Exchange Rate
Exchange Rate
December 2014
THE EXCHANGE RATE
KEY DEFINITIONS AND CONCEPTS
1. How is the exchange rate defined?
The exchange rate is the price of a unit of foreign currency in terms of the domestic currency. In the Philippines, for instance, the exchange rate is conventionally expressed as the value of one US dollar in peso equivalent.
For example, US$1 = P44.00.
In every exchange rate quotation, therefore, there are always two currencies involved.
2.
Why is the exchange rate important?
The exchange rate is important for several reasons:
It serves as the basic link between the local and the overseas market for various goods, services and financial assets. Using the exchange rate, we are able to compare prices of goods, services, and assets quoted in different currencies.
Exchange rate movements can affect actual inflation as well as expectations about future price movements. Changes in the exchange rate tend to directly affect domestic prices of imported goods and services. A stronger peso lowers the peso prices of imported goods as well as import-intensive services such as transport, thereby lowering the rate of inflation.For instance, an increase in the value of the peso from
US$1:P50 to US$1:P40 will lower the price of a $1 per liter gasoline from P50.00 (P50 X $1) to P40.00 (P40X $1).
•
Exchange rate movements can affect the country’s external sector through its impact on foreign trade. An appreciation of the peso, for instance, could lower the price competitiveness of our exports versus the products of those competitor countries whose currencies have not changed in value.
•
The exchange rate affects the cost of servicing (principal and interest payments) on the country’s foreign debt. A peso appreciation reduces the amount of pesos needed to buy foreign exchange to pay interest and maturing obligations.
3. How is the exchange rate determined?
Under the system of freely floating exchange rates, the value of the dollar in terms of the peso, like any
December 2014
THE EXCHANGE RATE
KEY DEFINITIONS AND CONCEPTS
1. How is the exchange rate defined?
The exchange rate is the price of a unit of foreign currency in terms of the domestic currency. In the Philippines, for instance, the exchange rate is conventionally expressed as the value of one US dollar in peso equivalent.
For example, US$1 = P44.00.
In every exchange rate quotation, therefore, there are always two currencies involved.
2.
Why is the exchange rate important?
The exchange rate is important for several reasons:
It serves as the basic link between the local and the overseas market for various goods, services and financial assets. Using the exchange rate, we are able to compare prices of goods, services, and assets quoted in different currencies.
Exchange rate movements can affect actual inflation as well as expectations about future price movements. Changes in the exchange rate tend to directly affect domestic prices of imported goods and services. A stronger peso lowers the peso prices of imported goods as well as import-intensive services such as transport, thereby lowering the rate of inflation.For instance, an increase in the value of the peso from
US$1:P50 to US$1:P40 will lower the price of a $1 per liter gasoline from P50.00 (P50 X $1) to P40.00 (P40X $1).
•
Exchange rate movements can affect the country’s external sector through its impact on foreign trade. An appreciation of the peso, for instance, could lower the price competitiveness of our exports versus the products of those competitor countries whose currencies have not changed in value.
•
The exchange rate affects the cost of servicing (principal and interest payments) on the country’s foreign debt. A peso appreciation reduces the amount of pesos needed to buy foreign exchange to pay interest and maturing obligations.
3. How is the exchange rate determined?
Under the system of freely floating exchange rates, the value of the dollar in terms of the peso, like any