The Impact of Exchange Rate Changes (Cambridge International IGCSE Business)
Exchange rates defined
Spec point — "• Depreciation and appreciation of an exchange rate • How exchange rate changes can affect businesses as importers and exporters of products, e.g. prices, competitiveness, profitability (exchange rate calculations will not be assessed)"
Exchange rates defined
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An exchange rate is the price of one currency in terms of another, e.g. £1 = €1.18
- International currencies are essentially products that can be bought and sold on the foreign exchange market (forex)
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The Central Bank of a country controls the exchange rate system that is used in determining the value of a nation's currency
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Exchange rates are an important economic influence for businesses that import raw materials and components, and for businesses that export their products
Appreciation and depreciation of exchange rates
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The value of a currency changes over time
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When global demand for the currency rises, the currency appreciates
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Appreciation occurs when the value of a currency rises, e.g. £1 = €1.18 goes to £1 = €1.25
- Europeans buying goods from the UK now have to pay more in euros than they did previously
- This appreciation makes exports from the UK relatively more expensive and imports less expensive
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When global demand for the currency falls, the currency depreciates
- Depreciation occurs when the **value of a currency falls, **e.g. £1 = €1.18 goes to £1 = €1.05
- Europeans buying goods from the UK now pay less in euros than they did previously****
- This depreciation makes exports to Europe relatively more attractive and imports less attractive
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Changing currency values can have a big impact on the business costs and sales revenue of MNCs
How changes to exchange rates affect importers and exporters
- The extent to which businesses are affected by currency fluctuations will depend upon the volume they are importing or exporting and the countries with which these transactions take place
- Exporting businesses benefit from currency depreciation, whilst importing businesses benefit from currency appreciation
The impact on business of currency appreciation and depreciation
| Change to currency value | Impact on exporting businesses | Impact on importing businesses |
|---|---|---|
| Appreciation An increase in the value of a currency against others | - Sales are likely to fall as products become more expensive when compared to overseas competitors - In order to remain competitive, exporting businesses may need to lower prices and accept lower profit margins | - Costs are likely to fall as raw materials from overseas become cheaper |
| Depreciation A decrease in the value of a currency against others | - Sales are likely to rise as products become cheaper when compared to overseas competitors | - Costs are likely to rise as raw materials from overseas become more expensive - Businesses may seek domestic suppliers to reduce costs and maintain profit levels |
Exam Hint Many businesses are affected as both importers of raw materials and exporters of goods/services overseas. It would be unusual for UK-based exporters to wholeheartedly celebrate a weak pound or be entirely dismayed at a strong pound, as the global nature of business means that for many firms, both costs and revenues are affected by exchange rate movement.
To help you remember the effects of an appreciating currency, remember the acronym SPICED - Strong Pound Imports Cheaper Exports Dearer
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