It is not very difficult to calculate exchange rates, but it may seem quite complicated at the beginning.
The exchange rate is the price of one currency in terms of another currency. It measures the value of the domestic currency in terms of foreign currencies. It determines the rate at which one country’s currency can be exchanged for another country’s currency.
In general, the exchange rate is determined by the laws of demand and supply on the foreign exchange market called Forex (FX). You can check daily exchange rates at FXStreet.
Moreover, movements in the exchange rate will affect companies. And the impact of price changes of different currencies will depend on whether the business is an importer or an exporter. It is because exchange rates affect the levels of exports and imports, and determine their affordability.
Currency Appreciation
Impact of USD$1 appreciation from RMB6 to RMB10. The USD$ is now stronger, so we need more RMB to buy USD$1.
IMPORTER
The importer from the US places an order for RMB60,000 worth of raw materials from the Chinese supplier.
1. At the old exchange rate (USD$1 = RMB6), this would cost USD$10,000.
RMB60,000 / RMB6 = USD$10,000
2. At the new exchange rate (USD$1 = RMB10), this would cost USD$6,000.
RMB60,000 / RMB10 = USD$6,000
The importer’s costs have decreased because now he only needs USD$6,000 to purchase the same amount of raw materials still worth the same RMB60,000 in China. Currency appreciation makes the USD$ stronger, therefore the cost of importing raw materials will decrease which will increase profitability. Domestic businesses in the US which sell the same raw materials will see lower demand as the Chinese ones will be cheaper.
EXPORTER
The exporter from the US has a contract to supply USD$50,000 worth of finished goods to a Chinese customer.
1. At the old exchange rate (USD$1 = RMB6), this would be sold for RMB300,000.
USD$50,000 x RMB6 = RMB300,000
2. At the new exchange rate (USD$1 = RMB10), this would be sold for RMB500,000.
USD$50,000 x RMB10 = RMB500,000
The exporter’s products are now less competitive on the Chinese market. The exporter’s costs have increase because now his buyer needs RMB500,000 to purchase the same amount of finished goods still worth the same USD$50,000. Currency appreciation makes the USD$ stronger, therefore the cost of exporting raw materials will increase. Domestic businesses in the US which sell products abroad will see lower demand and lost sales as the same products available in China will now be cheaper.
Currency Depreciation
Impact of USD$1 depreciation from RMB10 to RMB6. The USD$ is now weaker, so we need less RMB to buy USD$1.
IMPORTER
The importer from the US places an order for RMB60,000 worth of raw materials from the Chinese supplier.
1. At the old exchange rate (USD$1 = RMB10), this would cost USD$6,000.
RMB60,000 / RMB10 = USD$6,000
2. At the new exchange rate (USD$1 = RMB6), this would cost USD$10,000.
RMB60,000 / RMB6 = USD$10,000
The importer’s costs have increased because now he needs USD$10,000 to purchase the same amount of raw materials still worth the same RMB60,000 in China. Currency depreciation makes the USD$ weaker, therefore the cost of importing raw materials will increase which will decrease profitability. Domestic businesses in the US which sell the same raw materials will see higher demand as the Chinese ones will be more expensive.
EXPORTER
The exporter from the US has a contract to supply USD$50,000 worth of finished goods to a Chinese customer.
1. At the old exchange rate (USD$1 = RMB10), this would be sold for RMB500,000.
USD$50,000 x RMB10 = RMB500,000
2. At the new exchange rate (USD$1 = RMB6), this would be sold for RMB300,000.
USD$50,000 x RMB6 = RMB300,000
The exporter’s products are now more competitive on the Chinese market. The exporter’s costs have decreased because now his buyer only needs RMB300,000 to purchase the same amount of finished goods still worth the same USD$50,000. Currency depreciation makes the USD$ weaker, therefore the cost of exporting raw materials will decrease. Domestic businesses in the US which sell products abroad will see higher demand and increased sales as the same products available in China will now be more expensive.
In summary, exchange rate stability can very often guarantee the success of international trade in the long-term perspective.
