An exchange rate is the price of one currency expressed in terms of another currency. The exchange rate determines how much of one currency has to be given up in order to buy a specific amount of another currency.

Ways that exchange rates can impact business activity

  • Price of exports in international markets
  • Cost of goods bought from overseas
  • Revenues and profits earned overseas
  • Converting cash receipts from customers overseas


Strong Pound Imports Cheaper Exports Dearer

What might cause an increase in the exchange rate?

  • Increasing demand for exports results in higher demand for currency
  • Lower demand for imports results in lower demand for currency
  • Speculation - traders may bet that the exchange rate will rise
  • An increase in interest rates - making it more attractive to hold the currency
  • Foreign direct investment into the country leads to higher demand fro currency

Practice exercise 4

What is an exchange rate?

  • The amount of one currency that can be purchased for another currency.

Explain how free exchange rates are determined.

  • If the demand for payments in one currency increases, then the value of that currency would increase, whilst the opposite is also true.

State and explain three reasons why a currency might increase in value

  • Higher demand for exports
    • If one country has highly desired export demands then their currency is likely to increase in value
  • Trader speculation
    • If traders believe that the value will increase, then they will buy the currency up and that will lead to an increase in value
  • Foreign investment
    • Foreign investments into the country leads to greater demand

Select one of the following statements to complete the sentence…

  • If the value of the pound against the dollar rises, then prices of exports to America rise and prices of imports from America fall.
  • if the value of the pound against the dollar falls, then prices of export to America fall and prices of imports from America rise.

When the exchange rate rises

How might a firm ensure that its prices abroad do not rise?
  • They could use local suppliers as much as possible, reducing the impact as much as they can on tariffs and exchange rate fluctuations.
Why might a firm not always choose to take the above action?
  • It might not be viable for a firm to get a certain material locally, as it may either be much cheaper to import from an external supplier or it may be a natural resource that can only be extracted in certain regions, outside of the country.