Introduction to Finance & Economics - Mar 2010

Yipes, I feel a little out of my depth. Here goes:

1) Why do countries have currencies with different values to each other?

* Currency acts as a formally accepted measure of value, as currency moved away from shards of pottery and local currency to a centralised policy, as monarchies grabbed control of their currencies, these localised systems created financial islands with area's taking control of their own local economies. [1] As the world expanded and further exchange with remote countries was required, a translation layer was needed in order to exchange in equal worth. Initially this was based on a gold standard, which eventually fell away over time, so now currencies are measured against relative to each other, rather than relative worth to a fixed benchmark.

[1] Life Inc. - Douglas Rushkoff
2) How does a nation gain and / or lose when the value of their currency fluctuates?

Currency fluctuations effect a nation two-fold: By affected the relative worth of products or services offered by foreign suppliers, and effect the rate at which they borrow at.

3) How can government actions (central banks) affect the value of their currency and why do they do so?

Central banks can increase or decrease the amount of money in a system by releasing, or suppressing the release of the amount of money in the system. Creating scarcity as appropriate.

4) How does a currency trader make and lose money?

Currency traders trade on the potential increase or decrease of values around currencies on the forex market. Betting on information that the have gathered to establish a currencies worth to be more or less in the present than it will be in the future.

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.

I hope this makes sense:

1) Why do countries have currencies with different values to each other?
The currency for individual countries is dependant not only on interest rates, economic health, foreign trade, governmental factors, but most importantly on speculation. Each of the afordmentioned currency dependancies are intertwined by both the local(national) and foreign (international) stance of the Nation at hand. While most countries have some type of material backing to their currency and this actual physical amount/value may fluctuate, the real strength of a national currency is on the perception of the country's stability as determined by the different influences previously mentioned. For instance, a nation at war might be more unstable than one which is devoting their assets to the internal development due to the large amount of capital which must be invested in military and other war related expenses.

External Source:
Lowery, adrian. thisismoney"What makes currencies strong or weak?" http://www.thisismoney.co.uk/markets/article.html?in_article_id=429456&i...

2) How does a nation gain and / or lose when the value of their currency fluctuates?
When a nation's currency gains or looses value, this nation is directly affected in its ability to liquify its assets and to borrow from other nations. As the value of a nation's currency depreciates, this nation's purchasing power is deterred. Not only is the purchasing power lowered, but lenders will be less likely to want to grant loans since lower currency value is associated with more instability. For this very reason their interest rates will increase in an effort to guarantee returns in their investment.

3) How can government actions (central banks) affect the value of their currency and why do they do so?
Central banks can affect the value of their currency through the control they hold on the interest rates, policy, gold/raw reserves, and general regulation. Since they generally are incharge of the release of money into the market and controlling the interest rates, they have a strong influence on the economic stability of a nation.

External Source:
http://en.wikipedia.org/wiki/Central_bank

4) How does a currency trader make and lose money?.
Similar to a stock trader, a currency trader uses "knowledge" of diferent stabilities in an effort to make a profit. By using predictive ideals of how a market will react to different global or national circumstances, a money trader will take educated gambles by purchasing more of a certain currency and/or selling of others.

I would like to know how widely practiced is the backing of currency through the use of raw materials, and how central banks determine their investment in these.

1.A "Country" can be defined as an geographical region that has, over a period of time, come to share some sort of social cohesion, and along with it, a mechanism for commerce, with an accepted representation of value, i.e., a currency.Prior to modern international trade, these local currencies would have sufficed;however, in today's globalized economy there is a need for rapid exchange of money between businesses from different countries.Since money is required for both intra nation and inter nation trade, we need multiple currencies with values depending on the economies they represent.

2.Currency Appreciation:
Advantages:
(a)Importing goods becomes cheaper, benefitting consumers.
(b)Increased inflow of foreign currency leading to better foreign reserves.
Disadvantages:
(a)Exported goods are more expensive in foreign markets, leading to increased competition.

Currency Depreciation
Advantages:
(a)Exported goods are cheaper in foreign markets.
Disadvantages:
(a)Imported goods are more expensive.
(b)Foreign reserves are depleted.

apart from this, rise and fall in a currency's value also effects foreign investments in an economy.
extrapolated from: http://www.rediff.com/money/2004/mar/31perfin.htm

3.Central Banks can cause the value of their currency to appreciate or depreciate by varying the amount of money available to the public, and by participating on the international currency markets.
For example, China is widely reckoned to undervalue the yuan, in order to make it more attractive to outsource manufacturing activities to China, and also give Chinese imports an unfair price advantage.

http://articles.sfgate.com/2009-02-15/opinion/17187932_1_us-china-trade-...
http://articles.sfgate.com/2009-02-15/opinion/17187721_1_china-s-central...

4.A currency trader makes or loses money based on the positions he takes regarding various currencies.He buys a currency that he expects will appreciate, and sells currencies that he thinks will depreciate.

1) Why countries have currencies with different value to each other?
With the Breeton-Woods summit the gold standard for the value of currencies was removed. After that the value of currencies was determined by economic performance with main indicator GNP or the turnover of goods and services. Since different countries have different economic performance hence and different value of the currency.

2) How does a nation gains and/or lose when the value of their currency fluctuates?
Depreciated currency means that the nation gains from cheaper exports but the inflation rises and imports are expensive.
Overvalued currency means expensive export but also means that the currency is more often used in transactions other than with nation.

3) How can government actions (central banks) affect the value of their currency and why do they do so?
Central Banks can affect the value of the currency with a reserve of stable currencies (don't know its name in English) With intervention by the currency reserve by buying or selling domestic currency its value is changed. Also political decisions can affect the value of a currency. They can boost or decline foreign investment hence the dealings with the currency increase or decrease.

4) How does a currency trader make and lose money?
Currency trader makes money by exploiting fluctuations of the comparative value between two currencies.

In reply to Dennis Riedel question:

I think that maybe doesn´t have a lot of sense in the fixed case, but depends of his reserves and the offer/demand of the “principal” currency and the socioeconomic ambient of the country that decide to adopt that rate exchange.

I found a “curious” case: the Cuban peso.

http://en.wikipedia.org/wiki/Cuban_peso

I think that the Forex market concentrates mainly “top” currencies by the volume that they represent in the international commerce transactions and the policies of their respective countries. In the past they obeyed to international agreements.

http://www.economist.com/research/Economics/alphabetic.cfm?term=exchange...

Some examples of the situations and consequences of the fixed case:

http://en.wikipedia.org/wiki/Currency_board

In reply to Dennis Riedel question:

I think that maybe doesn´t have a lot of sense in the fixed case, but depends of his reserves and the offer/demand of the “principal” currency and the socioeconomic ambient of the country that decide to adopt that rate exchange.

I found a “curious” case: the Cuban peso.
http://en.wikipedia.org/wiki/Cuban_peso

I think that the Forex market concentrates mainly “top” currencies by the volume that they represent in the international commerce transactions and the policies of their respective countries. In the past they obeyed to international agreements.

http://www.economist.com/research/Economics/alphabetic.cfm?term=exchange...

Some examples of the situations and consequences of the fixed case:
http://en.wikipedia.org/wiki/Currency_board