Question

1. What is the difference between devaluation and depreciation of a currency?

2. What are the main types of currency risk? Describe the three types of exposure.

3. Describe the main factors that affect the supply and demand for a currency.

Answer 1

• Devaluation occurs when country lowers their exchange rate in fixed exchange rate regime where a currency of a country have a fixed exchange rate against other currency. Depreciation occurs in a floating exchange rate system where exchange rate between two countries changes as per economic conditions. Depreciation is the fall in value of currency against other currency.
• Main types of currency risk are:

1) Transaction: It occurs when the currency appreciates of selling country rises against buying country. It makes buying country liable to pay more more for that good.

2) Translation: It occurs when a company have atleast two offices across the world and the currency of one of the operations country falls against the other currency in which all transactions are made.

3) Economic risk: It occurs when valuation of countries changes due to change fluctuations in currency.

• Factors affecting demand and supply of currency:

1) Rate of return: Demand of currency with high rate of return in their investment projects is high.

2) Inflation rate: Country with a lower inflation rate would have high demand for money.

3) Economics Conditions: If country's budget is running under surplus and economy is not suffering from recession, demand for that currency would be high.