Why People Buy and Sell Foreign Currencies — Exchange Rates | IGCSE Economics

Exam Frequency Analysis

Past paper frequency (2018 to 2024)

This topic accounts for approximately 11% of your exam marks.

increasing

Medium

Increasing11%

Exchange rate definitions, depreciation/appreciation effects on exports, imports, and inflation are increasingly examined since 2021.

Before looking at how the rate is set, it helps to know who is buying and selling currency, because every reason to buy one currency is a reason to sell another. The syllabus lists six main reasons.

Trade in goods and services. An importer must pay foreign firms in their currency, so it sells its own currency to buy theirs. Foreign buyers of a country's exports do the reverse, buying that country's currency to pay for the goods.
Investment in capital goods between countries. A firm building a factory abroad (foreign direct investment) needs the host country's currency to pay for land, machinery and labour.
Payment of profit, interest and dividends between countries. Profits earned by a firm operating abroad, and interest or dividends paid to foreign investors, have to be converted into the receiver's currency.
. Migrant workers send part of their wages home, converting the currency they earn into the currency of their family's country.
. Traders buy a currency they expect to rise and sell one they expect to fall, hoping to profit from the change in its value.
Government intervention in currency markets. A central bank may buy or sell its own currency to influence the exchange rate.

Exam tip

Identify reasons for buying or selling a foreign currency (2 marks)

What comes up: a 2-mark "Identify two reasons why a firm or individual may buy foreign currency."

Write (two marks): give any two distinct reasons, each stated clearly. Credited reasons include: to pay for imported goods or services (1); to invest in assets or build a business abroad (1); to pay profit, interest or dividends to people in another country (1); to send remittances to workers' families abroad (1); to speculate on a rise in the currency's value (1).

Watch out: "to make money" on its own is too vague; name the activity (importing, investing, speculating) that creates the need for the foreign currency.