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An exchange rate fluctuation may not make much of a difference with a relatively small purchase like the gift paper. But for companies making multi-million dollar purchases overseas, even small fluctuations can have a big impact on purchasing power. To observe this, change the gift wrap scenario to assume the purchase is 200,000 yards of paper. The price is still 500 rupees per yard. At a dollar-to-rupee FX of 1:62 the paper is $8.08 per yard, for a total cost of $1,616,000. Assume a rate fluctuation to 1:57, and the per yard price rises to $9.27 which increases the total cost by $238,000. What if Gilda’s company were buying 500,000 yards? That would be some loss of purchasing power! What makes exchange rates fluctuate? Currency is a commodity and just like any other commodity, its price reflects how much demand there is for it. Many things can cause the demand for a currency to rise or fall, triggering a movement in the exchange rate : • economic news or events. • trade relations between the two countries. A week later, upon Gilda's return to her office, she contacted the paper maker to place the order and arrange for shipping. When she rechecked the price using an exchange program, Gilda got the shock of her life! The cost was way over her $8000 budget! Gilda immediately contacted the seller to find out what happened. The seller assured Gilda that the price of the paper did not change – it was still 500 per yard. What happened? Being financially literate, the Know It All reporter was able to solve this mystery. The FX (exchange rate) had changed causing Gilda’s dollars to lose purchasing power. Now Giftmore Giftwrap Company cannot afford to buy as much paper. Of course, had the dollar risen against the rupee, the paper would have cost less. SLIDE 5I PRODUCT PREVIEW • political instability (or improved stability) in one of the countries. • any perceived strength or weakness in a country’s economic condition. • interest rate changes which make investments in a country more (or less) attractive. Strong Currency = Strong Economy In the foreign exchange (FX) market, the terms weak and strong are used to describe the relative value and strength of currencies . A weak currency is relatively cheap to buy so you get more of it for less. If you’re in the unfortunate position of exchanging a weak currency for a stronger currency, yours has less muscle, less power. It takes more of it to buy the other country’s currency. In the gift wrap purchase scenario, it’s possible that the dollar weakened (fell in value) in reaction to some unfavorable economic news in the U.S., perhaps a negative Consumer Confidence Report , or a controversial monetary policy decision made by the Fed. On the other hand, it’s possible that the change in the exchange rate was the result of a rise in the value (strenghtening) of the rupee , possibly in reaction to some favorable economic news for India. As a financially literate person, you should understand that the value of a currency is often an indicator of the issuing country’s economic health . A currency whose value is consistently falling or has become
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THE 21st CENTURY STUDENT’S GUIDE TO FINANCIAL LITERACY
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