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BUS138: INTERNATIONAL FINANCE
EXCHANGE RATE DETERMINATION
Factors that affect exchange rates! How is each of the factors (events) below expected to
affect exchange rates? Why?
Please answer the questions below and submit online via ILearn.

1. Increase in foreign imports and an increase in trade deficits
The dollar will depreciate. When a country has a trade deficit, its foreign exchange
reserves decrease, the international competitiveness of its commodities weakens, and the
country's foreign trade is at a disadvantage during this period. A large trade deficit will
aggravate the outflow of domestic resources and increase the external debt, so a large
amount of dollars is needed to repay the external foreign payments, so a large amount of
dollars will lead to the dollar's depreciation.

2. Increase in government budget deficits
When the government runs a budget deficit, most of it is accompanied by a high rate of
external borrowing, which reduces the domestic currency's purchasing power, meaning
that the exchange rate falls when it is converted into foreign currency.

3. Inflation
When inflation occurs, the purchasing power of money decreases. As a result, when the
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