Kenneth R. Szulczyk
other currency falls in value. Consequently, appreciation and depreciation are relative concepts
applied to one exchange rate. Trick is to examine the currency that has one unit. When you
know what happens to that currency, then you automatically know what has happened to the
other currency.
$1 = 2 euros ( 5 )Exchange rate can also move in the other direction. If the exchange rate changes to
Equation 6, subsequently, the U.S. dollar buys fewer euros. Thus, the U.S. dollar depreciated
while the euro appreciated.
$1 = 1 euro ( 6 )Financial analysts use the terms strong and weak to refer to a currency, which differs from
appreciation and depreciation. For instance, a weak U.S. dollar implies we compare the dollar to
a “basket” of currencies. Overall, the dollar fell in value relative to the currencies in the basket.
Basket of currencies includes other industrialized countries, such as Britain, Canada, Eurozone,
and Japan.
Fluctuating exchange rates leads to the exchange rate risk, which can financially harm
international banks, investors, and businessmen. Thus, they must analyze and examine the
trends in exchange rates, when accepting deposits and granting loans. For example, an
international bank accepts $1 million from depositors in the United States, and the bank lends to
a business in Russia for $1 million. Many countries enforce laws, where business activity must
be denominated in that country’s currency. Hence, the bank converts the U.S. dollars into
Russian rubles because businesses use the ruble in Russia. If the exchange rate equals $1 for 25
rubles, we compute the bank’s loan at 25 million rubles in Equation 7.
= millionrubles
$rubles
BankLoan=$ , 25
125
1,000 000 ( 7 )
What would happen if the exchange rate varies? Then the international bank could gain or
lose from the exchange rate movement. If the currency exchange rate changes to $1 for 50
rubles, subsequently, the U.S. dollar appreciated while the Russian ruble depreciated. When the
Russian business repays its 25 billion-ruble loan, we calculate the bank receives $0.5 million in
Equation 8. Therefore, the bank experienced a major loss.
500000
50
1
25000000 =$ ,
rubles$
BankLoan= , , rubles^ (^8 )^If the exchange rate changes to $1 equal 10 rubles, then the Russian ruble appreciated while
the U.S. depreciated. We compute the Russian business repays a total of $2.5 million dollars in
Equation 9. Consequently, the international bank benefits in this case.