1. An exchange rate is the price at which one currency can be exchanged for another (e.g. how many yen are needed to buy a euro). In theory, exchange rates should be at the level that gives purchasing power parity (PPP). This means that the cost of a given selection of goods and services (e.g. a loaf of bread, a kilowatt of electricity) would be the same in different countries. So if the price level in a country increases because of inflation, its currency’s exchange rate should go down in order to return to PPP. For example, if inflation increases in the US, the dollar exchange rate will go down, and it will take more dollars to buy the same products in other countries.
2. In fact, PPP does not work, as exchange rates can change due to currency speculation - buying currencies in the hope of making a profit. Financial institutions, companies and rich individuals all buy currencies, looking for high interest rates or short-term capital gains if a currency increases in value. This means exchange rates change due to speculation rather than PPP. Over 95% of the world's currency transactions are purely speculative, and not related to trade. Banks and currency traders make huge profits from the spread between a currency's buying and selling prices.
3. Since the early 1970s, there has been a system of floating exchange rates in most western countries. This means that exchange rates are determined by people buying and selling currencies in the foreign exchange markets. A freely floating exchange rate means one which is determined by market forces: the level of supply and demand. If there are more buyers of a currency than sellers, its price will rise; if there are more sellers, it will fall.
4. Governments and central hanks sometimes try to change the value of their currency. They intervene in exchange markets, using foreign currency reserves to buy their own currency - in order to raise its value - or selling to lower it. The resulting rates are known as managed floating exchange rates. But speculators generally have a lot more money than a government has in its reserves of foreign currency, so central banks or governments only have limited power to influence exchange rates.
Ex. 1 Decide whether the information is: True False Not stated
Purchasing power parity is a theory that doesn’t work in reality.
Ex. 2Decide whether the information is: True False Not stated
Inflation should lead to an increase in the value of a country’s currency.
Ex. 3 Decide whether the information is: True False Not stated
If more people want to buy a currency than sell it, its price will go down.
Ex. 4 Decide whether the information is: True False Not stated
Since the introduction of euro exchange rates among European countries are no longer a problem.
Ex. 5 In what paragraph (1, 2, 3, 4) is there the following information?
Currency traders offer different buying and selling prices.
Ex. 6 In what paragraph (1, 2, 3, 4) is there the following information?
Floating exchange rates are determined by supply and demand.
Ex. 7 Answer the following question: What does the spread between a currency’s buying and selling price allow?
· to return exchange rates to PPP.
· to make considerable profits.
· to determine supply and demand for a currency.
· to buy and sell currencies under the control of the Central Bank.
Ex. 8 What is the main idea of the text?
· PPP is an efficient instrument of monetary policy.
· Advantages and drawbacks of the exchange rate system.
· Currency is the best asset.
· Disadvantages of floating exchange rates.