Introduction to Finance & Economics - Mar 2010

Discussion questions:

1) Why do countries have currencies with different values to each other?
 2) How does a nation gain and / or  lose when the value of their currency fluctuates?
3) How can  government  actions (central banks) affect the value of their currency and why do they do so?
4) How does a currency trader make and lose money?

1.  Sovereign nations have certain rights, one of which is usually to mint its own currency.  For many countries, currency originally was minted with a certain amount of gold or silver to back it up, meaning that the dollar represented an amount of gold in the national treasury.  In America, eventually there was a breakdown in the gold-standard.  The value of a dollar stopped representing a certain amount of gold, but was rather dependant upon the health of the national economy.  The better the economy, the more the dollar could buy.  National currencies are different from each other because they're no long based on the same, constantly valued commodity.  They're based on the economic status of the minting nation and is a good measure of how each nation's economy is faring relative to other countries'. 

2.  The nation whose currency drops in value relative to ther currencies loses a kind of credibility, a marketability.  It's a sign that their economy is doing less well, meaning there's a higher risk in losing money when dealing with that country.  Loans to that country would probably end up with higher interest rates and other nations would probably put more thought into investing into the "fallen" nation.  All of these things reverse when the value of a nation's currency rises.  There are more investers, loans are less of risk, the rising nation has more fluidity with its neighbors. 

3.  National governments control the minting of the currency.  The more of any one kind of currency, the lower the value of any individual sample of that currency.  This is inflation.  The more money printed/minted, the less value the money has on an individual basis.  In America, central, government banks can designate what kind of percentage banks are supposed to have in reserve of any money that's saved with them.  Meaning the higher percentage, the more of anyone's particular savings they actually have to have available.  The lower the rate, the less of a person's savings they actually need to have access to at any one time.  This can control how much money can actually be on the market at once, creating a kind of interactive inflation. 

4.  A currency trader, if keeping an eye on the values of currencies relative to each other, such as the Euro and the American Dollar, can buy an amount of Euros with a starting amount of dollars.  Then, if the Euro increases in value relative to the dollar, the trader can then exchange his euros back for dollars, resulting in more dollars.  Then, if they market continues to favor the trader and the Euro then depreciates relative to the dollar, he can then spend his dollars by exhanging them back for Euros, with more dollars than he had at the beginning and potentially more Euros than he had the first time he bought some.  And so the pattern continues, the trader able to make money by playing depreciating currencies against each other.  The risk comes when a currency depreciates when he wanted it to appreciate, or the other way around.  When the market does the opposite of what would let him run a profit, the trader loses money.