pairs, like USD/GBP. The first currency in the pair is the base currency, and the second is the quote currency.

Investors and traders analyze Forex to capitalize on fluctuations in exchange rates. Understanding the intricacies of the Forex market is key to making informed decisions regarding investments and global trades. Through Forex, businesses hedge against risks, individuals speculate to make profits, and central banks manage financial stability.