6.2 Foreign exchange rates  (Page 4/4)

Think about a time where lots of South Africans are visiting the United Kingdom, and other South Africans are importing goods from the United Kingdom. That means there are lots of Rands (high supply) trying to buy Pounds. Pounds will start to become more expensive (compare this to the house price example at the start of this section if you are not convinced), and the exchange rate will change. In other words, for R1 000 you will get fewer Pounds than you would have before the exchange rate moved.

Another context which might be useful for you to understand this: consider what would happen if people in other countries felt that South Africa was becoming a great place to live, and that more people were wanting to invest in South Africa - whether in properties, businesses - or just buying more goods from South Africa. There would be a greater demand for Rands - and the “price of the Rand" would go up. In other words, people would need to use more Dollars, or Pounds, or Euros ... to buy the same amount of Rands. This is seen as a movement in exchange rates.

Although it really does come down to supply and demand, it is interesting to think about what factors might affect the supply (people wanting to “sell" a particular currency) and the demand (people trying to “buy" another currency). This is covered in detail in the study of Economics, but let us look at some of the basic issues here.

There are various factors which affect exchange rates, some of which have more economic rationale than others:

• economic factors (such as inflation figures, interest rates, trade deficit information, monetary policy and fiscal policy)
• political factors (such as uncertain political environment, or political unrest)
• market sentiments and market behaviour (for example if foreign exchange markets perceived a currency to be overvalued and starting selling the currency, this would cause the currency to fall in value - a self-fulfilling expectation).

The exchange rate also influences the price we pay for certain goods. All countries import certain goods and export other goods. For example, South Africa has a lot of minerals (gold, platinum, etc.) that the rest of the world wants. So South Africa exports these minerals to the world for a certain price. The exchange rate at the time of export influences how much we can get for the minerals. In the same way, any goods that are imported are also influenced by the exchange rate. The price of petrol is a good example of something that is affected by the exchange rate.

Foreign exchange

1. I want to buy an IPOD that costs £100, with the exchange rate currently at $\pounds 1=R14$ . I believe the exchange rate will reach $R12$ in a month.
   1. How much will the MP3 player cost in Rands, if I buy it now?
   2. How much will I save if the exchange rate drops to $R12$ ?
   3. How much will I lose if the exchange rate moves to $R15$ ?
2. Study the following exchange rate table:

   Country	Currency	Exchange Rate
   United Kingdom (UK)	Pounds(£)	$R14,13$
   United States (USA)	Dollars ($)	$R7,04$

   1. In South Africa the cost of a new Honda Civic is $R173400$ . In England the same vehicle costs $\pounds 12200$ and in the USA $ $21900$ . In which country is the car the cheapest when you compare the prices converted to South African Rand ?
   2. Sollie and Arinda are waiters in a South African restaurant attracting many tourists from abroad. Sollie gets a $\pounds 6$ tip from a tourist and Arinda gets $ 12. How many South African Rand did each one get ?

Summary

• There are two types of interest: simple and compound.
• The following table summarises the key definitions that are used in both simple and compound interest.

  $P$	Principal (the amount of money at the starting point of the calculation)
  $A$	Closing balance (the amount of money at the ending point of the calculation)
  $i$	interest rate, normally the effective rate per annum
  $n$	period for which the investment is made

• For simple interest we use:
  $$\mathrm{A}=P(1+i·n)$$
• For compound interest we use:
  $$\mathrm{A}=P{(1+i)}^n$$
• The formulae for simple and compound interest can be applied to many everyday problems.
• A foreign exchange rate is the price of one currency in terms of another.

The following three videos provide a summary of how to calculate interest. Take note that although the examples are done using dollars, we can use the fact that dollars are a decimal currency and so are interchangeable (ignoring the exchange rate) with rands. This is what is done in the subtitles.

Note in this video that at the very end the rule of 72 is mentioned. You will not be using this rule, but will rather be using trial and error to solve the problem posed.

End of chapter exercises

1. You are going on holiday to Europe. Your hotel will cost 200 euros per night. How much will you need in Rands to cover your hotel bill, if the exchange rate is 1 euro = R9,20?
   
2. Calculate how much you will earn if you invested R500 for 1 year at the following interest rates:
   1. 6,85% simple interest.
   2. 4,00% compound interest.
3. Bianca has R1 450 to invest for 3 years. Bank A offers a savings account which pays simple interest at a rate of 11% per annum, whereas Bank B offers a savings account paying compound interest at a rate of 10,5% per annum. Which account would leave Bianca with the highest accumulated balance at the end of the 3 year period?
   
4. How much simple interest is payable on a loan of R2 000 for a year, if the interest rate is 10%?
   
5. How much compound interest is payable on a loan of R2 000 for a year, if the interest rate is 10%?
   
6. Discuss:
   1. Which type of interest would you like to use if you are the borrower?
   2. Which type of interest would you like to use if you were the banker?
7. Calculate the compound interest for the following problems.
   1. A R2 000 loan for 2 years at 5%.
   2. A R1 500 investment for 3 years at 6%.
   3. An R800 loan for l year at 16%.
8. If the exchange rate for 100 Yen = R 6,2287 and 1 Australian Doller (AUD) = R 5,1094 , determine the exchange rate between the Australian Dollar and the Japanese Yen.
   
9. Bonnie bought a stove for R 3 750. After 3 years she had finished paying for it and the R 956,25 interest that was charged for hire-purchase. Determine the rate of simple interest that was charged.