What is Flexible or Floating
Exchange Rate
Year
2020
2021
2022
Exchange Rate
70
75
80
In this case, Exchange Rate is determined by forces of
Demand and Supply
Demand of
Foreign Exchange
Supply of
Foreign Exchange
More the Exchange Rate
Less the Foreign Exchange Demand (it is Inversely Proportional)
More the Exchange Rate
More the Foreign Exchange Supply
(it is Directly Proportional)
SUMMARY
Factors Affecting Exchange Rate under Flexible Rate System
Demand of Foreign Currency
Case
If Demand increases
If Demand Decreases
$ Rate
Increase
Decrease
Domestic Currency
Depreciation
Appreciation
Supply of Foreign Currency
Case
If Supply Increase
If Supply Decreases
$ Rate
Decrease
Increase
Domestic Currency
Appreciation
Depreciation
Income of Customer
Case
If Income Increases,
more
imports
If Income Decreases,
less imports
$ Rate
Increase
Decrease
Appreciation
If $ expected
to increase,
buy
If $ expected to decrease, sell
Increase
Decrease
Domestic
Depreciation
Appreciation
Interest Rate Differential
Case
If Interest
Rate in
country low, people sell
Bonds
If Interest
Rate in country high, people
buy bonds
$ Rate
Increase
Decrease
Domestic Currency
Depreciation
Appreciation
Purchasing Power Theory
As per this
Theory,
Same Product
cost same
in different countries in long run
$ Rate
Increases/
Decreases
(Adjusts)
Domestic Currency
Increases/
Decreases
(Adjusts)
CA Maninder Singh is a Chartered Accountant for the past 12 years and a teacher from the past 16 years. He teaches Science, Economics, Accounting and English at Teachoo
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